Money and Banking

1. Money and Banking Chapter 24

2. What is Money? • Three functions of money • Serves as a medium of exchange- trade money for goods and services • Store of value- hold it until we are ready to use it, and it does not lose value • Measure of value- used to assign value to a good or service

3. What is Money? • Anything that people are willing to accept in exchange for goods is money • Three characteristics of money • Portable • Divisible • Durable • Currency is both coins and paper money • We accept money because we are sure that someone else will accept its value as well

4. What is Money? • The Financial System • Why banks? • Used as a safe place to store money • Money is put to work by lending it to people or businesses • Financial institutions make a profit from the interest they charge on loans • Act to bring savers and borrowers together • Types of Financial institutions • Commercial banks • Provide full banking services to businesses and individuals • Most important part of our financial system • Savings and Loans • Traditionally loan money to people buying homes and real estate • Credit Unions • Work on a not for profit basis • Often sponsored by certain business groups • Give workers a financial institution with low costs

5. What is Money? • Keeping our financial system safe • Two factors that make the U.S. banking system safe • Regulation • One of the most regulated industries in the country • Required to follow rules to minimize risk • Insurance • When banks fail the federal government insures their deposits up to $250,000 • Federal Deposit Insurance Corporation (FDIC) federal corporation that insures accounts • Makes customers feel safe wherever they deposit their money

6. The Federal Reserve System • Federal Reserve is the central bank of the US • When banks need money they borrow from the Fed • US divided into 12 Federal Reserve districts • Federally chartered commercial banks are required to be members of the Fed • Member banks own stock in the Fed and earn dividends from it

7. The Federal Reserve System • Fed was established in 1913 • To raise money they sold stock and required largest banks to buy it • The president, with the approval of the Senate, appoints the seven members of the Board of Governors • The president appoints one board member as the chairman who serves a four year term • Board is independent of politics because they do not rely on Congress for appropriations for operating expenses

8. The Federal Reserve System Advisory Councils report on • the condition of the economyin each district • financial institutions • issues related to consumer loans Major policy making group is the Federal Open Market Committee (FOMC) • Makes decisions by manipulating the money supply Regulatory functions of the Fed • Banking regulation • Oversees large commercial banks and regulates mergers • Regulates American connections with foreign banks and foreign banks in the US • Consumer borrowing • Requires lenders to spell out terms of loans • Specifies what information lenders must provide

9. The Federal Reserve System Acting as the Government’s Bank • Holds the governments money • Sells US Bonds and Treasury Bills • These help fund government activity • When they reach maturity after a period of time they can be exchanged for cash with interest • Fed issues the nations currency and controls its circulation

10. The Federal Reserve System Conducting Monetary Policy • Controls the supply of money and the cost of borrowing money Ways the Fed manipulates the monetary supply • Can raise or lower the discount rate • The rate the Fed charges member bans for loans • Stimulate economy= lower discount rate • Slow down the economy= raises the discount rate • Can raise or lower the reserve requirement for banks • Banks have to keep certain percentage of total deposits in Federal Reserve Banks • If they raise requirement banks have less money to lend • Can change money supply through open market operations • The purchase and sale of government bonds and Treasury bills puts money in the hands of investors and the government

12. The Federal Reserve System • Monetary policies are effective because • They are made by relatively few people • Decisions can be made quickly if one policy does not work • They are free of the constraints of politicians

13. How Banks Operate • Banks are started by investors • Pool money, property and certificates of deposit to capitalize bank • Banks need to attract depositors • Offer checking accounts • Savings accounts • pay interest based on how much money customer has deposited • Certificates of deposit • customer gives money to bank for specific time and bank pays interest at the end of the time period • CDs pay higher interest than savings accounts • Making loans • This is how banks make a profit • Loan money to businesses and consumers • Can increase the supply of money

14. Government Finances Chapter 25

15. The Federal Government • Each year the federal government creates a budget • Blueprint of how the government will spend its money • Created by the president and Congress • Budget year is called a fiscal year (FY), lasts from Oct. 1 –Sept. 30

16. The Federal Government Budget Process • President presents a proposed budget to Congress • Congress passes a budget resolution • Sets targets for revenues and spending and how much will be spent in each category Categories of spending • Mandatory spending does not need annual approval • Social security, interest payments on government debt • Discretionary spending government expenditures that need to be approved each year • Military, highway construction, agriculture subsidies, etc. • Appropriations Bills • Law that approves spending for a particular activity • 13 separate appropriations bills • Each must be approved by both houses of Congress and the president

17. The Federal Government • Federal Revenues • Income tax provides nearly half of all government revenue • Some paid by April 15th of each year and some is withheld from paychecks • Corporations pay taxes on their profits • Payroll Taxes- second largest source of federal income • Taxes deducted from workers paychecks to fund Social Security and Medicare

18. The Federal Government • Excise taxes- paid when consumers purchase gasoline, tobacco, alcohol, telephone services • Estate Taxes- paid when wealthy people die and pass money on to their heirs • Other federal revenues –fees paid at national parks, fees paid by companies to extract natural resources from government property

19. The Federal Government • Forms of Taxation • Proportional tax- takes same amount from everyone regardless of how much someone earns • Sales tax is an example • Progressive tax- taxes increase as income increases • Federal income tax is an example • Regressive tax- percentage paid goes down as your income rises

20. The Federal Government • Federal Expenditures • Social Security is the largest expenditure by the federal government (22.4 cents on every dollar) • Will grow in the future as the population ages • National defense is the second largest category of federal spending (16.3 cents for every dollar) • Each year the government spends a portion of the budget to pay the interest on money the government has borrowed • Education, highways and foreign aid account for billions of dollars in spending, but less than most people think

21. State and Local Governments • State and local governments have their own budget approval process, revenues and expenditures • State Governments • Most important state revenues are intergovernmental revenues (money one level of government receives from another) • Federal government gives money to states for highways, education, healthcare, etc. • Most states depend on sales tax as a source of revenue • Tax levied on consumer purchases of all products • Collected by business owners and turned over to state on a regular basis • Not all states have sales taxes • Third largest source is comes from contributions state employees make to pension and retirement plans • State Income tax is the fourth largest source • Not all states have state income tax

22. State and Local Governments • Local Governments • Also depend on intergovernmental revenues • Most of the money is provided by the state • Second largest source of local revenue is property tax • Taxes paid on land, houses and property owned • Real property- land and buildings • Personal property- stocks, bonds, cars • Most local governments tax only on real property • Property taxes based on assessed (estimated) value • Revenue from utility companies, sales taxes, fees and fines are other sources of local revenue

23. State and Local Governments • Expenditures • Entitlement programs are an important state expenditure • States try to provide and maintain basic health and living conditions • Entitlement programs provide health, nutritional or payment programs to people meeting eligibility requirements • States spend money on higher education • States subsidize college education to keep costs reasonable • Highway construction • States have to maintain local highways and roads • Employee retirement, hospitals, education, corrections equal a relatively small amount of state expenditures

24. State and Local Governments • Local Government Expenditures • Education • Local tax revenue goes to pay for public education • Accounts for one-third of local government spending • Police and Fire Protection • Water Supply • Local governments usually in charge of maintaining local water supply (Lake Maumelle) • Sewage and Sanitation • Responsible for sewage and solid waste disposal • Local governments maintain sewage treatment plants and landfills

25. Managing the Economy • Surplus when the government collects more than they spend • Deficit when the government spends more than they collect • Deficit for 2009 was 1.42 trillion dollars • When federal government needs to borrow money they sell bonds • All money borrowed and not paid back is the government's debt • Huge budget deficits of 1980s, early 90’s and last few years have increased federal debt • Each person in the US now owes $46,000 per person

26. Managing the Economy • Balanced budget is when spending equals revenue • Federal government is not required by law to have a balanced budget • Many state and local governments are required by law to balance their budgets (Arkansas is required) • When revenues go down states are required to make cuts • Revenue often goes down during bad economic times, when states need to spend more on entitlements • Many states try to maintain an emergency fund to help budget shortfalls

27. Managing the Economy • In theory federal government can stimulate the economy by increasing spending and cutting taxes • This increases deficits , drives up debt and creates problems in the future • When economy grows government can reduce spending, increase taxes to increase revenue and lower government debt • Politics make cutting spending, spending money and raising taxes difficult, if times are good or bad • Most people want lower taxes and no cuts in government services • It takes time to pass appropriations bills

28. Managing the Economy • Government action sometimes takes a long time to take effect or sometimes do not have the desired effect • The economy has automatic stabilizers to stimulate the economy • Unemployment insurance • Welfare programs • Progressive income tax structure • These programs provide income during hard economic times • Automatic stabilizers go into effect faster than discretionary spending measures