1. Money and Banking CHAPTER 18 18.1 Origins of Money
18.2 Origins of Banking and the Federal Reserve System
18.3 Money, Near Money, and Credit Cards

2. 18.1 Origins of Money Learning Objectives
LO1 Trace the evolution from barter to money.
LO2 Describe the three functions of money.
LO3 Identify the properties of ideal money.
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3. Key Terms
medium of exchange
commodity money
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4. The Evolution of Money Problems with barter The birth of money
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5. Three Functions of Money
Medium of exchange
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
Unit of account
Store of value
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6. Commodity Money
Limitations of commodity money—most falls short of the ideal money
Coins
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7. Seven Desirable Qualities of Ideal Money
Quality 1
Durable
Rationale
Money should not wear out quickly.
Good Examples
Paper money
Coins
Sea shells
Bad Examples
Strawberries
Seafood
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8. Seven Desirable Qualities of Ideal Money
Quality 2
Portable
Rationale
Money should be easy to carry, even large sums.
Good Examples
Diamonds
Paper money
Bad Examples
Lead bars
Potatoes
Corn
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9. Seven Desirable Qualities of Ideal Money
Quality 3
Divisible
Rationale
Market exchange is easier if denominations support a wide range of possible prices.
Good Examples
Honey
Paper money
Coins
Bad Examples
Cattle
Diamonds
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10. Seven Desirable Qualities of Ideal Money
Quality 4
Uniform Quality
Rationale
If money is not of uniform quality, people will hoard the best and spend the rest, reducing the quality of money in circulation
Good Examples
Salt bricks
Paper money
Coins
Bad Examples
Diamonds
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11. Seven Desirable Qualities of Ideal Money
Quality 5
Low Opportunity Cost
Rationale
The fewer resources tied up in creating money, the more available for other uses.
Good Examples
Iron coins
Paper money
Bad Examples
Gold coins
Diamonds
Corn
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12. Seven Desirable Qualities of Ideal Money
Quality 6
Stable Value
Rationale
People are more willing to accept and hold money if they believe it will keep its value over time.
Good Examples
Anything whose supply can be controlled by the issuing authority, such as paper money.
Bad Examples
Farm crops
Gold
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13. Seven Desirable Qualities of Ideal Money
Quality 7
Limited Supply
Rationale
Anything that can be easily gathered or produced would not serve well as money.
Good Examples
Gold and silver are produced with great effort.
Bad Examples
Leaves
Rocks
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14. 18.2 Origins of Banking and the Federal Reserve System
CONTEMPORARY ECONOMICS
9/11/2018
18.2 Origins of Banking and the Federal Reserve System
Learning Objectives
LO1 Describe how the earliest banks made loans.
LO2 Based on whom they lend to, identify two types of depository institutions.
LO3 Explain when and why the Federal Reserve System was created.
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15. CONTEMPORARY ECONOMICS
9/11/2018
Key Terms
check
fractional reserve banking system
representative money
fiat money
Federal Reserve System (the Fed)
discount rate
Federal Open Market Committee (FOMC)
open-market operations
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16. 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, where it could be easily stolen.
But visiting the goldsmith every time you needed money was a nuisance.
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17. 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.
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18. Bank Loans Checking account Medium of exchange Public confidence
Fractional reserve banking system
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.
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19. Bank Notes
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.
Checks could be redeemed for gold only if endorsed by the payee.
Bank notes could be redeemed for gold by anyone who presented them to the issuing bank.
A bank note was “as good as gold.”
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20. Representative Money
Bank notes that exchanged for a specific commodity, such as gold, were called representative money.
The paper money represented gold in the bank’s vault.
Initially, these promises to pay were issued by banks.
Over time, governments took a larger role in printing and circulating bank notes.
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21. Fiat Money
Once representative money became widely accepted, governments began issuing fiat money.
Fiat money is money of no value in itself and not convertible into gold, silver, or anything else of value; declared money by government decree.
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22. Depository Institutions
Commercial banks
Thrifts
Savings and loan associations
Mutual savings banks
Credit unions
Dual banking system
State banks
National banks
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23. The Federal Reserve System
Birth of the Federal Reserve System
Established in 1913
Federal Reserve System (the Fed)—the central bank and monetary authority of the United States
Powers of the Federal Reserve System
Reserves
Discount rate—interest rate the Fed charges banks that borrow reserves
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24. The Federal Reserve System
(continued)
Directing monetary policy
Federal Open Market Committee
Federal Open Market Committee (FOMC)—12-member group that makes decisions about open-market operations
Open-market operations—buying or selling U.S. government securities as a way of regulating the money supply and interest rates
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25. The 12 Federal Reserve Districts
Figure 18.2
Source: Federal Reserve Board.
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26. Organization Chart for the Federal Reserve System
Figure 18.3
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27. 18.3 Money, Near Money, and Credit Cards
CONTEMPORARY ECONOMICS
18.3 Money, Near Money, and Credit Cards
Learning Objectives
LO1 Describe the narrow definition of money.
LO2 Explain why distinctions among definitions of money have become less meaningful over time.
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28. CONTEMPORARY ECONOMICS
9/11/2018
Key Terms M1
checkable deposits M2
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29. Narrow Definition of Money: M1
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.
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30. Currency in Circulation
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.
Currency makes up about one-half of M1.
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31. U.S. Currency Abroad
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.
Some countries, such as Panama, Ecuador, and El Salvador, even use U.S. dollars as their own currency, a process called dollarization.
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32. Checkable Deposits
Checkable deposits—deposits in financial institutions against which checks can be written and ATM, bank, or debit cards can be applied
About half of checkable deposits are demand deposits.
In recent years, banks have developed other types of checking accounts.
Checkable deposits make up about one-half of M1.
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33. Traveler’s Checks Users sign traveler’s checks twice.
Once at the bank at the time of purchase
Again when the check is spent
A merchant compares the two signatures to confirm the user is the rightful owner.
Traveler’s checks are safer than cash because they can be replaced in the event of loss or theft.
Traveler’s checks are a tiny part of the money supply—only a fraction of 1 percent of M1.
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34. 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
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35. Savings Deposits
Savings deposits earn interest but have no specific maturity date.
This means that you can withdraw them any time without a penalty.
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36. Time Deposits
Time deposits earn a fixed rate of interest if held for a specified period.
The holding period ranges from several months to several years.
Holders of time deposits are issued certificates of deposit, or CDs for short.
Early withdrawals are penalized by forfeiture of several months’ interest.
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37. Money Market Mutual Fund Accounts
Money market mutual fund accounts are another component of the money supply more broadly defined as M2.
Funds deposited in these accounts are used to purchase a collection of short-term interest-earning assets by the financial institution that administers the fund.
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38. Debit Cards but Not Credit Cards
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.
You don’t use money until you pay your credit card bill.
The credit card has not eliminated your use of money.
It has merely delayed it.
When you use a debit card, you draw down your checking account—part of M1.
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39. Electronic Money
Much of modern money consists of electronic entries in bank computers.
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.
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40. M1 and M2: Alternative Measures of the Money Supply, Week of June 20, 2011
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