UNIT 5- MONEY, BANKING,
FISCAL AND MONETARY POLICY
Chapters 9-11, 12 and 15
Rev 7/11, © Robin Foster
CHAPTER 15
THE FEDERAL RESERVE SYSTEM
THE FEDERAL RESERVE
The Federal Reserve (the Fed) was established in
1913 as America’s central Bank.
It sets the nation’s monetary policy.
The actions of the fed affect everyone daily.
THE FEDERAL RESERVE ACT
Mandates of the Act:
Stable prices
Moderate long term interest rates
Maximum employment
FED ACT-CON’TDECENTRALIZED STRUCTURE


7 member Board of Governor’s in Washington,
DC who are appointed by the President and
confirmed by the Senate.
12 regional Reserve banks with a separate board
of directors and a President
25 branch banks
 Financial Independence
 Congressional oversignt

THE FEDERAL RESERVE DISTRICTS
The country is divided into 12 districts.
 Washington, DC is the headquarters.
 Each district has a main bank located in a major
city. These cities were selected so they are no
more than a 1 days train ride apart.


Houston is in the 11th district.
Dallas is the main Bank
 San Antonio and El Paso have branch banks for our
region.

THE FEDERAL RESERVE
DISTRICTS
ORGANIZATION OF THE FED.



The Fed is a corporation member banks own
stock.
The Fed pays member banks a 6% annual
dividend on Fed stocks.
Any profit by the Fed is returned to the US
treasury. In 2009, this amount was $47.4 billion.
ORGANIZATION OF THE FED
FUNCTIONS OF THE FED
Maintain Stability of the
Financial System
Approve bank mergers
 Watch bank actions
and lending
 Currency supplier

Provide Financial
Services
Bank for U.S.
Government accounts
 Clear checks

FUNCTIONS OF THE FED
Supervise and regulate
banking industry
Regulate foreign
banks in the United
States
 Regulate U.S. banks
overseas
 Regulate military
banks

Conduct monetary policy
Sets reserve
requirement.
 Buy/sell bonds to
raise/lower interest
rates.

FUNCTIONS OF THE FED
Lender of Last Resort

Loans money to
member banks.
THE FED IS A BANKER’S BANK
Payment System
Check processing
 Electronic funds
transfer (EFT)
 Paid over $30 billion
in checks in 2006

Issuer and distributor of
currency



Puts money in
circulation
Distroy’s old money
By 2010 the Fed will
have only 4 check
clearinghouses-Atlanta,
Dallas, Philadelphia
and Cleveland
FISCAL AGENT FOR THE US
TREASURY
Maintain the
treasury’s bank
account.
 Handle weekly actions
of treasury securities.
 Issue and redeem
savings bonds
 The bank for the US
government

REGULATOR AND SUPERVISOR
Examine banks to
foster a sound
banking system
 Ensure compliance
with all consumer
protection laws
 Evaluate Community
Investment
performance

MONETARY POLICYMAKER





Major function of all
central banks
Monetary policy actions
influence availability
and cost of money and
credit
Focus on price stability
Promote savings and
investment
Keep inflation and
unemployment in check.
EXPANDED ROLE OF THE FED.

The fed will have
expanded oversight of
the banking and
credit industry,
including credit card
interest rates.
DIFFERENCE BETWEEN FED AND
TREASURY
The Treasury is the
department in
government which is
in charge of revenue,
taxation and public
finances. They are
the financial
operations for the
government.
 Jack Lew

The Federal Reserve
System is the nations
bank. Its primary
purpose is to regulate
the flow of money and
credit in the country.
 Janet Yellen

SECTION 2: TOOLS OF MONETARY POLICY


The Federal Open
Market Committee
(FOMC) meets 8 times
a year in Washington,
DC and announces
any monetary action
taken.
Actions of the FOMC
affect the country.
SECTION 2: TOOLS OF MONETARY POLICY


The Federal Open
Market Committee
(FOMC) meets 8 times
a year in Washington,
DC and announces
any monetary action
taken.
Actions of the FOMC
affect the country.
RESPONSIBILITIES OF THE FOMC
 Assess
National and regional economic
and financial conditions using regional
perspectives.
 Determine credit and interest rates
policies.
 Target the Federal Funds rate.
 Direct open market operations conducted
by the New York Fed to achieve goals of
price stability and sustainable economic
growth.
SIX TOOLS OF MONETARY POLICY
Open Market Operations

Buy/sell government
securities. This
increases the money
supply
Discount rate

Interest rate the Fed
charges to member
banks for loans.
SIX TOOLS OF MONETARY POLICY
Reserve Requirement
Increase or decrease
required reserves held
by banks.
 Currently 10%

Margin Requirements

How much money is
needed to purchase
stocks.
SIX TOOLS OF MONETARY POLICY
Moral Suasion

Chairman of the Fed
gives his opinion on
the economy.
Selective Credit Controls


Selective, specific
goals usually in
wartime.
During WWII, no cars
were produced.
THE CHAIRMAN OF THE FED.
Ben Bernacke
 Reappointed by
President Obama for a
14 year term.
PART 3MONETARY POLICY, BANKING AND THE
ECONOMY


Short run impact-of an increase or decrease in
the money supply affects the price of borrowing.
The prime rate is the interest rate at commercial
banks charge their best customers.
MONETARY POLICY, BANKING AND THE
ECONOMY
Long run impact- of a change in the money supply
affects the general level of prices or inflation.
The Quantity Theory of Money—example: the
Continental Congress issued $250 million in
currency causing 123% inflation.
EASY MONEY POLICY

A group of actions to
increase the money
supply, fight a
“recession”—easy
money.
Buy government
securities
 Lower discount rate
 Lower reserve
requirement

Interest rates fall
Spending/borrowing
increases
Money supply increases
TIGHT MONEY POLICY

A group of actions by
the Fed to cut the
money supply to fight
inflation—”tight”
money.
Sell government
securities.
 Raise discount rate
 Raise reserve
requirement

Interest rates rise
Spending/borrowing
falls
Money supply falls
THE FED AND THE PRESIDENT

Interest rates are
political because
Presidential elections
are political.

The actions of the fed
are political because
the chair of the Fed is
appointed by the
President.
FEDERAL GOVERNMENT EXPENDITURESOR THE BUDGET



The federal budget year is Oct. 1 to Sept 30 of
each year.
The budget is prepared by the by the Office of
Management and Budget.
The budget must be sent to Congress no later
than Feb. of each year for Congressional
approval.
TWO KINDS OF GOVERNMENT SPENDING
Mandatory Spending


Spending authorized
by law that continues
without the need for
government approval.
Examples: social
security, medicare,
debt payments
Discretionary Spending


Programs that must
receive annual
authorization.
Examples: military
and welfare
ENTITLEMENT PROGRAMS



Entitlement is a guarantee of access to benefits
because of rights or by agreement through law.
Social Security, Medicaid, Medicare are large
entitlement programs that take.
These account for over $1 trillion of the federal
budget.
CHAPTER 10-GOVERNEMENT SPENDING
IMPACT OF GOVERNMENT SPENDING
Easy?
 Recessions-push government spending toward a
deficit.



Why?
Expansionary periods-push government spending
toward a surplus

Why?
TAX REVENUE VS EXPENSES
Gov’t revenue
surplus
Gov’t spending
deficit
balanced budget.
KEYNES-GENERAL THEORY ON
EMPLOYMENT, INTEREST AND MONEY
The level of employment needed is determined by
the spending of Money.
 Which means-persons working cost the
government less money and government collects
more money.

SECTION 4-DEFICITS, SURPLUSES AND
THE NATIONAL DEBT.
DEFICITS, SURPLUSES AND NATIONAL
DEBT
Deficit spending-is the amount by which a
government, private company, or individual's
spending exceeds income over a particular period
of time, also called simply "deficit," or "budget
deficit," the opposite of budget surplus.
 Federal Debt or surplus-The annual government
deficit or surplus refers to the cash difference
between government receipts and spending.


Debt ceiling-limit on government spending
currently-$14.294 trillion by H.J.Res. 45 was
signed into law on February 12, 2010
NATIONAL DEBT


National Debt
What happens when the USA reaches the debt
ceiling?

No more money can be borrowed to finance
government spending.

There is no constitutional requirement that the USA
have an anually balanced budget
STATE OF TEXAS AND DEBT

The State of Texas is required by the
Constitution to have an annually balanced
budget.

This means Texas cannot have a budget deficit.

What happens if they take in less money than they
need to spend?
IMPACT OF THE NATIONAL DEBT



Taxes and tax burden-increase taxes, less money
for consumers to spend.
Larger the debt, the larger the interest
payments; and therefore the more taxes to pay
them.
Increased taxes reduce incentive to work, save
and invest.
PART 1-FUNCTIONS AND CHARACTERISTICS OF MONEY
What is money?
Money is any
substance used
to pay for goods
or services.
Most people say
they do not have
enough money.
History of money
BARTER

Barter is the trading of goods without money.

Yes, barter still happens today.


Pro’s of barter-no government, no taxes. Get
what you need without money, if you have
something to trade.
Con’s of barter-products/services may not divide
evenly. Comparable values may not exist.
FUNCTIONS OF MONEY
Medium of exchange-people must accept as
payment for goods.
Measure of value-measure of what a good is worth
in dollars and cents.
Store of value-place holder of an amount.
EARLY MONEY
CHARACTERISTICS OF MONEY
Portable-easy to carry and exchange
Durable-lasts over time, withstands wear
and tear.
Divisible-divide into smaller units.
*Stable in value-retains value over time.
But, can lose value due to inflation.
Scarce-limited supply.
Accepted-Government or an agency must
approve for use. You can’t just create
your own money.
MONEY IN EARLY SOCIETIES
Commodity money-money with an alternative
use.
 Wampum-sea shells used for money.
 Fiat money-money by government decree.
 Legal tender-currency that must be accepted.
 Representative money-an be exchanged for gold
or silver.
 Specie-gold/silver coins from Europe.

IN THE COLONIES
Commodity and fiat
money was used
including:
tobacco
Gunpowder
Coins
Colonial paper money
MONEY TODAY
Our money today is:
Inconvertible Fiat
Money
MONETARY UNIT
a standard unit of currency.
 Unique to each country

USA-dollar
 Mexico-Peso
 Japan-Yen
 France-Euro

GOLD STANDARD
Advantages
Trade money for gold
 Trust in money
 Keeps government
from printing too
much money.

Disadvantages
Holds back economic
growth.
 Increased demand for
gold lowers reserves.
 Gold price must
remain constant.

GOLD STANDARD




During the Depression
the government gave up
on the gold standard.
People were encouraged
to turn in their gold.
Many did not due to
their loss of faith in
paper money.
Having gold could result
in fines, but people hid
their gold.
GOLD STANDARD
After leaving the gold
standard the US
changed to
inconvertible fiat
money.
 People cannot demand
gold or silver in return
for their money.
 The government
controls the money
supply and issues a
single currency.

BANKS

An organization, usually a corporation, chartered
by a state or federal government, which does
most or all of the following: receives demand
deposits and time deposits, honors instruments
drawn on them, and pays interest on them;
discounts notes, makes loans, and invests in
securities; collects checks, drafts, and notes;
certifies depositor's checks; and issues drafts and
cashier's checks.
SAVINGS AND LOANS

Savings and Loan (S&L)- A federally or state
chartered financial institution that takes
deposits from individuals, funds mortgages, and
pays dividends.
CREDIT UNIONS


A non-profit financial institution that is owned
and operated entirely by its members.
When a person deposits money in a credit union,
he/she becomes a member of the union because
the deposit is considered partial ownership in the
credit union.
BANKS AND BANKING SERVICES


Since deregulation-banks do not charge the same
fees for all services they provide.
Shop for the bank that is right for you.
TYPES OF DEPOSITS
Demand deposits-checking accounts
 Time deposits-savings accounts

Money Market Accounts-a checking account that
is invested in the stock market and can earn
interest and is charged a fee based on market
fluctuations.
 NOW account- Negotiable Order of Withdraw)-An interest-bearing checking account at a bank
or savings and loan.

OTHER BANKING SERVICES

Overdraft protection-A checking account/debit
card feature in which a person has a line of credit
to write checks for more than the actual account
balance.
BANKING SERVICES


Electronic Funds Transfer
(EFT)- Any transfer of funds
that is initiated by
electronic means, such as an
electronic terminal,
telephone, computer, ATM
or magnetic tape.
Automated Teller Machines
(ATM)-a machine at a bank
branch or other location
which enables a customer to
perform basic banking
activities (checking one's
balance, withdrawing or
transferring funds) even
when the bank is closed.
BANKING AND YOU


Debit card- A card which allows customers to
access their funds immediately, electronically.
Unlike a credit card, a debit card does not have
any float.
Certificates of Deposit (CD’s)-CDs are low risk,
low return investments, and are also known as
"time deposits", because the account holder has
agreed to keep the money in the account for a
specified amount of time, anywhere from three
months to six years
BANKING AND YOU



Safe Deposit Box-a lock box in a bank that is
used to store valuable items and documents.
Electronic Banking-banking done on line. This
can be used to pay bills, transfer funds, etc.
Service Charge-Bank fee charged for specific
services or as a penalty for not meeting certain
criteria
TRUTH IN LENDING LAWS


Legislation passed in
some countries, such as
the Home Mortgage
Disclosure Act of 1968
and Consumer Credit
Protection Act of 1969 in
the US.
Under these laws a
lender must, clearly and
conspicuously, reveal all
the key details of a
home mortgage or
consumer loan before
the borrower signs the
loan agreement.

Borrowers who
mortgage their dwelling
house as a collateral are
generally allowed a
cooling off period
(usually three days) to
rethink the implications
of the loan agreement
and to cancel it if they
so decide.
MONEY TODAY
MONEY
Currency
Paper money.

Coins
metal money.

DENOMINATIONS OF MONEY

Currency
$1, $2, $5, $10, $20, $50
and $100’s


Coins
$.01, $.05, $.10, $.25.
$.50, $1.00
OUR MONEY:
BY THE NUMBERS Facts about on how much
each denomination represents in the 9.12 billion
currency notes the Bureau of Engraving and
Printing will produce in the current budget year
and the average life for each note:
 $1 note: 45.5% of total note production; 21
months.
 $5 note: 15.4%; 16 months.
 $10 note: 0.9%; 18 months.
 $20 note: 21.6%; 24 months.
 $50 note: 4.7%; 55 months.
 $100 note: 11.9%; 89 months.

COMPONENTS OF THE MONEY SUPPLY
M1 money-currency, coins and travelers
checks. Money is more liquid.
M2 money-M1+checking and savings
accounts +money market accounts and CD’s.
Money is less liquid.
FT. KNOX KENTUCKY HOLDS THE US
GOLD
FT. KNOX, KENTUCKY AND GOLD
Not all currency is
backed by gold.
 There are 147.3
million ounces of gold.
 The gold is held as an
asset of the US
Government at a book
value of $42.22 per
ounce.
 A gold bar is 400
ounces or 27.5 pounds

MONEY IN CIRCULATION


Approximately $829
billion in circulation.
Most is held outside
the USA.
COUNTERFEIT MONEY


Yes, printing your
own money is a crime.
The Secret Service
investigates
counterfeit money.
SO YOU WANT TO OWN A BANK?
How banks operate:
Banks make money by accepting deposits and
making loans
Liabilities are the debt/obligations of the bank.
Assets are the property/posessions of the bank.
A balance sheet is a statement showing
assets/liabilities of a bank.
The net worth is the excess of assets over
liabilities.

STARTING A BANK
Organize, obtain a charter.
 Buy into the Fed (like buying insurance)
 Make loans

Excess reserves are deposits-reserves
Reaching maturity deposits=loans=economic growth
Loans=monetary growth---loans increase money for
loans.
BANKS IN ACTION
Equity-investment against bankruptcy
 Bank liabilities-obligations to others


Required reserves are the amount of money that
a bank must set aside and not loan. The size of
the reserve is set by the Fed.

This is a fractional reserve system.
BANKS IN ACTION


Most of the deposits are returned to the
community in the form of loans.
Banks invest in bonds: they are a safe
investment and are easily converted to cash.
BANK BALANCE SHEETS
Assets
Liabilities
Bonds
Demand Deposits
Reserve requirement
Time Deposits
Excess Reserves
Capital Stock
Loans
CD’s
Building/Equipment
Total:
Total:
Assets and liabilities must always equal
Notes page 16
BANK PROFIT

For a bank to make a profit it must have a spread
between what is paid out in interest and what it
takes in on interest on loans over 3%
BANKING


A state bank is generally a financial institution
that is chartered by a state. It differs from a
reserve bank in that it does not necessarily
control monetary policy (indeed, the state in
question may have no legal capacity to create
monetary policy), but instead usually offers only
retail and commercial services.
They oppose mandatory membership in the Fed.
BRANCH AND ELECTRONIC
BANKING



Until the 1990’s branch banking was illegal
(having more that one location of the same bank.)
Banks are facing increasing competition.
Electronic banks are putting pressure on brick
and mortar banks due to lower costs.
DEPOSITORY INSTITUTION DEREGULATION
AND MONETARY CONTROL ACT
]
Passed in 1980, gave the Federal Reserve greater control over non-member
banks.
It forced all banks to abide by the Fed's rules.
It allowed banks to merge.
It removed the power of the Federal Reserve Board of Governors to set the
interest rates of savings accounts.
It raised the deposit insurance of US banks and credit unions from $40,000
to $100,000.
It allowed credit unions and savings and loans to offer checkable deposits.
Allowed institutions to charge any interest rates they chose.
FDIC

Since the start of FDIC insurance on January 1,
1934, no depositor has lost a single cent of
insured funds as a result of a failure.
The FDIC receives no Congressional
appropriations – it is funded by premiums that
banks and thrift institutions pay for deposit
insurance coverage and from earnings on
investments in U.S. Treasury securities.
FDIC AND FSLIC
Your money is guaranteed by these groups.
 Look for the seal at your bank.

IS YOUR BANK INSURED?
WHY BANKS FAIL?
Depositors lose money.
 Banks give bad loans
 Confidence is lost in banks


The FDIC/FSLIC can put a bank on a watch list;
if things do not improve the bank will be declared
insolvent.