CONTEMPORARY ECONOMICS© Thomson South-Western LESSON 16.1 SLIDE 1 Money and Banking Origins of Money 16.2Origins of Banking and the Federal Reserve System 16.3Money, Near Money, and Credit Cards

CONTEMPORARY ECONOMICS© Thomson South-Western MONETA – Roman Goddess in whose temples coins were minted SLIDE 2

CONTEMPORARY ECONOMICS© Thomson South-Western LESSON 16.1 SLIDE 3 Three Functions of Money 1) Medium of exchange 1) Medium of exchange Medium of exchange—anything generally accepted by all parties in payment for goods or services Medium of exchange—anything generally accepted by all parties in payment for goods or services Commodity money—anything that serves both as money and as a commodity, such as gold, cattle, or salt Commodity money—anything that serves both as money and as a commodity, such as gold, cattle, or salt 2) Unit of account – standard on which to base prices 2) Unit of account – standard on which to base prices 3) Store of value – ability to retain purchasing power over time 3) Store of value – ability to retain purchasing power over time

CONTEMPORARY ECONOMICS© Thomson South-Western 15.1 The Evolution of Fiscal Policy SLIDE 4

CONTEMPORARY ECONOMICS© Thomson South-Western The Power to Coin Coinage determined both the amount and quality of the metal Coinage determined both the amount and quality of the metal Power originally vested in a feudal lord (seignior) Power originally vested in a feudal lord (seignior) If the exchange value exceeded the cost of making it, minting coins became a source of revenue If the exchange value exceeded the cost of making it, minting coins became a source of revenue Token Money – money whose exchange value exceeds its cost of production Token Money – money whose exchange value exceeds its cost of production Quarter costs 5¢ to make Quarter costs 5¢ to make Federal govt. nets $500 million each year in seigniorage Federal govt. nets $500 million each year in seigniorage Paper money is the greatest source Paper money is the greatest source 15.1 The Evolution of Fiscal Policy SLIDE 5

CONTEMPORARY ECONOMICS© Thomson South-Western 15.1 The Evolution of Fiscal Policy SLIDE 6 Seigniorage

CONTEMPORARY ECONOMICS© Thomson South-Western 16.2 Origins of Banking and the Federal Reserve System SLIDE 7 The Earliest Banks Keeping money, such as gold coins, on deposit with a goldsmith was safer than carrying it around or leaving it at home. Keeping money, such as gold coins, on deposit with a goldsmith was safer than carrying it around or leaving it at home. Still, visiting the goldsmith every time one needed money was a nuisance. Still, visiting the goldsmith every time one needed money was a nuisance.

CONTEMPORARY ECONOMICS© Thomson South-Western 16.2 Origins of Banking and the Federal Reserve System SLIDE 8 Bank Checks Notes instructing the goldsmith to pay someone were the first bank checks. Notes instructing the goldsmith to pay someone were the first bank checks. A check is a written order for the bank to pay money from amounts deposited. A check is a written order for the bank to pay money from amounts deposited.

CONTEMPORARY ECONOMICS© Thomson South-Western 16.2 Origins of Banking and the Federal Reserve System SLIDE 9 Fractional Reserve Banking System In a fractional reserve banking system only a portion of bank deposits is backed by reserves. In a fractional reserve banking system only a portion of bank deposits is backed by reserves. The reserve ratio measures bank reserves as a share of deposits. The reserve ratio measures bank reserves as a share of deposits.

CONTEMPORARY ECONOMICS© Thomson South-Western 16.2 Origins of Banking and the Federal Reserve System SLIDE 10 Bank Notes and Representative Money Bank notes were pieces of paper promising the bearer a specific amount of gold or silver when the notes were redeemed at the issuing bank. Bank notes were pieces of paper promising the bearer a specific amount of gold or silver when the notes were redeemed at the issuing bank. A bank note was “as good as gold.” A bank note was “as good as gold.” Bank notes that exchanged for a specific commodity, such as gold, were called representative money. Bank notes that exchanged for a specific commodity, such as gold, were called representative money.

CONTEMPORARY ECONOMICS© Thomson South-Western Fiat Money US Currency is fiat money US Currency is fiat money Money of no value in itself and not convertible into gold, silver, or anything else of value Money of no value in itself and not convertible into gold, silver, or anything else of value Fiat money is money because the government says it is Fiat money is money because the government says it is 15.1 The Evolution of Fiscal Policy SLIDE 11

CONTEMPORARY ECONOMICS© Thomson South-Western 15.1 The Evolution of Fiscal Policy SLIDE 12

CONTEMPORARY ECONOMICS© Thomson South-Western 16.2 Origins of Banking and the Federal Reserve System SLIDE 13 Depository Institutions Commercial banks Commercial banks Thrifts Thrifts Savings and loan associations Savings and loan associations Mutual savings banks Mutual savings banks Credit unions Credit unions Dual banking system Dual banking system State banks State banks National banks National banks

CONTEMPORARY ECONOMICS© Thomson South-Western The Federal Reserve (The Fed) 15.1 The Evolution of Fiscal Policy SLIDE 14

CONTEMPORARY ECONOMICS© Thomson South-Western 16.2 Origins of Banking and the Federal Reserve System SLIDE 15 The Federal Reserve System Birth of the Federal Reserve System Birth of the Federal Reserve System Established in 1913 Established in 1913 Federal Reserve System (the Fed)—the central bank and monetary authority of the United States Federal Reserve System (the Fed)—the central bank and monetary authority of the United States Powers of the Federal Reserve System Powers of the Federal Reserve System Reserves Reserves Discount rate—interest rate the Fed charges banks that borrow reserves Discount rate—interest rate the Fed charges banks that borrow reserves The Fed creates money by having banks accept deposits and lending them out The Fed creates money by having banks accept deposits and lending them out

CONTEMPORARY ECONOMICS© Thomson South-Western 15.1 The Evolution of Fiscal Policy SLIDE 16

CONTEMPORARY ECONOMICS© Thomson South-Western 16.2 Origins of Banking and the Federal Reserve System SLIDE 17 Organizational Chart for the Federal Reserve System Figure 16.2

CONTEMPORARY ECONOMICS© Thomson South-Western 16.2 Origins of Banking and the Federal Reserve System SLIDE 18 The Twelve Federal Reserve Districts Figure 16.1

CONTEMPORARY ECONOMICS© Thomson South-Western 15.1 The Evolution of Fiscal Policy SLIDE 19

CONTEMPORARY ECONOMICS© Thomson South-Western The US Treasury and the Fed US Treasury US Treasury Prints the “Federal Reserve Notes” Prints the “Federal Reserve Notes” The Fed The Fed Has the responsibility for putting the notes into circulation Has the responsibility for putting the notes into circulation 15.1 The Evolution of Fiscal Policy SLIDE 20

CONTEMPORARY ECONOMICS© Thomson South-Western Monetary Policy The Fed is responsible for setting and carrying out the nation’s monetary policy The Fed is responsible for setting and carrying out the nation’s monetary policy Monetary Policy: the regulation of the economy’s money supply and interest rates to promote full employment, price stability, and economic growth Monetary Policy: the regulation of the economy’s money supply and interest rates to promote full employment, price stability, and economic growth

CONTEMPORARY ECONOMICS© Thomson South-Western Federal Open Market Committee (FOMC) Twelve-member group that makes decisions regarding the most important tool of monetary policy – open market operations Twelve-member group that makes decisions regarding the most important tool of monetary policy – open market operations Open-market operations—buying or selling U.S. government securities as a way of regulating the money supply and interest rates Open-market operations—buying or selling U.S. government securities as a way of regulating the money supply and interest rates 15.1 The Evolution of Fiscal Policy SLIDE 22

CONTEMPORARY ECONOMICS© Thomson South-Western 15.1 The Evolution of Fiscal Policy SLIDE 23

CONTEMPORARY ECONOMICS© Thomson South-Western 16.3 Money, Near Money, and Credit Cards SLIDE 24 Narrow Definition of Money: M1 Money aggregates are various measures of the money supply. Money aggregates are various measures of the money supply. The narrow definition, called M1, consists of currency (including coins) held by the nonbanking public, checkable deposits, and traveler’s checks. The narrow definition, called M1, consists of currency (including coins) held by the nonbanking public, checkable deposits, and traveler’s checks.

CONTEMPORARY ECONOMICS© Thomson South-Western 16.3 Money, Near Money, and Credit Cards SLIDE 25 Currency in Circulation Dollar bills and coins in circulation are part of the money supply as narrowly defined. Dollar bills and coins in circulation are part of the money supply as narrowly defined. Money in bank vaults or on deposit at the Fed is not in circulation as a medium of exchange and so is not counted in the money supply. Money in bank vaults or on deposit at the Fed is not in circulation as a medium of exchange and so is not counted in the money supply. Currency makes up about half of M1. Currency makes up about half of M1.

CONTEMPORARY ECONOMICS© Thomson South-Western 16.3 Money, Near Money, and Credit Cards SLIDE 26 U.S. Currency Abroad More than half of all Federal Reserve notes, particularly $100 notes, are in foreign hands. More than half of all Federal Reserve notes, particularly $100 notes, are in foreign hands. Wealthy people around the world, especially in unstable countries or countries that have experienced high inflation, often hoard U.S. currency as insurance against hard times. Wealthy people around the world, especially in unstable countries or countries that have experienced high inflation, often hoard U.S. currency as insurance against hard times. Some countries, such as Panama, Ecuador, and El Salvador, even use U.S. dollars as their own currency, a process called dollarization. Some countries, such as Panama, Ecuador, and El Salvador, even use U.S. dollars as their own currency, a process called dollarization.

CONTEMPORARY ECONOMICS© Thomson South-Western 16.3 Money, Near Money, and Credit Cards SLIDE 27 Counterfeiting Improvements in copy machines, computers, and printers allow even amateurs to make passable counterfeits of U.S. currency. Improvements in copy machines, computers, and printers allow even amateurs to make passable counterfeits of U.S. currency. U.S. currency is being redesigned to make it harder to copy. U.S. currency is being redesigned to make it harder to copy. The Fed and the Treasury have announced plans to redesign the currency every 7 to 10 years. The Fed and the Treasury have announced plans to redesign the currency every 7 to 10 years.

CONTEMPORARY ECONOMICS© Thomson South-Western 16.3 Money, Near Money, and Credit Cards SLIDE 28 Checkable Deposits Checkable deposits—deposits in financial institutions against which checks can be written and ATM, or debit, cards can be applied Checkable deposits—deposits in financial institutions against which checks can be written and ATM, or debit, cards can be applied About half of checkable deposits are demand deposits. About half of checkable deposits are demand deposits. In recent years, banks have developed other types of checking accounts, In recent years, banks have developed other types of checking accounts, Checkable deposits of all types make up nearly half of M1. Checkable deposits of all types make up nearly half of M1.

CONTEMPORARY ECONOMICS© Thomson South-Western 16.3 Money, Near Money, and Credit Cards SLIDE 29 Broader Definitions of Money: M2 M2—A broader definition of the money supply, consisting of M1 plus savings deposits, small-denomination time deposits, and money market mutual fund accounts owned by households M2—A broader definition of the money supply, consisting of M1 plus savings deposits, small-denomination time deposits, and money market mutual fund accounts owned by households

CONTEMPORARY ECONOMICS© Thomson South-Western 16.3 Money, Near Money, and Credit Cards SLIDE 30 Savings Deposits Savings deposits earn interest but have no specific maturity date. Savings deposits earn interest but have no specific maturity date. This means that you can withdraw them any time without a penalty. This means that you can withdraw them any time without a penalty.

CONTEMPORARY ECONOMICS© Thomson South-Western 16.3 Money, Near Money, and Credit Cards SLIDE 31 Time Deposits Time deposits earn a fixed rate of interest if held for a specified period. Time deposits earn a fixed rate of interest if held for a specified period. The holding period ranges from several months to several years. The holding period ranges from several months to several years. Holders of time deposits are issued certificates of deposit, or CDs for short. Holders of time deposits are issued certificates of deposit, or CDs for short. Early withdrawals are penalized by forfeiture of several months’ interest. Early withdrawals are penalized by forfeiture of several months’ interest.

CONTEMPORARY ECONOMICS© Thomson South-Western 16.3 Money, Near Money, and Credit Cards SLIDE 32 Debit Cards but Not Credit Cards A credit card itself is not money. A credit card itself is not money. Using a credit card is a convenient way of obtaining a short-term loan from the card issuer. Using a credit card is a convenient way of obtaining a short-term loan from the card issuer. You don’t use money until you pay your credit card bill. You don’t use money until you pay your credit card bill. The credit card has not eliminated your use of money. The credit card has not eliminated your use of money. It has merely delayed it. It has merely delayed it. When you use a debit card you draw down your checking account—part of M1. When you use a debit card you draw down your checking account—part of M1.

CONTEMPORARY ECONOMICS© Thomson South-Western 16.3 Money, Near Money, and Credit Cards SLIDE 33 Electronic Money Much of modern money consists of electronic entries in bank computers. Much of modern money consists of electronic entries in bank computers. So, money has evolved from a physical commodity to an electronic entry. So, money has evolved from a physical commodity to an electronic entry. Money today not so much changes hands as it changes computer accounts through electronic funds transfers. Money today not so much changes hands as it changes computer accounts through electronic funds transfers.