M ONEY AND B ANKING Chapter 10

M ONEY Money is anything that serves as a medium of exchange, unit of account or store of value Medium of exchange- determines value during exchange of goods and services Without money goods and services acquired through barter As economy becomes more specialized bartering becomes too difficult and time consuming Money as a unit of account- provides means of comparing value of goods and services (dollars, Euros, rubles, pesos) Money as a store of value- keeps value if you decide not to spend it, always recognized as a medium of exchange Exception is when there is inflation, does not work well as a store of value

S IX C HARACTERISTICS OF M ONEY Currency - coins and paper bills used as money Various objects through human history used as money Six Characteristics 1. Durability - must withstand wear and tear 2. Portability - needs to be easily carried 3. Divisibility - easily divided into smaller units, needs various denominations 4. Uniformity - needs to be the same in terms of what it will buy, be able to count and measure accurately 5. Limited Supply- too much in circulation, it looses value 6. Acceptability - must be able to be exchanged for goods and services

S OURCES OF M ONEY ’ S V ALUE Commodity Money- objects that have value in and of themselves (salt, cattle, precious stones) and have other uses as well Not portable, durable or divisible Only works in simple economies Representative Money- objects with value because they can be exchanged for something else Paper receipts that could be exchanged for gold or silver were an early form of money Fiat Money- money valuable because government said it can be redeemed for debt Has value and is limited in supply

A MERICAN B ANKING Early banks in US were unstable, money was unreliable Banks were independent, many worried that government would own banks (American tradition of distrust of central government) Late 1800’s gold standard gave money value It was in limited supply and paper money could be redeemed for it at any time Panic 1907 occurred because not enough gold to back currency in circulation, showed economy needed central banking system to avoid system in the future

F EDERAL R ESERVE S YSTEM 1913 Federal Reserve Act passed A. Federal Reserve System served as nations first central bank and reorganized banking system B. Created regional banks that store cash reserves for member banks C. Regional feds loan money to member banks to prevent bank panics D. Created national currency and allowed Federal Reserve to regulate money supply E. Federal Reserve Board supervises all banks in the US Unable to prevent Great Depression (kept money supply too low to prevent inflation) 1933 banking reform passed during the New Deal Glass Stegall Act separated banking and finance industries, regulated interest rates Established Federal Deposit Insurance Corporation that covered losses if banks fail up to a certain amount ($200,000 today)

B ANKING IN THE L ATER 20 TH C ENTURY Banks closely regulated from 1930’s-1960’s restrictions on interest rates and loans to customers Late 1970’s and early 80’s banks became deregulated Contributed to Savings and Loan (S&Ls) crisis in the late 1980’s S&Ls unprepared to deal with lack of regulation 1980’s interest rates went up and S&Ls had too many low interest loans Made risky loans Many made bad loans to failed businesses 1999 Glass-Stegall Act repealed it allowed banks to buy and sell stocks and bonds and established new privacy rules for banks

B ANKING T ODAY Money supply- all the money in the US economy Divided into several categories, two main categories M1, M2 M1- represents money people have easy access to A. Consists of assets that have liquidity (assets that can be directly converted into cash) B. 48% is held by people outside of bank vaults C. Money in checking accounts is M1 money M2 - all assets in M1 and additional assets Additional funds called near money (deposits in savings accounts, money market mutual funds)

F UNCTIONS OF F INANCIAL I NSTITUTIONS Banks and financial institutions essential to managing money supply, largest source income from interest received from loans A. Storing Money- provide safe place to store money B. Saving money- savings accounts, checking accounts, money market accounts, certificates of deposit Money market accounts and CDs pay higher rate of interest than other accounts A. Loans - banks make profit lending deposits to borrowers and charging interest Fractional reserve banking (keeps a fraction of funds on hand and lends rest out) banks today operate under this principle

F UNCTIONS OF F INANCIAL I NSTITUTIONS Loans - more money banks lend out more money they make Failure to payback loan called default and bank loses money E. Mortgage - specific type of loan used to buy real estate  Terms of loan years E. Credit cards- entitles holders to but goods and services based on promise to pay for them Simple and Compound Interest- interest is price paid for borrowed money Simple interest paid only on principal Compound interest paid on principal and accumulated interest

T YPES OF F INANCIAL I NSTITUTIONS AND E LECTRONIC B ANKING Commercial banks - provide wide variety of services from checking and savings accounts to loans Most are regulated by the federal government One third are part of the federal reserve system Savings and loan associa tions- originally chartered to provide funds to members for home loans Credit Unions- cooperative lending associations for employees of a specific group Finance companies- make installment loans to customers, usually for people with poor credit, interest rates are high Electronic Banking Use of computers has increased dramatically in banking since 1970’s ATMs, debit cards, internet banking, automatic clearing houses (automatic draft from bank accounts to pay bills), stored value cards (gift cards)