Chapter 12
12
Money and
Banking
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Copyright 2008 The McGraw-Hill Companies
Chapter 12
Chapter Objectives
• The Functions of Money and the
Components of the U.S. Money Supply.
• What “Backs” the Money Supply, Making
Us Willing to Accept It?
• The Makeup of the Federal Reserve and
the U.S. Banking System.
• The Functions and Responsibilities of the
Federal Reserve.
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Copyright 2008 The McGraw-Hill Companies
Chapter 12
Money Defined
• Money is any item that is generally
acceptable to sellers in exchange for
goods and services.
• The Functions of Money.
– Medium of Exchange.
• Money can be used for buying and selling
goods and services.
– Unit of Account.
• Prices are quoted in dollars and cents.
– Store of Value.
• Money allows us to transfer purchasing power
from present to future. It is the most liquid
(spendable) of all assets, a convenient way to
store wealth.
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Copyright 2008 The McGraw-Hill Companies
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Chapter 12
Money Defined
Components of the Money Supply.
• Narrow definition of money: M1 includes
currency and checkable deposits.
– Currency (coins + paper money) held by
public.
• Accounts for 54% of M1.
– Checkable Deposits.
• Accounts for 46% of M1.
– Other Liquid Savings Deposits.
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Copyright 2008 The McGraw-Hill Companies
Chapter 12
Money Defined
• Currency.
– Coins and Paper Money.
– Token Money.
• Means its intrinsic value is less than actual
value. For example, the metal in a dime is
worth less than 10¢.
– Federal Reserve Notes.
• All paper currency consists of Federal Reserve
Notes issued by the Federal Reserve.
• Checkable Deposits.
– Commercial Banks.
• Commercial banks are a main source of
checkable deposits for households and
businesses.
– Thrift Institutions.
• Savings & loans, credit unions, and mutual
savings banks also have checkable deposits.
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Copyright 2008 The McGraw-Hill Companies
Chapter 12
Money Defined
• A Qualification.
– Currency and checkable deposits held by
the federal government, Federal Reserve,
or other financial institutions are not
included in M1.
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Copyright 2008 The McGraw-Hill Companies
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Chapter 12
Money Defined
• M1
– Currency.
– Checkable Deposits.
• M2
– M1
– Near-Monies.
– Savings Deposits Including Money Market
Deposit Accounts (MMDA).
– Small Time Deposits.
• Small time deposits (certificates of deposit) less
than $100,000.
– Money Market Mutual Funds (MMMF).
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Copyright 2008 The McGraw-Hill Companies
Chapter 12
Money Defined
M1
February 2006
54%
M1
Checkable Deposits +
46%
20%
Small Time Deposits +
15%
Money Market Mutual
Funds Held By Individuals +
(MMMF)
11%
Savings Deposits
Including Money Market +
Deposit Accounts (MMDA)
54%
Totals
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M2
Currency +
$1,375
Billion
$6,758
Billion
Copyright 2008 The McGraw-Hill Companies
Chapter 12
Money Defined
• Money Definition MZM.
• MZM = M2 – small time deposits + money
market mutual fund balances owned by
businesses.
• MZM stands for “money zero maturity”
and measures monetary balances that are
immediately available, at no cost, for
household and business transactions.
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Copyright 2008 The McGraw-Hill Companies
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Chapter 12
Money Defined
• Money Definition MZM.
–
–
–
–
Money Zero Maturity.
Immediately Available.
From M2 Subtract Small Time Deposits.
Add Back Money Market Mutual Funds.
Owned by Businesses (MMMF).
– Slightly Larger than M2.
– February 2005 M2 was $6,758 Billion and
MZM was $6,934 Billion.
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Copyright 2008 The McGraw-Hill Companies
Chapter 12
Money Supply
• Are Credit Cards Money?
– Credit cards are not money, but their use
involves short term loans.
• What “Backs” the Money Supply?
– The government’s ability to keep its value
stable provides the backing.
– Stable Value of Money.
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Copyright 2008 The McGraw-Hill Companies
Chapter 12
Money Supply
Value of Money.
• Value of money arises not from its
intrinsic value, but its value in exchange
for goods and services.
– Acceptability.
• It is acceptable as a medium of exchange.
– Legal Tender.
• Currency is legal tender or fiat money.
– Relative Scarcity.
• The relative scarcity of money compared to
goods and services will allow money to retain
its purchasing power.
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Copyright 2008 The McGraw-Hill Companies
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Chapter 12
Money Supply
• Money and Prices.
– Purchasing Power of the Dollar.
– Money’s purchasing power determines its
value. Higher prices mean less purchasing
power.
$V = 1/P
– Inflation and Acceptability.
• Stabilizing Money’s Purchasing Power.
– Intelligent Management of the Money
Supply (Monetary Policy).
– Appropriate Fiscal Policy.
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Copyright 2008 The McGraw-Hill Companies
Chapter 12
Federal Reserve System
• The Federal Reserve and the Banking System.
– Historical Background.
• The Federal Reserve System (the “Fed”) was
established by Congress in 1913 and holds power
over the money and banking system.
– Board of Governors.
• The central controlling authority for the system is
the Board of Governors and has seven members
appointed by the President for staggered 14 year
terms.
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Chapter 12
Federal Reserve System
• The Federal Reserve and the Banking
System.
– Federal Open Market Committee
(FOMC).
• The FOMC includes the seven governors plus
five regional Federal Reserve Bank presidents
whose terms alternate.
• They set policy on buying and selling of
government bonds (Open Market Operations),
the most important type of monetary policy,
and meet several times each year.
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Chapter 12
Federal Reserve System
Framework of the Federal Reserve
System and the Relationship to the Public
Board of Governors
Federal Open Market Committee
12 Federal Reserve Banks
Commercial Banks
Thrift Institutions
(Savings and Loan Associations,
Mutual Savings Banks,
Credit Unions)
The Public
(Households and
Businesses)
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Chapter 12
Federal Reserve System
The 12 Federal Reserve Banks
Source: Federal Reserve Bulletin
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Copyright 2008 The McGraw-Hill Companies
Chapter 12
Federal Reserve System
The 12 Federal Reserve Banks
• Private and Public Control.
• Central Bank.
• Quasi-Public Banks.
– It is owned by member banks but controlled
by the government’s Federal Reserve Board,
and any profits go to the U.S. Treasury.
• Banker’s Banks.
– They act as bankers’ banks by accepting
reserve deposits and making loans to banks
and other financial institutions.
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Chapter 12
Federal Reserve System
• Commercial Banks and Thrifts.
– About 7,600 commercial banks existed in
2006. They are privately owned and consist
of state banks (about 75% of total) and large
national banks (chartered by the Federal
government).
– Thrift institutions consist of savings and loan
associations, credit unions, and mutual
savings banks. They are regulated by the
Treasury Dept. Office of Thrift Supervision,
but they may use services of the Fed and
keep reserves on deposit at the Fed. Of the
approximately 11,400 thrift institutions, most
are credit unions.
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Chapter 12
Federal Reserve System
Fed Functions and the Money Supply
• Issuing Currency.
• Setting Reserve Requirements and
Holding Reserves.
• Lending Money to Banks and Thrifts.
– Charge them an interest rate called the
discount rate.
•
•
•
•
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Check Collection.
Fiscal Agent for U.S.
Supervising Banks.
Controlling the Money Supply.
Copyright 2008 The McGraw-Hill Companies
Chapter 12
Federal Reserve System
Fed Functions and the Money Supply
• Federal Reserve Independence.
• Recent Developments.
– Relative Decline of Banks and Thrifts.
– Consolidation Among Banks and Thrifts.
– Convergence of Services Provided by
Financial Institutions.
– Globalization of Financial Markets.
– Electronic Payments.
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Chapter 12
Financial Institutions
Global Perspective
World’s Largest Financial Institutions
2005 Assets (Millions of U.S. Dollars)
•
•
•
•
•
•
•
•
•
•
•
•
Barclays (U.K.)
UBS (Switzerland)
Citigroup (U.S.)
ING Group (Netherland)
Mizuho Financial (Japan)
Allianz Worldwide (Germany)
Bank of America (U.S.)
HSBC Group (U.K.)
BNP Paribus (France)
JPMorgan Chase (U.S.)
Deutsche Bank Group (Germany)
Royal Bank of Scotland (U.K.)
$1,587,061
1,519,399
1,494,037
1,369,546
1,325,227
1,300,648
1,291,795
1,274,219
1,227,951
1,198,942
1,134,826
1,119,901
Source: Forbes Global 2000
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Copyright 2008 The McGraw-Hill Companies
Chapter 12
Financial Institutions
Major U.S. Financial Institutions
•
•
•
•
•
•
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Commercial Banks.
Thrifts.
Insurance Companies.
Mutual Fund Companies.
Pension Funds.
Securities Firms.
Copyright 2008 The McGraw-Hill Companies
Chapter 12
Key Terms
•
•
•
•
•
•
•
•
•
•
•
•
•
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Medium of exchange
Unit of account
Store of value
M1
Token money
Federal Reserve Notes
Checkable deposits
Commercial banks
Thrift institutions
Near-monies
M2
Savings account
Money market deposit
account (MMDA)
• Time deposits
• Money market mutual
fund (MMMF)
• MZM
• Legal tender
• Federal Reserve
System
• Board of Governors
• Federal Reserve Banks
• Federal Open Market
Committee (FOMC)
• Financial services
industry
• Electronic payments
Copyright 2008 The McGraw-Hill Companies
8
Chapter 12
Next Chapter Preview…
Money Creation
Chapter 13
12-25
Copyright 2008 The McGraw-Hill Companies
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