Chapter 24
Money and the Federal
Reserve System
• Key Concepts
• Summary
• Practice Quiz
• Internet Exercises
©2002 South-Western College Publishing
1
What is barter?
The direct exchange of one
good for another good,
rather than for money
2
What is the problem
with barter?
It requires a
coincidence of wants
3
What is money?
Anything that serves as
a medium of exchange,
unit of account, and
store of value
4
What is the advantage
of money?
The use of money
simplifies and therefore
increases market
transactions
5
What are the
functions of money?
• Medium of exchange
• Unit of account
• Store of value
6
What is a
medium of exchange?
The primary function of
money to be widely
accepted in exchange
for goods and services
7
What is a
unit of account?
The function of money to
provide a common
measurement of the
relative value of goods
and services
8
What does it mean that
money is liquid?
It is available to spend in
exchange for goods
and services without
any additional expense
9
Are credit
cards money?
No, credit cards fail to
meet the store-ofvalue criterion and are
therefore not money
10
What is the best level
of scarcity for money ?
The supply of money
must be great enough
to meet ordinary
transactions needs, but
not be so plentiful that
it becomes worthless
11
What are other
properties of money?
Money must be …
• portable
• divisible
• uniform
• acceptable
12
What is
commodity money?
Anything that serves as
money while having
market value in other uses
13
Is our money backed
up by gold or silver?
No, our paper money was
exchangeable for gold until
1934, and in 1963 Congress
removed the right to
exchange $1 bills for silver
14
What is fiat money?
Money accepted by
law and not because
of redeemability or
intrinsic value
15
What makes our dollar
bills fiat money?
All our bills claim that “This
note is legal tender for all
debts public and private”
16
What does
legal tender mean?
Legally dollar bills
cannot be refused as
payment for a debt
17
What is currency?
Money, including coins
and paper money
18
What are
checkable deposits?
The total of checking
account balances in
financial institutions
convertible to currency “on
demand” by writing a check
without advance notice
19
What is M1?
The narrowest definition
of the money supply. It
includes currency,
traveler’s checks, and
checkable deposits
20
What is M2?
The definition of the
money supply that
equals M1 plus near
monies, such as
savings deposits and
small time deposits of
less than $100,000
21
What is M3?
The definition of the
money supply that
equals M2 plus large
time deposits of
$100,000 or more
22
What distinguishes M1
from M2 and M3?
M1 is more liquid
than M2 or M3
23
The Money Supply
Currency
Traveler's checks checkable deposits
24
The Money Supply
M1
Savings deposits
Small time
deposits
25
The Money Supply
M2
Large time
deposits
26
What is the federal
reserve system?
The 12 central banks that
service banks and other
financial institutions
within each of the
Federal Reserve districts
27
What is the Board of
Governors of the Fed?
The seven members
appointed by the
President and confirmed
by the U.S. Senate
28
How long does a
board member serve?
They serve for a
non-renewable
fourteen-year term
29
What is the
responsibility of
the board?
To supervise and control the
money supply and the
banking system of the U.S.
30
What is the chairman
of the Board of
Governors?
The President designates
one member of the Board
to serve as chair for a
renewable four-year term
31
Who is
Alan Greenspan?
Chairman of the Board
of Governors of the Fed
32
What is the Federal
Open Market
Committee?
The FOMC is the Fed’s
committee that directs the
buying and selling of U.S.
government securities
33
What is the purpose
of the FOMC?
To increase the
money supply if we
have unemployment
and decrease it if we
have inflation
34
What is the Federal
Advisory Council?
12 prominent commercial
bankers who council
board members but who
do not have voting rights
35
What percent of all
deposits reside in
member banks?
About 70%
36
The Fed’s
Board of Governors Organization
Regional Fed Banks
U.S. Banking System
37
What does a Federal
Reserve Bank do?
• Controls the money supply
• Clears checks
• Supervises and regulates
banks
• Maintains and circulates
currency
• Protects consumers
• Maintains federal government
checking accounts and gold
38
What is the Federal
Deposit Insurance
Corporation?
The FDIC is a government
agency established in
1933 to insure commercial
bank deposits up to a
specified limit
39
What is the
Monetary Control Act?
A 1980 law that gave
the Fed greater
control of nonmember
banks and makes all
financial institutions
more competitive
40
Key Concepts
41
Key Concepts
•
•
•
•
•
•
•
What is barter?
What is money?
What are the functions of money?
What does it mean that money is liquid?
What are other properties of money?
What is commodity money?
Is our money backed up by gold or silver?
42
Key Concepts cont.
•
•
•
•
•
•
•
What is fiat money?
What is currency?
What is M1?
What is M2?
What is M3?
What is the Federal Reserve System?
What is the Board of Governors?
43
Key Concepts cont.
• What is the Chairman of the Board of
Governors?
• What is the Federal Open Market
Committee?
• What is the Federal Advisory Council?
• What does a Federal Reserve Bank do?
• What is the Federal Deposit Insurance
Corporation (FDIC)?
44
Summary
45
Money can be anything that
meets these three tests. Money
must serve as (1) a medium of
exchange, (2) a unit of account,
and (3) a store of value. Money
facilitates more efficient
exchange than barter. Other
desirable properties of money
include scarcity, portability,
divisibility, and uniformity.
46
Medium of exchange is the most
important function of money. This
means that money is widely
accepted in payment for goods
and services.
47
Unit of account is another important
function of money. Money is used to
measure relative values by serving
as a common yardstick for valuing
goods and services.
48
Store of value is the property
of money to hold its value over
time. Money is said to be
highly liquid, which means it is
readily usable in exchange.
49
Credit cards are not money.
Credit cards represent a shortterm loan and therefore fail as
a store of value.
50
Commodity money is money
that has a marketable value,
such as gold and silver. Today,
the U.S. uses fiat money,
which must be accepted by
law, but is not convertible into
gold, silver, or any commodity.
51
M1 is the narrowest definition
of money, which equals
currency plus traveler’s checks
plus checkable deposits.
52
M2 is a broader definition of
money, which equals M1 plus
near monies, such as savings
deposits and small time deposits.
53
M3 is an even broader definition
of money, which equals M2 plus
large time deposits of more than
$100,000 or more.
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Chapter 24 Quiz
©2002 South-Western College Publishing
55
1. Which of the following is a problem with
barter?
a. Individuals will not exchange goods.
b. Individuals’ wants must coincide in
order for there to be exchange.
c. Goods can be exchanged, but services
cannot.
d. None of the above is a problem.
B. Finding coincidence of wants
complicates and therefore decreases
market transactions.
56
2. Which of the following is not a
characteristic of money?
a. It provides a way to measure the
relative value of goods and services.
b. It is always backed by something of
high intrinsic value such as gold or
silver.
c. It is generally acceptable as a medium
of exchange.
d. It allows for saving and borrowing.
B. Gold or silver backing for U.S. paper
money was removed in 1934.
57
3. Which of the following is a store of
value?
a. NOW account.
b. Money market mutual fund share.
c. Repurchase agreement.
d. All of the above.
D. Each of the above hold its
value over time.
58
4. The easier it is to convert an asset
directly into goods and services without
loss, the
a. less secure it is.
b. more secure it is.
c. more liquid it is.
d. less liquid it is.
C. Money is the most liquid form of
wealth because it can be spent
directly in the marketplace.
59
5. M1 refers to
a. the money supply.
b. currency held by the public plus
checking account balances.
c. the smallest of the money-supply
definitions.
d. all of the above.
D. M1 is the narrowest definition of
the money supply.
60
6. The M1 definition of the money supply
includes
a. coins and currency in circulation.
b. coins and currency in circulation,
checkable deposits, and traveler’s
checks.
c. Federal Reserve notes, gold
certificates, and checkable deposits.
d. Federal Reserve notes and bank
loans.
B. Answers a is incomplete and c and d
are not answers because gold
certificates and bank loans are not
included in M1.
61
7. Which of the following items is
not included when computing
M1?
a. Coins in circulation.
b. Currency in circulation.
c. Savings accounts.
d. Checking account entries.
C. Savings accounts are included in M2.
62
8. Which one of the following is part of
the M2 definition of the money supply,
but not part of M1?
a. Traveler’s checks.
b. Currency held in banks.
c. Currency in circulation.
d. Money market mutual shares.
D. Note that M1 is part of M2.
63
9. Which of the following is not part of
M1?
a. Checking accounts.
b. Coins.
c. Credit cards.
d. Traveler’s checks
e. Paper currency.
C. Credit cards are not considered
money. They fail to meet the store of
value characteristic.
64
10. Which definition of the money supply
includes credit cards, or “plastic
money”?
a. M1.
b. M2
c. M3.
d. All of the above
e. None of the above.
E. Credit cards are not money because
they fail to serve as a store of value.
65
11. Which of the following institutions
has the responsibility to control the
money supply?
a. Commercial banks.
b. Congress.
c. The U.S. Treasury Department.
d. The Federal Reserve System.
D. The Federal Reserve System is our
central bank.
66
12. Which of the following is not one of
the function of the Federal Reserve?
a. Clearing checks.
b. Printing currency.
c. Supervising and regulating banks.
d. Controlling the money supply.
B. The U.S. Treasury prints our
currency.
67
13. Which of the following is in charge of
the buying and selling of government
securities by the Fed?
a. The president.
b. The Federal Open Market Committee.
c. The Congress.
d. None of the above.
B. Selling U.S. securities (Treasury bills,
notes, and bonds) is one of the major
tools for controlling the money supply.
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14. The major protection against sudden
mass attempts to withdraw cash from
banks is the
a. Federal Reserve.
b. Consumer Protection Act.
c. deposit insurance provided by the
FDIC.
d. gold and silver backing the dollar.
C. The FDIC is a government agency
established by Congress in 1933 to
insure commercial bank deposits up
to $100,000 per bank account.
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END
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