2. Money, Banking, and the Federal Reserve Bank (Monetary Policy) Chapter 6.1

3. Money Part I

4. Money Objectives: In this lesson, students will be able to identify characteristic of money and the advantages of money. Students will be able to identify and/or define the following terms: Barter System Medium of Exchange Commodity Money Unit of Account Money Supply Store of Value Money Specie Representative Money Currency Fiat Money

5. Money- History barter system (people traded for what they needed and didn’t have). When America was first being settled there was no money system. Colonists used the barter system (people traded for what they needed and didn’t have). Trades are made in goods and services instead of money. 1

6. Money- History Early European settlers in America adopted “wampum” – small shells that American Indians used ceremonially – as a form of currency.

7. Money- History During the colonial period in America, foreign coins from Spain, England, Portugal, Holland, France, and elsewhere were used in the colonies. The most commonly circulated coin was the peso, or Spanish milled dollar which could be divided into halves, quarters, and eights. When divided into eights, the sections were called “pieces of eight” or “bits”- hence the slang “two bits” to mean a quarter of a dollar. The milled edges were designed to prevent people shaving silver off. 2 bits Peso

8. Money- History commodity moneyobjects that have value in themselves as well as for use as money. Commodities were commonly accepted: furs, tobacco, salt, gun powder, fish hooks, etc. These items were known as commodity money, objects that have value in themselves as well as for use as money. Some goods that evolved into money were gold, silver, and copper. 2

9. Money-History Problems with bartering: compare worth A.Difficult to compare worth or value of things. timeeffort B. Bartering took a lot of time and effort to find the right person to make an exchange. (This was the main problem.) For bartering to work, “You have to want what the other person wants and visa versa.” 3

10. Money- History money supply In 1789, one of President George Washington’s first challenges was to establish a money supply for the new country – a uniform standard currency. There were pesos, shillings, talers, and other European coins in the colonies from which to design a new medium of exchange. Money supply Money supply is defined as: All the money available in the United States economy. Consisting of coins, currency and Demand Deposits (also called checking accounts and travelers checks). Money supply is important because it affects prices, loans, jobs, and other things. Money Money is defined as: A good that is widely accepted for purposes of exchange and in the repayment of debt. 4

11. Money- History In 1861 the U.S. Treasury issued its first paper currency since the Continental. The official name of the currency was “Demand Deposits,” but people called them greenbacks because the were printed with green ink. (Used during the Civil War). 4B The Continental, from American Revolution issued by the Continental Congress.

12. Money-History representative money Later as America developed into a more complex economic system, tobacco, gun powder, and other objects (used as commodity money) were no longer universally accepted as money, and there was a need to build confidence in the banking system. The nation needed a more convenient payment system. The U.S. government issued representative money in the form of silver and gold certificates. Used until 1913. Representative Money Representative Money is defined as: specie Paper money that has value because the holder can exchange it for something else of value, such as gold or silver also called specie coins. 5

13. Money-History In the 1870’s the nation adopted a “Gold Standard” – a monetary system in which paper money and coins had the value of certain amounts of gold. (Representative Money) Set Value: 1 oz. goal = $20 5B

14. Our dollars were once backed by gold. You could exchange a dollar for gold and silver. USA Gold Certificate - “In gold coin payable to the bearer on demand” The Government stopped converting paper money in to gold and silver in the 1930’s. At one time you could exchange this for this

15. A $1 Silver Certificate is the only piece of U.S. paper currency (1891) to bear the portrait of a woman: Martha Washington

16. Money-History In 1929, the severe economic decline and the stock market crash lead to widespread bank runs (bank panics in which people raced to their banks to withdraw their deposits). The combination of unpaid loans and bank runs resulted in the failure of thousands of banks across the country. After becoming President, Roosevelt acted to restore public confidence in the nation’s banking system. He declared a “bank holiday” (closed all banks) as the last resort to restore trust in the nation’s financial system. Within a matter of days sound banks began to reopen. Later in 1933, Congress passed the Federal Deposit Insurance Corporation (FDIC) to insure customer deposits if a bank fails. Today, deposits are insured up to $250,000. In an attempt to increase the money supply, Roosevelt also issued an executive order that effectively ended the nation’s gold standard. Going off the gold standard allowed the Federal Reserve to maintain a money supply at adequate levels to support a growing economy (could not increase money supply with limited gold). These actions helped the nation recover somewhat but did not end the Great Depression. 6A

17. Money-History fiat money Today, our money is fiat money. (Fiat is an order or decree.) Fiat Money Fiat Money is defined as: Money that has value because the government has ordered or decreed that it is an acceptable means to pay debts, and is called “legal tender”. It remains in limited supply, and therefore valuable, because the Federal Reserve controls its supply. This control of the money supply is essential for a fiat system to work. From Representative Money to Fiat Money 6B

18. Not All Money is the Same Commodity Money Fiat Money Representative Money Objects like this gun powder once served as commodity money. Today, Federal Reserve notes are fiat money, decreed by the federal government to be an acceptable way to pay debts. Representative Money like this silver certificate could be exchanged for silver. Quick Review

19. Are You Better Off Living in a Money Economy? specialized work People who live in money economies do more specialized work because transaction costs are low. Instead of spending time bartering, they can focus on producing one thing. They can then sell that one thing (EXP: their labor) for money and use the money to buy other goods and services. extra time saved The extra time saved in a money economy can be used to produce more goods and services, to consume more leisure, or to do both! money economies are richer Residents of money economies are richer in goods, services, and leisure than the residents of barter economies. 7

20. Three Functions of Money 1. Medium of Exchange Exchange (Acceptable) (Acceptable) 3. Store of Value (Keeps it’s Value) 2. Unit of Value Value (Compares Value) As a medium of exchange, money measures value during the exchange of goods and service. Money holds its value even if it is not used immediately to buy goods and services. (Unless very high inflation occurs.) An expensive price tag tells us something about the good’s value. $30.00 $44.00 8

21. Six Characteristics of Money AcceptableAcceptable PortablePortable DivisibleDivisible DurableDurable UniformUniform ScarceScarce 9

22. What gives Money Value ? AcceptabilityAcceptability in exchange gives money its value. It’s scarce.It’s scarce. 10

23. Banking Part 2

24. Banking Objectives: In this lesson, students will be able to identify the first bankers and discuss how banking create money without printing it. Students will be able to identify and/or define the following terms: Bank Fractional Reserve Banking Money Supply M1 and M2 Money Interest Default Required Reserve Excess Reserve Mortgage Credit & Debit Cards

25. A Bank A Bank is defined as an institution for receiving, keeping, and lending money. Banks are for individuals and businesses. Types: Commercial Banks, Savings and Loan Associations, Mutual Savings Banks, Credit Unions, State Banks, and Federal Banks. Banking 11

26. Banking - History Goldsmiths were the first bankers. When money was principally gold coins, carrying it was neither easy nor safe. As a result, people wanted to store their gold in a safe place. Most often, people stored their gold coins with goldsmiths because goldsmiths had safe storage facilities. Goldsmiths were the first bankers. 12

27. Banking - History receipts People began using gold coins gold receipts as money Goldsmiths would give receipts stating the amount of gold stored. People began using receipts in place of actual gold coins because it was easier to do so. People accepted the gold receipts as money because they trusted the goldsmiths and knew the receipts were fully backed by gold. 13

28. Banking - History lend out interest Then, some goldsmiths began to lend out some of the gold they were storing, and collected interest on the loans. receipts However, instead of lending the actual gold, the goldsmiths gave receipts to the borrowers. As a result, there were more receipts than there was actual gold. The goldsmiths’ lending activity increased the supply of money. The goldsmiths’ lending activity increased the supply of money. That is, it increased the number of receipts compared with the actual amount of gold. (Credit increased, not gold.) 14

29. Banking - History Fractional Reserve Banking The goldsmiths’ activity was the beginning of a process of Fractional Reserve Banking. Under Fractional Reserve Banking, banks are like the goldsmiths of years past. They hold only a fraction of the deposits and lend out the remainder. Fractional Reserve Banking Fractional Reserve Banking is defined as: fraction loans a bank keeps only a fraction of deposits on hand and loans out the rest. (See example of “money creation” next) 15

30. Banking - History Fractional Reserve Banking Fractional Reserve Banking – How it works! The availability of credit (or loans), is how banks increase the money supply, “money creation,” without actually printing more money. Raise RRR percentage = decrease in Money Supply Raise RRR percentage = decrease in Money Supply Lower RRR percentage= increase in Money Supply Lower RRR percentage= increase in Money Supply $100 is deposited in the bank $100 Fed. Required Reserve Ratio is 10%. This is set by the Fed. loaned out 90% or $90 is excess reserves that can be loaned out by the bank to customers. bank’s 10% or $10 of deposit must be kept in bank’s required reserve. 16

31. Money Creation Formula : Deposit \ RR Rate = Increase in money supply. $10,000 \.20 = $50,000 increase in M.S. $10,000\.10 = 100,000 increase in M.S. Starts when banks begin to loan out their excess reserves.

32. Banking Today A bank’s loans is it’s assets. A bank’s deposits is it’s liabilities.

33. money supply The money supply is all the money available in the United States – coins, cash, demand deposits and travelers checks. M1M2. The money supply consists of M1 and M2. Banking Today Review of definition “Money Supply” 17

34. Banking Today M1 currencychecking accounts (call demand deposits)traveler’s checks M1 is money that people can easily use to pay for goods and services – currency, checking accounts (call demand deposits), and traveler’s checks (has liquidity). 18

35. Banking Today M2savings accounts, time deposits, and money market accounts. M2 is M1 plus savings accounts, time deposits, and money market accounts. Savings Account– interest-earning account ;some have check-writing privileges. Time Deposits – interest-earning account with a specified maturity date. Penalties for early withdrawal. Money Markets Accounts – interest-earning account; requires minimum balance, limited check writing privileges. Review of definition s 19

36. Banking Today Facts About Interest Facts About Interest : When money is deposited in a bank, the customer receives interest on money.When money is deposited in a bank, the customer receives interest on money. A person who borrows money must pay interest.A person who borrows money must pay interest. A Bank’s primary revenue is from interest on the loans they make.A Bank’s primary revenue is from interest on the loans they make. Interest is defined as the price of borrowed money.Interest is defined as the price of borrowed money. 20

37. Bank’s Revenues and Expenses Most of a Bank’s income comes from interest from bank loans. 20 B

38. Banking Today Default Default : When a person fails to pay back a loan, he/she has defaulted on the loan.When a person fails to pay back a loan, he/she has defaulted on the loan. Defaulting on a loan leads to bad credit and higher interest rates in the future.Defaulting on a loan leads to bad credit and higher interest rates in the future. By defaulting, a person ruins his/her reputation for repaying a loan.By defaulting, a person ruins his/her reputation for repaying a loan. 21

39. Banking Today Credit Cards are not money. Credit Cards are not money. Credit Cards create loans. Loans place people in debt. To get out of debt, people have to repay the loan with money. 22

40. Banking Today Debit Cards are considered demand deposits (checking account). Debit Cards are considered demand deposits (checking account). They are included in part of the money supply and as part of M1 money. 23

41. Banking Today A mortgage is a loan on real estate. A mortgage is a loan on real estate. ( Learning the language of banking, a person makes better choices.) 24

42. The “Fed” Federal Reserve System Part 3 Federal Reserve, Washington, D.C

43. Federal Reserve System Objectives: In this lesson, students will be able to explain how it came into existence, and what it does. Students will be able to identify and/or define the following terms: Bank Panics Federal Reserve Act Federal Reserve System FOMC Lender of Last Resort

44. BANKS and THE FEDERAL RESERVE BANKS BANKS are -- Institutions for receiving, keeping and lending money. Banks for individuals and businesses. Types: Commercial Banks, Savings and Loans Associations, Mutual Savings Banks, Credit Unions, State Banks and Federal Banks. THE FEDERAL RESERVE THE FEDERAL RESERVE is -- The nation’s central banking system. This means that it is the chief authority on money in the country, commonly referred to as “The Fed”. The U.S.’s bank and a bank’s bank. Review 25

45. Before the Federal Reserve System Background As stated earlier, banks were informal and not completely safe. After the American Revolution, the leaders of our new nation agreed that one of their main goals must be to establish a safe, stable banking to restore confidence in the bank system. Such a system was also important for increasing trade with other countries and ensuring the economic growth of the new United States. The nation’s leaders did not agree on how these goals should be accomplished. Continued…

46. Before the Federal Reserve System Background The nation’s leaders debated during the 1780’s and 1790’s on banking and the role of the government in our young country. As you may remember from your study of American History, there were two political views on the creation of a National Bank: Anti- Federalist –- led by Thomas Jefferson (against) Federalist ------- led by Alexander Hamilton (for) Continued… 25 B

47. Before the Federal Reserve System Background Thomas Jefferson Anti-Federalist Believed in a bank system run by the States. He worried that a National Bank would lend to only wealthy people or businesses and ordinary people (farmers) would be refused loans. Alexander Hamilton Federalist Believed in a strong central Government bank. He proposed a National Bank with one single national currency, managed by the National Government. 25 C

48. Before the Federal Reserve System Background The Federalist were successful (by one vote) and in 1791 Congress set up the first Bank of United States, granting a 20 year charter. This bank brought order and stability. Anti-Federalist pointed that the National Bank was unconstitutional. After the charter expired, state banks began issuing bank notes again. Many state banks were not stable or trustworthy. People lost confidence in banks again. In 1862, Congress passed the National Bank System (with uniform currency that was backed by gold). Continue…

49. Before the Federal Reserve System Background in which people raced to their banks to withdraw their deposits Before the founding of the Federal Reserve, the nation was plagued with financial crises. At times, these crises lead to “bank panics,” in which people raced to their banks to withdraw their deposits. Continued… 26

50. The Federal Reserve System Background A particularly severe panic in 1907 resulted in bank runs that wreaked havoc on the fragile banking system and ultimately led Congress in 1913 to write the Federal Reserve Act, defined as chief authority on money in the U.S. (Initially created to address these banking panics, the Federal Reserve is now charged with a number of broader responsibilities, including fostering a sound banking system and a healthy economy.) Continued Signing of the Federal Reserve Act, 1913. President Wilson in signing it. 27

51. The Federal Reserve System Background Establishing the nation’s first central bank was no simple task. What emerged with the Federal Reserve System was a central bank under pubic/private control, with countless checks and balances. Congress oversees the entire Federal Reserve System. And the Fed must work within the objectives established by Congress. Yet Congress gave the Federal Reserve autonomy (self-rule) to carry out its responsibilities insulated from political pressure. 28

52. The Federal Reserve System Purpose of FED? It is responsible for Monetary Policy – Controlling the money supply and the availability of credit. The Fed can expand or contract the money supply to support the following: 1. Maintain stable prices 2. Keep employment high 3. Stimulate economic growth 29

53. The Federal Reserve System Structure of the FED 30 A Known as the most powerful person in the world. Janet Yellen Fed Chairman Appointed by President Obama, in 2014, Confirmed by Congress, and serves a term of 4 years.

54. The Federal Reserve System Structure of the FED 2.Board of Governors (7) * Regulates and supervises the Fed. *Controls Fed activities. (Term-14 yr) 3.Federal Reserve Banks (12) Monitors and reports on economic and banking conditions in its district to the Board of Governors. 30

55. The Federal Reserve System Structure of the FED 4. FOMC (12) – makes decisions on Monetary Policy (growth of money supply). Fed uses 3 tools: Fed uses 3 tools: 1. Interest Rate (called Discount Rate) 2. Bank’s Required Reserve 3. Buying/Selling Gov. securities (FOMC) Increase the Money Supply: Decrease the Money Supply: -Lower RR Ratio -Raise the RR Ratio -Buy U.S. Securities (FOMC) - Sell U.S. Securities (FOMC) -Lower Discount Rate (interest) -Raise Discount Rate (interest) 30 B

56. The Federal Reserve System Structure of the FED 5. Federal Advisory Council(7) Consults with and advises the Board of Governors. 6. Member and Non-Member Banks (about 6891 total) (about 6891 total) Federally chartered banks must be members of Fed, approximately 4000. 30 C

57. The Federal Reserve System Fed is under both public and a private control? Public Part Private Part Input from Both President nominates Chair, Senate approves. Board of Governors- 7 Members committee includes the Chair. Regulates and supervises the Federal Reserve System. Federal Open Market Committee (FOMC) 12 Members - Regulates the money supply through Monetary Policy. 12 District Banks With their own 9 board of directors. Member banks Local Banks

58. The Federal Reserve System The 12 Federal Reserve Districts: Each of the 12 Fed Reserve District is made up of more than one state ensuring that one single District does not dominate or exploit the central bank’s power at the another’s expense. Each District has 9 directors and a President. 31

59. The Federal Reserve System Districts #11 – Dallas, Texas: Texas is in District #11, along with part of two other states, New Mexico and Louisiana. Our District Reserve Bank is located in Dallas, Texas. Texas has 3 branches in El Paso, Houston, & San Antonio. 32

60. The Federal Reserve System Responsibilities of the FED? 1. Control the Money Supply 2. Supply the economy with paper money 3. Hold bank reserves ($$$) 4. Provide check-clearing services 5. Supervise member banks to ensure they are following bank regulations. 6. Serve as the “lender of last resort” for banks suffering cash management problems. This means that the Fed may lend banks money when no one else will. 33

61. The Federal Reserve System How the Fed Serves the Government: 1. It functions as the Government’s banker, called the U.S. “central bank”. It maintains a checking account for the U.S. Treasury Dept. and processes payments, such as: Social Security checks and IRS refunds. 2. Acts as an agent of the government and sells, transfers, and redeems Gov. securities (through the FOMC): Bonds, Notes, and Bills (called securities) 2. Acts as an agent of the government and sells, transfers, and redeems Gov. securities (through the FOMC): Bonds, Notes, and Bills (called securities) 3. The Fed issues paper currency (does not print it) and takes worn or torn bills out of circulation. 3. The Fed issues paper currency (does not print it) and takes worn or torn bills out of circulation. US Treasury: US Mint – coins; Bureau of Engraving and Printing – paper bills. 34

62. Video (Dallas Fed)

63. Wrap Up

64. Review – True/False 1. Banks are allowed to print currency. False – Only U.S. Treasury’s Bureau of Engraving and Printing 2.Checking accounts are called demand deposits. True 3.Credit cards are a form of money. False (they are a form of debt) 4.Money has value because it is accepted and scarce. True

65. Review – True/False 1. The first bankers were blacksmiths. False – Goldsmiths 2.The central banking system has 10 Federal Reserve District Banks. False (12) 3.Debit cards are considered checking accounts. True (they are demand deposits & are part of M1) 4.If $300 was deposited a bank and the required reserve ratio was 10%, the amount placed in required reserves would be $30, & excess reserves would be $270. True

66. Review – True/False 1.The problem with bartering is its difficult to compare worth and it takes time and effort to find the right person to make the exchange. True – Prevents individual specialization, too. 2.Commodity money consists of objects that have value in themselves as well as for use as money. True 3.M1 does not include savings accounts. True (currency, checking accounts, traveler’s ck.) 4.The Fed’s activities are controlled by the U.S. Treasury. False (Fed’s Board of Governors)

67. Review – True/False 1.Our money is fiat paper money backed by gold. False – Fiat money is not backed by gold. 2.We refer to the Fed as the central bank because it is the chief monetary authority in the country. True 3.Monetary Policy is the action by the Fed to control the money supply and available credit. True (FOMC makes decisions about growth of money supply) 4.A barter economy in an economy with no money. True

68. Review – True/False 1.Fed Open Market Operation has 5 tools it uses to control the growth of the money supply. False – (3) Interest rates; banks Required Resv; buy/selling Gov. securities 2.The functions of money include the “unit of interest”. False (Med. Of Exchg., Unit of Value, & Store of Value) 3.The money creation process begins when banks loan out their excess reserves. True 4. The goldsmiths’ lending activities (had more receipts than there was gold) was the beginning of increasing the money supply by a process called fractional reserve banking. True

69. Review – True/False 1.Credit cards are the same as money. False – Debt 2.Banks make most of their income from interest on loans they make. True 3.Representative money was commonly accepted commodities, such as, salt and fish hooks. False (salt/hooks are commodity money) 4.The Fed issues paper money, acts as our nation’s bank, holds bank reserves, supervises bank, and serves as the lender of last resort. True (and many other things)

70. Review Questions 1.Who is Janet Yellen? Chairman of the Federal Reserve Bank. 2.What did Alexander Hamilton (Federalist) and Thomas Jefferson (Anti-federalist) debate about? A centralized National Banking System 3.How is the Fed both privately and publicly run? President appoints/Congress approves (Bd. of Gov.) - Public District Bank, Member and Local Banks- Private Both have some influence, however, Congress gave the Fed autonomy (self-rule) to carry out its responsibilities insulated from political pressure. 4. The first National Bank (1791) was successful, so why did it close? The 20 yr. charter ended and Anti-Federalist continued to debate that it was unconstitutional.

71. Money, Banking, and the Fed Test

72. The End