MONEY AND BANKING

1. MONEY AND BANKING

2. What is money (defn)? • Medium of exchange- determines value during the exchange of G/S without it we would have to use bartering (defn) which means you would spend a lot of time and effort trying to make exchanges of one G/S for another

3. Unit of account- it provides a means for comparing the values of G/S. You can compare the cost of one item with the same item in another store to establish value because both are expressed in dollars

4. Store of value- it keeps its value if you decide to hold on to it or store it. One exception is when inflation occurs- rising prices Currency (defn)- dollars in USA Has 6 characteristics: 1. durability- must withstand wear and tear over time

5. portability- need to be able to carry it around easily and to transfer it from one to another easily as well • divisibility- must be able to divide into smaller parts or units of value so that exact amounts can be used

6. uniformity- its value is the same; in other words, one dollar is one dollar • limited supply- this must be true for money to maintain its value; think of Law of Supply • acceptability- everyone must be able to exchange the objects that serve as money; expectations are everything

7. Measuring the money supply (defn): • M1 consists of currency (coins and paper money), traveler’s checks, demand deposits (checking accts) • M2 includes M1 plus savings accts, money market accts, CDs • M3 includes everything plus large denomination savings accts and CDs over $100,000

8. Functions of Financial Institutions: • Provide a safe place to store money where it is insured • Opportunity to save money • Investment opportunities • Loans- this is the primary source of profit for banks; making loans encourages business growth and increases the money supply

9. How banking works: • People make deposits • A portion of that money is kept by the bank for operating purposes; this is known as a required reserve ratio • The rest is loaned out which increases the circulation of money and stimulates the economy

10. As loans are repaid with interest, depositors are paid part of it and the bank keeps the other part as a profit This system is known as fractional reserve banking (defn).

12. The Federal Reserve System: • The nation’s central bank system • Divided the USA into 12 districts • Each district has 1 Federal Reserve Bank that is central for its area • Member banks use that bank for needed services

14. Board of Governors- oversee the Fed; appointed by the President with one of them chosen to be the Chairman. Current Chair is Ben Bernanke. • Number one job is to regulate the money supply which is called monetary policy (defn) • Fed Open Mkt Committee- sets interest rates

15. Functions of the Fed: • Serving govt by maintaining its bank accts, buying and selling securities, & issuing currency • Serving banks by providing check clearing, supervising lending practices, and providing loans to banks in case of an emergency

16. Regulating the banking system • Regulating the money supply- demand for money depends on cash needed on hand, interest rates, price levels, and level of income; they must work to keep the money supply stable in an effort to combat inflation

17. Tools used by the Fed to regulate the money supply: • Reserve requirements- easiest but least used b/c it places a strain on banks • Discount rate- interest rate they charge banks for borrowing; higher rates discourage borrowing which reduces money available

18. Open Mkt Operations- most used & most important; buying and selling of govt securities: -bond purchases increase the money supply -bond sales decrease the money supply Easy money supply vs. Tight money supply