Macroeconomics
1 Money & Banking
Money provides a low-cost method of trading one good or service for
another. It makes the system of voluntary exchange efficient. Money is
important to everyone in our society. What were the last three economic
transactions you completed using money? Imagine what it would have been
like to make those purchases without paper bills and coins!
This section corresponds to Chapter 10: Sections 1 & 2.
OBJECTIVES
44. Outline the functions that money performs and the characteristics that
money possesses
45. Describe how the money supply in the United States is measured
46. Describe how banking developed in the United States
XLIV. What is Money?
 KEY CONCEPTS
o Money—anything people will accept as a medium of exchange
o Medium of exchange—means through which products can be
exchanged
o Barter—exchanging goods or services for other goods or
services
A. Whatever it is that people accept as money, it should perform 3
important functions.
1. Medium of Exchange: Money should be ways that products
can be exchanged—without which, people have to barter. Barter
is inefficient, because both people must want what the other one
has to exchange. Money is more convenient ★
2. Standard of Value: Money can measure the economic worth of
goods, services in the exchange process. In United States, the
dollar is the standard of value of all products.
3. Store of Value: Money should hold its value over time, and be
set aside for later use—meaning that it will be accepted in the
future. But, it does not function well as store of value when there
is significant inflation.
B. To perform as money, it must have certain physical and economic
properties.
1. ★
a. Durability—sturdy enough to last through many
transactions
b. Portability—small, light, easy to carry
c. Divisibility—divisible so change can be made
d. allows for flexible pricing
e. Uniformity—distinctive features and markings make it
recognizable
2. ★
a. Stability of value—purchasing power should be relatively
stable
b. Scarcity—must be scarce to have any value
c. Acceptability—users must agree that it is valid medium
of exchange
XLV. The Money Supply
 KEY CONCEPTS
o Commodity money—value based on the material from which
it is made
o Representative money—paper money backed by something
tangible
o Fiat money—declared by government to have value, accepted
by citizens
o Currency—paper money and coins
o Demand deposits—checking accounts; funds become currency
on demand
o Near money—savings accounts, time deposits; funds become
cash easily
A. Types of Money: Money derives value from one of three sources.
1. Type 1: Commodity Money is when items have value in
themselves apart from their value as money.
a. It includes gold, precious stones, salt, olive oil. ★
b. Coins most common types of commodity money;
precious metal in them is worth their face value. If the
item becomes too valuable, people hoard it and take it out
of circulation.
2. Type 2: Representative Money can be exchanged for
something else of value.
a. Its beginnings came from the Middle Ages, when people
issued promises to pay in metal, but found it unsafe or
inconvenient to transport gold and silver. Later,
governments regulated the amount stored of metal needed
to back paper.
b. Its value changes with metal supply and price; ★
3. Type 3: Fiat Money is money whose value is based on
government fiat, or order, saying the money has value. The
coins have only a token amount of precious metal; but paper
money has no intrinsic value. The government maintains value
by controlling supply—★
B. Money is an item used immediately for transactions. It includes
currency, demand deposits, and other checkable deposits. Other
financial tools are considered “near money”.
1. Money in narrowest sense sometimes called transactions
money.
a. Currency—paper money and coins—★
b. Demand deposits are mostly noninterest-bearing
checking accounts. Other demand deposits are accounts
like a Negotiable Order of Withdrawal (NOW) and other
checkable deposits.
2. Are Savings Accounts Money? Near money cannot be used
directly to make transactions.
a. Savings account: ★
b. Time deposits: funds deposited for specific period to
receive higher interest. It includes certificates of deposit
(CDs) and money market accounts.
3. How much money is in the United States? The most often
cited instruments for measuring money are M1, M2.
a. M1—currency, demand deposits, other checkable
deposits called ★
b. M2—M1, plus savings accounts, small time deposits, and
money market accounts.
XLVI. Development of Banking
A. Origins of Banking
1. In the Late Middle Ages, Italian merchants stored people’s
money and made loans. American colonial merchants followed
same practice. But private banks were insecure: if merchant’s
business failed, ★
2. After the U.S. Revolution, state banks were chartered by state
governments. Many banks issued own currency, not backed by
gold or silver held
B. Alexander Hamilton: The First Bank of the United States
1. In 1789, Hamilton became first Secretary of the Treasury; He
proposed national bank. Against strong opposition, First Bank of
the United States was chartered in 1791 ★
2. The bank controlled the money supply by refusing state bank
money not backed by gold or silver. It loaned money to federal
government, state banks, and businesses.
C. 19th-Century Developments
1. In. 1811, Congress refused to renew charter of First Bank of
the U.S. But then the government had difficulty financing the
War of 1812. Plus, without a central bank, State banks again
issued currency not linked to gold and/or silver reserves. The
increased money supply ★
2. In 1816, Congress chartered the Second Bank of the United
States. It had more resources than First Bank and made the
money supply more stable. Still, opponents thought the bank
was too powerful and too close to the wealthy. And in 1832,
President Andrew Jackson vetoed renewal of its charter.
D. When the Second Bank’s charter lapsed in 1836, there was no
federal oversight of banking. All banks were state banks, and issued
their own paper currency called bank notes. States passed free
banking laws, resulting in “wildcat banks”, susceptible to bank runs
leading to panics and economic instability.
E. The Struggle for Stability
1. In 1863, the National Banking Act created national banks
chartered by U.S. government. It created a national currency
backed by U.S. Treasury bonds, and required a minimum
amount of capital for national banks to back the currency. They
also taxed state bank notes issued after 1865, ★
2. In 1900, the USA adopted a gold standard, making the dollar
equal a set amount of gold.
F. 20th-Century Developments
1. In 1913, the Federal Reserve System was created, consisting
of 12 regional banks and one decision-making board. It provides
financial services to federal government, makes loans to banks
that serve the public, issues Federal Reserve notes as national
currency, ★
2. Then, in 1929, many banks failed due to bank runs. The
Banking Act of 1933 was part of President Franklin Roosevelt’s
New Deal, regulating the interest rates that banks paid and
prohibited the sale of stocks by banks.
3. Federal Deposit Insurance Corporation (FDIC) insured
people’s savings
4. In 1980 and 1982, laws lifted federal limits on savings interest
rates. The result was that Savings and Loans Associations were
then operating like commercial banks—and made riskier loans.
When so many S&Ls failed, Congress funded an industryrestructuring.
Macroeconomics
2 Modern Banking & Loans
We are living through a time of transition in banking. Technology has
changed the way business operates, and banks are in the middle of that
This section corresponds to Chapter 10: Sections 2 and 3.
OBJECTIVES
47. Identify the banking institutions that operate in the United States
48. Describe the services that banks provide
49. Discuss the changes that deregulation has brought to banking
XLVII. Banking Institutions
A. The term “Bank” includes commercial banks, savings and loan
associations, and credit unions. Both state and federal governments
charter financial institutions. They regulate the amount of money
owners must invest in a bank, the size of reserves a bank must hold,
★
B. Type 1: ★
1. Privately owned commercial banks are oldest type of banks.
They were initially created to provide business loans.
2. Today, they offer checking and savings accounts, loans,
investments, and credit cards. All national banks, and about
16% of state commercial banks belong to the Fed.
C. Type 2: ★
1. S&Ls were first chartered by states in 1830s. They took
savings deposits and provided home mortgage loans.
2. Today, they provide many of same services as commercial
banks.
3. Since 1933, the Federal Government also charters S&Ls. Many
federally chartered S&Ls call themselves savings banks.
D. Type 3: ★
1. In 1909, the first credit union was chartered. In 1934, the
federal system was created.
2. Credit Unions offer savings and checking accounts. They
specialize in auto and mortgage loans. Their deposits insured by
National Credit Union Association (NCUA).
3. Credit unions have membership requirements. They are
cooperatives: nonprofit organizations owned by and operated for
its members.
XLVIII. What Services Do Banks Provide?
A. Banks are like stores where money is bought (borrowed), sold
(lent). Customers can store money, earn money, and/or borrow
money. Banks earn money by charging interest or fees.
B. Service 1: Customers Can Store Money. Banks literally store
currency in vaults. Their deposits are insured against theft or other
loss. Customers also store money in bank accounts. These accounts
are insured against bank failure. ★
C. Service 2: Customers Can Earn Money. Savings accounts and some
checking accounts pay interest—though Money market accounts and
CDs ★
D. Service 3: Customers Can Borrow Money. Banks lend money
through fractional reserve banking, where a percent of deposit banks
must keep is set by Fed, but otherwise, banks make loans to
customers it approves. Loans have a set time period and interest rate.
Property serves as collateral to secure the loan for the bank. Credit
card purchases are also loans, with interest charged after one month.
XLIX. Banking Deregulation
A. Before the 1980s, government regulated interest rates the paid and
charged by banks. They required banks to operate in one state, and
some states limited the number of branches that a bank could have. In
the 1980s and 1990s, deregulation ended those restrictions ★
B. Deregulation led to mergers, as there were no more restrictions on
interstate banking
1. Advantages: More competition meant low interest rates, more
services, and also more branches. Banks can operate with
economies of scale—especially for technology.
2. Disadvantages: There are fewer banks to choose from. Many
people fear that larger banks are uninterested in small
customers or local communities.
C. The Financial Services Act of 1999 lifted last restriction on banks.
Now, banks, insurance companies, and investment companies can
compete to sell stocks, bonds, and insurance, as well as traditional
banking services. Still, ★