Money, Banking, and the Federal Reserve

1. Money, Banking, and the Federal Reserve People have used money for thousands of years as an exchange for goods and/or services (from bills, coins, checks to shells, gold, and other goods)

2. Money • For something to be considered money, it must have three functions: • Medium of exchange – seller accepts in exchange for goods or services • Money can be used to buy whatever you want or need • Without money,barter (trading of goods and services) would dominate • Double coincidence (buyers and sellers must have exchangeable desires) necessary for barter to occur

3. Money • Unit of accounting – “yardstick” of measuring value of goods and services (determines values in amounts) • U.S. – Dollar Japan – Yen • Allows for accurate record keeping • Store of value – can store purchasing power for later use • save money for larger purchases • ex. - waiting for paycheck on payday, not everyday

4. Characteristics of Money • Durable– must be able to last over a period of time • Portable– easily carried • Divisible– divided into smaller parts for purchases at any price • Stable value– value cannot change quickly or usefulness will fall (store of value) • Scarce– gives value to money • Accepted– must be taken in exchange for goods or services

5. Types of Money • Commodity money – medium of exchange as a good and money • Ex.- sheep, diamonds • Representative money – backed by valuable items (gold or silver) • U.S. – gold or silver certificates – banknotes (promise to convert into coin on demand) for bullion • Fiat money– value from government order as acceptable payment • Legal tender – money by law that must be accepted

6. Basic History of American Money • England forbade the colonies from using printed money or coins • Still some gold and silver was used in bartering • Spanish dolár – common coin, later called dollar by colonists • Bartering for goods prevailed • To help pay for Revolutionary War debts, Continental Congress issued continentals(bills of credit), but printed too many, became worthless and were unaccepted • U.S. looked for more reliable means of exchange; Constitution gives Congress the ability to print money, backed by gold and silver values. • But private banks could still issue banknotes

7. Banking Services • Wide variety • Checking accounts • Automatic deposits and payment • Storage of values – safety deposit boxes • Money transfers – moving money from person to person • Overdraft checking – allows for checks to be written for more than person has in their account, but must be repaid with interest or fee • Banks usually offer similar commodities but with a variety of services and charges • Electronic banking – computer age • EFT – electronic funds transfer – banking functions on computers rather than on paper • ATM – automated teller machine • Bank from home – online • Concerns: tampering, lack of privacy, “float” time • EFT Act (1978) protects against fraud

8. How To Write a Check • Can you label these parts to a check?

9. Types of money in the U.S. • Money and near moneys • Currency – coins and bills (notes from Federal Reserve) • Checks – checking accounts and checkable deposits (demand deposits) • Credit cards– not really money, but represents future payments • Loan by issuer of card • Debit cards– automatically withdraw money from accounts • Closer to being electronic checks • Near moneys– assets that can be quickly turned into money without risk of loss of value (savings account)

10. Money Supply • Two most basic definitions of money supply: • M1: narrowest definition – currency, checkable deposits, and traveler’s checks • M2: broader definition – all of M1 and savings, certificates, money market deposits, mutual funds, and other specialized account balances

11. The Federal Reserve • Created in 1913 as central banking operation in the United States to settle financial “panics” of the late 1800’s and early 1900’s • Also known as the Fed

12. Organization • Board of Governors: • Direct operations of the Fed and supervise the Federal Reserve banks and activities • 7 members, appointed by the President with Senate approval • serve for 14 years (one opening every two years) • cannot be reappointed, but do not have to have approval of President or Congress in decisions • Federal Advisory Council (FAC): • Assists Board of Governors by reporting on the nation’s business conditions • 12 members (each elected by the director of each Federal Reserve district bank) • Federal Open Market Council (FOMC): • Decide how to control money supply • Raise or lower interest rates (big effect on economy)

13. Organization • Federal Reserve Banks: • Nation divided into 12 districts (each with Federal Reserve district bank – set up as a corporation owned by member banks, who have bought stock in district banks) • 9 member boards supervise each district • 25 Federal Reserve branch banks – acting as offices and aid each district in operations and duties • Member Banks: • All national banks must join • State charted banks have option to join • Regulated by Federal Reserve district banks

15. Functions of Federal Reserve • Clear checks– Figure 15.3 p.403 (complex process) • Acts as federal government’s bank– tracking deposits and checks, advising government spending • Supervising member banks– regulating member banks and operations • Federal Deposit Insurance Corporation (FDIC) – guarantees deposits of member banks for up to $250,000 per depositor • Holding reserves and setting reserve requirements– • Certain percentage of deposits must be kept in reserve (on hand) • Change in reserve requirements controls money supply • Supply paper currency– • All printed in D.C. but with mark of which district bank issues the federal reserve note • Most new money is for replacing old money (worn out) • Regulate money supply (monetary policy)- determine amount of money in circulation • Consumer protection– truth-in-lending • make known interest rates and monthly payments

16. Monetary Policy • Monetary policy: changing rate of growth of the money supply to affect costs and credit • Cost of credit = interest • If interest ↑, credit demanded ↓, and vice versa • Two types: • Loose money policy (expansionary) – make credit easier to get and abundant – encourages economic growth • more people borrow, more spending, expanding of business, more employment • may lead to inflation • Tight money policy (contractionary) – makes credit expensive • to slow economy (control inflation) • less borrowing, less spending, less production

17. Fractional Reserve Banking • Fractional reserve banking– only percentage of deposits required to be in reserve (on hand) • Rest of the money can be lent • Reserve requirements:certain percentage that must be kept (about 10% now) • in case of large withdrawals

18. Money Expansion • Most money is in deposits (by Fed and customers) • Because reserve requirements are not 100%, excess can be used to create “new money” – to be borrowed • after time and time again – multiple expansion of money

19. Changing Reserve Requirements • Lower requirements = more money to lend (and vice versa) • If raises, banks can call loans, sell investments, or borrow to meet reserve requirements • This has an extreme effect on economy, not changed much because of this.

20. Changing Discount Rate • Discount rate – interest rate Fed charges banks on borrowed money • Prime rate – interest rate charged to customers by banks • if DR ↑, PR ↑ - discourages borrowing • if DR ↓, PR ↓ - banks borrow more to lend more • Federal funds rate – interest rate banks charge each other on short term loans (usually overnight – to ensure meeting reserve requirements) • if FFR ↑ - less borrowing • if FFR ↓ - more borrowing

21. Open-Market Operations • Open-marketing operations: buying and selling United States securities to affect money supply (major tool of the Fed) • Securities– government IOUs- treasury notes, bills, and bonds • By buying securities, can increase bank’s money supply, therefore increasing their lending ability (and vice versa)

22. Difficulties of Monetary Policy • Hard to gather and interpret information on the money supply • Too much money and activity to track • Critics say Fed should stay out of regulating money supply • Government influences with taxes and spending have affect on the economy and monetary policy actions