Chapter Introduction
Section 1:
The Evolution,
Functions, and
Characteristics of
Money
Section 2:
The Development of
Modern Banking
Section 3:
The Federal
Reserve System
and Monetary Policy
Visual Summary
Congratulations, you have just
been hired by the federal
government to completely redesign
our money. Before getting started
on your design, think about how we
use money. Working with a partner,
create a design for the new bills
and coins. Share your finished
product with the class and explain
why your money will serve the
same purpose(s) as our existing
money. Read Chapter 14 to learn
more about our monetary system
and how the government works to
promote economic stability
and growth.
Governments strive for a
balance between the costs
and benefits of their
economic policies to promote
economic stability and
growth.
Section Preview
In this section, you will learn that money functions
as a medium of exchange, a measure of value,
and a store of value.
Content Vocabulary
• Federal
• commodity
Reserve
money
System (Fed)
• fiat money
• Federal
• specie
Reserve
notes
• monetary unit
• barter
• medium of
economy
exchange
Academic Vocabulary
• evolution
• converted
• measure of value
• store of value
• demand deposit
accounts (DDAs)
• M1
• M2
Would you prefer to obtain goods by
bartering or exchanging paper
currency?
A. bartering
B. exchanging paper currency
A. A
B. B
0%
A
0%
B
The Evolution, Functions, and
Characteristics of Money
• The Federal Reserve System (Fed)
issues most of the money in U.S.
circulation.
• Paper currency—Federal Reserve notes
The Evolution of Money
People invented money to
make life easier.
The Evolution of Money (cont.)
• In a barter economy, exchange of goods
and services must have a “mutual
coincidence of wants.”
• Money in primitive societies
– Commodity money
– Fiat money
The Evolution of Money (cont.)
• The Continental Congress issued paper
money to finance the Revolutionary War
in 1775.
• Colonists also used specie like English
shillings, Austrian talers, and Spanish
pesos brought over by immigrants.
• The dollar is the basic monetary unit of
currency in the U.S. money system.
A “mutual coincidence of wants”
refers to
A. A barter economy
B. Commodity money
C. Fiat money
0%
A
A. A
B. B
C.0%C
B
0%
C
Characteristics and Function
of Money
Anything can be used as
money as long as it is
portable, durable, divisible,
and limited in supply.
Characteristics and Function
of Money (cont.)
• Characteristics of money
– Portable
– Durable
– Divisible into smaller units
– In limited supply
Characteristics and Function
of Money (cont.)
• Functions of money in the economy
– Medium of exchange
– Measure of value
– Store of value
Characteristics and Function
of Money (cont.)
• Today’s money
– Federal Reserve notes
– Metallic coins issued by the U.S. Bureau
of the Mint
– Demand deposit accounts (DDAs)
Characteristics and Function
of Money (cont.)
• The Fed has different definitions for the
money supply.
– M1
– M2
What areas of the world were participants in
the “triangular trade”?
A. Africa, Spain, and the
North American colonies
0%
D
0%
C
D. Caribbean, Spain, and Africa
B
C. Africa, Caribbean, and
North American colonies
A. A
B. B
C. C
0%
0%
D. D
A
B. Spain, North American
colonies, and the Caribbean
Section Preview
In this section, you will learn that many different
types of money have been used throughout
American history, and fiat money is used today.
Content Vocabulary
• state bank
• legal tender
• national bank
• national
currency
• gold certificate • fractional
reserve system
• silver certificate
• legal reserves
• central bank
• reserve
• bank run
requirement
• bank holiday
• member bank
reserves (MBR)
Academic Vocabulary
• clauses
• initially
• excess reserves
Do you think the government should
regulate banking?
A. Yes
B. No
C. Sometimes
0%
A
A. A
B. B
C.0%C
B
0%
C
The Development of Banking
in America
The United States
experimented with many
different kinds of money
before it created the Federal
Reserve System.
The Development of Banking
in America (cont.)
• Abuse and other problems in an
unregulated money supply led to
government intervention.
• After ratification of the U.S. Constitution,
state banks issued their own paper
currency.
The Development of Banking
in America (cont.)
• Currency problems
– Each bank issued own currency in
different sizes, colors, and
denominations.
– Banks were tempted to issue more
notes than backed with silver or gold.
– Counterfeiting became a problem.
The Development of Banking
in America (cont.)
• Congress printed paper currency in 1861
declaring it legal tender.
• Individuals referred to new paper notes as
“greenbacks.”
• The National Currency Act in 1863 created
a National Banking System (NBS).
The Development of Banking
in America (cont.)
• A national bank issued its own notes
called national currency.
– This was backed with bonds banks
purchased from federal government.
– Government was engaged in bank
inspections.
– 10% tax applied to all privately issued
bank notes.
The Development of Banking
in America (cont.)
– Gold certificates were issued.
– Silver certificates were introduced
in 1878.
What event changed the commercial
banking industry in the United States
forever?
A. Revolutionary War
B. Industrialization
C. Civil War
D. Mining of silver
0%
A
A.
B.
C.
0%
D.
B
A
B
C
0%
D
C
0%
D
The Creation of the Fed
The Federal Reserve System
is the nation’s central bank.
The Creation of the Fed (cont.)
• By the 1900s, the National Banking
System was showing signs of strain.
– Difficulty in providing enough currency
for a growing nation
– System not designed for popular method
of paying—checking accounts
– Minor recessions caused major
problems for banks and lending
institutions.
The Creation of the Fed (cont.)
• Congress created the Federal Reserve
System, or Fed, as the nation’s central
bank in 1913.
– Membership required by all national
banks
– State-chartered banks were eligible for
membership.
– Membership banks purchased stock in
the Fed.
The Creation of the Fed (cont.)
• The Fed issued its own currency, replacing
all other types of currency.
• Despite creation of the Fed, banking
industry was overextended when Great
Depression began in 1929.
State and National Banks
The Creation of the Fed (cont.)
• Banks did not have deposit insurance for
customers.
• Bank runs caused many banks to fail.
• Bank holiday—declared by President
Roosevelt March 5th, 1933
The Creation of the Fed (cont.)
• The Banking Act of 1933 (Glass-Steagall
Act) created the FDIC:
– Insures customer deposits to a
maximum specified amount if case of
failure
– Provides sense of security
– Can seize banks and sell them if in
danger of collapse
The Creation of the Fed (cont.)
• Popularity of checking accounts led to
reforms in the use of fractional bank
reserves.
• Fractional reserve system—banks are
required to keep only a portion of their total
deposits in the form of legal reserves.
• Size of reserve is determined by a reserve
requirement and is set aside in vault as
cash or in a member bank reserve (MBR).
The Creation of the Fed (cont.)
• Remaining excess reserves represents
the bank’s lending power and can be
loaned out.
Fractional Reserves and the Money Supply
What is the percentage of reserve
requirement currently used by banks?
A. 25%
B. 15%
C. 20%
D. 10%
0%
A
A.
B.
C.
0%
D.
B
A
B
C
0%
D
C
0%
D
Section Preview
In this section, you will learn how the Federal
Reserve System is organized and conducts
monetary policy.
Content Vocabulary
• member bank • tight money
policy
• monetary
policy
• open market
operations
• interest rate
• discount rate
• easy money
policy
• prime rate
• quantity theory
of money
Academic Vocabulary
• Regulation Z
• aspects
• functions
• currency
• coins
• bank holding
companies
The chairman of the Federal Reserve
Board is considered to be the second
most powerful individual in the
nation.
A. True
A. A
B. B
B. False
0%
A
0%
B
Structure of the Fed
The Fed is organized as a
corporation, owned by its
member banks, and
directed by a governmentappointed board.
Structure of the Fed (cont.)
• The Fed
– Privately owned by its member banks
– Directed by a seven-member Board of
Governors
• Appointed by the President and approved by
the Senate
• Each serves a 14-year term
• Primarily a regulatory and supervisory
agency to member banks
Structure of the Fed (cont.)
• The Fed
– Operates 12 Federal Reserve district banks
• The Federal Open Market Committee (FOMC)
makes decisions about interest rates.
– Twelve voting members including sevenmember Board of Governors
– Meet eight times a year to review the
economy and make monetary changes
Structure of the Fed (cont.)
• Three committees advise the Board of
Governors.
– The Federal Advisory Council advises
on matters concerning overall health of
economy.
– The Consumer Advisory Council advises
on consumer credit laws.
Profiles in Economics:
Ben S. Bernanke
Structure of the Fed (cont.)
• Three committees advise the Board of
Governors.
– Thrift Institutions Advisory Council
advises on matters pertaining to Savings
and Loan industry.
Structure of the Federal Reserve System
What are some trends in the economy
that the FOMC reviews?
A. Construction
B. Employment
C. Consumer spending
D. All of the above
0%
A
A.
B.
C.
0%
D.
B
A
B
C
0%
D
C
0%
D
Conducting Monetary Policy
Monetary policy involves
expanding and contracting
the money supply to change
the level of interest rates.
Conducting Monetary Policy (cont.)
• The Fed is responsible for monetary
policy.
• More money is demanded when the
interest rate is low.
• Easy money policy
• The Fed restricts the size of the money
supply in a tight money policy.
Short-Run Impact of Monetary Policy
Conducting Monetary Policy (cont.)
• Fed uses three major tools to conduct
monetary policy:
– Reserve requirement
– Open market operations
– Discount rate—Prime rate
The Reserve Requirement as a
Tool of Monetary policy
Conducting Monetary Policy (cont.)
• Impact of monetary policy
– Impact is complex
– Length of time for impact is unknown.
– Money supply also affects general price
level—quantity theory of money.
Monetary Policy Tools
If the Fed lowers the discount rate,
what effect does that have on your
purchase of a used car?
A. Interest rate decreases, lowering
the cost of financing.
A. A
B. B
C. C
A
C. No impact on your purchase
0%
0%
C
0%
B
B. Interest rate increases; therefore,
cost of financing goes up.
Other Fed Responsibilities
As the nation’s central bank,
the Fed is responsible for
most aspects of banking and
the payments system.
Other Fed Responsibilities (cont.)
• Additional Fed responsibilities
– Maintaining the money supply
• Currency—notes printed by the U.S. Bureau
of Engraving and Printing
• Coins produced by the Bureau of the Mint
Other Fed Responsibilities (cont.)
• Additional Fed responsibilities
– Maintaining the payments system
• Electronic transfer of funds via
clearinghouses
• Internet banking
Other Fed Responsibilities (cont.)
• Additional Fed responsibilities
– Regulating and supervising banks
• Establishes and monitors guidelines
governing banking behavior including bank
holding companies
Other Fed Responsibilities (cont.)
• Additional Fed responsibilities
– Preparing consumer legislation
• Implements consumer legislation such as
federal Truth in Lending Act
– Regulation Z
• Serving as the federal government’s bank
Which is not considered an action
conducted by the government’s bank?
A. Nationwide auctions of
Treasury securities
B. Regulation Z disclosures
C. Maintains demand deposit
accounts for Treasury
D. Operation of clearinghouses
A. A
B. B
C. 0%
C
0%
D. D
A
B
0%
C
0%
D
Money People began using money because it
made buying and selling easier than bartering.
Development of Modern Banking Problems with
the money supply before 1914 led to the creation of
the Federal Reserve System.
Monetary Policy The Federal Reserve System has
three main policy tools at its disposal. It uses these
tools to affect the money supply and interest rates.
Ben S. Bernanke (1953–
• distinguished academic
career as an economics
professor
• sworn in as chairman of the
Federal Reserve Board
in 2006
)
Economic Concepts
Transparencies
Transparency 5
Economic
Institutions and
Incentives
Transparency 6
Exchange, Money,
and
Interdependence
Transparency 18 Monetary Policy
Select a transparency to view.
Federal Reserve System (Fed)
privately owned, publicly controlled,
central bank of the United States
Federal Reserve notes
paper currency issued by the Fed in
use today
barter economy
moneyless economy that relies on
trade or barter
commodity money
money that has an alternative use as
an economic good
fiat money
money by government decree
specie
money in the form of gold or
silver coins
monetary unit
standard unit of currency in a
country’s money supply
medium of exchange
money or other substance generally
accepted as payment for goods and
services
measure of value
a function of money that allows it
to serve as a common way to
express value
store of value
a function of money that allows
people to preserve value for
future use
demand deposit account
(DDA)
account from which funds can be
removed by writing a check and
without having to gain prior approval
from the depository institution
M1
component of the money supply
relating to money’s role as a medium
of exchange
M2
component of the money supply
relating to money’s role as a store
of value
revolution
an overthrow of government
converted
changed into a different form
state bank
bank that receives its charter from the
state in which it operates
legal tender
fiat currency that must be accepted
for payment by decree of the
government
national bank
commercial bank chartered by the
National Banking System
national currency
currency backed by government
bonds and issued by commercial
banks in the National Banking System
gold certificate
paper currency backed by gold and
issued between 1863 and 1934
silver certificate
paper currency backed by, and
redeemable for, silver from 1878
to 1968
central bank
bank that can lend money to other
banks in times of need
bank run
sudden rush by depositors to
withdraw all deposited funds,
generally in anticipation of bank
failure or closure
bank holiday
brief period during which all banks or
depository institutions are closed to
prevent bank runs
fractional reserve system
system requiring financial institutions
to set aside a fraction of their deposits
in the form of reserves
legal reserves
currency and deposits used to meet
the reserve requirement
reserve requirement
formula used to compute the amount
of a depository institution’s required
reserves
member bank reserve (MBR)
reserves kept by member banks at
the Fed to satisfy reserve
requirements
excess reserves
financial institution’s cash, currency,
and reserves not needed for reserve
requirements
clauses
distinct articles or provisions in a
contract, treaty, will, or other formal or
legal document
initially
originally; at the beginning
member bank
bank belonging to the Federal
Reserve System
monetary policy
actions by the Federal Reserve
System to expand or contract the
money supply in order to affect the
cost and availability of credit
interest rate
the price of credit to a borrower
easy money policy
monetary policy that results in lower
interest rates and greater access to
credit
tight money policy
monetary policy that results in higher
interest rates and restricted access to
credit
open market operations
sales or purchases of U.S.
government securities by the Fed
discount rate
interest rate that the Federal Reserve
System charges on loans to the
nation’s financial institutions
prime rate
lowest rate of interest rate that banks
charge their best customers
quantity theory of money
hypothesis that the supply of money
directly affects the price level over the
long run
currency
paper component of the money
supply, today consisting of Federal
Reserve notes
coins
metallic forms of money such as
pennies, nickels, dimes, and quarters
bank holding company
company that owns and controls one
or more banks
Regulation Z
provision extending truth-in-lending
disclosures to consumers
aspects
parts, phases
functions
roles or purposes
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