Money & banking

Money & banking
Chapter 10
• Money – anything people will accept as
payment for goods and services.
• Money itself has changed over time: salt,
paper money, gold coins, beads, shells, etc.
Functions of Money
1. Money must serve as a medium
of exchange.
People must be willing to accept
your money for goods and
Contrasts with bartering- trading
goods and services for other
goods and services.
Functions of Money , cont.
2. Money also serves as a standard of value—
a set value that allows people to measure
the relative cost of goods & services.
Functions of Money , cont.
3. Store of value-something that holds its value
over time.
People understand that money will be accepted
wherever and whenever it is presented to
purchase goods and services.
Inflation (a general rise in overall prices) causes
money to have less stored value.
Properties of money
1. Physical properties:
• Durability-should be sturdy to
last throughout many
• Portability –must be small and
easy to carry
• Divisibility-must be divisible in
order to make change
• Uniformity-must be identical,
having features that make it
Song Dynasty Jiaozi, the
world's earliest paper money
Properties of money , cont.
2. Economic properties (how valuable it is) :
• Stability of value-purchasing power should be
• Scarcity- when supply outstrips demand, there
is a surplus and that item loses value
• Acceptability-people recognize that your
money has value and they are willing to
accept it as payment
Types of Money
1. Commodity money- something that has
intrinsic (built-in) value.
Commodity money is something that is
considered valuable on its own. Precious
metals, jewels, etc.
Types of Money, cont.
2. Representative Money- money that can be
exchanged with something of value.
Rep. money is backed by something of tangible
Types of Money, cont.
3. Fiat money – money that has value simply
because the government has issued an order
(a fiat) declaring it has value.
Governments help to maintain the value of its
fiat money by controlling the supply.
Can be greatly affected by political instability.
US money
Money consists of what can be used immediately
for transactions. “transactions money”
Currency-paper money and coins (about half of
transactions money). US currency is the dollar.
Demand deposits-checking accounts bc funds can
be converted into currency “on demand.” Most
are non-interest earning accounts.
Near money
Money that cannot be used directly to make
transactions. These monies can be easily
transferred into a checking account or removed
from an ATM. Ex.:
• Traditional savings accounts
• Time deposits-funds people place in a financial
institution for a specific period of time for a
higher interest rate. Usually placed in cdscertificates of deposit
• Money market accounts-require a min. and limit
your # of transactions.
How much money?
Economists use the terms M1 and M2 to measure the
money supply.
• M1=currency and liquid assets-that which can easily
be transferred into currency.
• M2=M1 + near money.
M1 or M2?
• Dollar bill?
• Savings account? M2
• Money market account? M2
• Traveler’s check? M1
• $50,000 cd?
Review questions
1. Why are economic transactions easier with
money than with barter?
2. What aspect of fiat money allows it to have
more stability than representative money?
3. The US govt has tried to get people to use dollar
coins rather than dollar bills. Consumers would
rather use bills. Why would each feel this way?
4. Why is there more near money than
transactions money in the US money supply?
10.2-the development of US banking
1. Modern banking is thought to have originated in Italy in the
mid to late 1300s. Merchants would store money an valuables
for nobles and merchants would loan some of those deposits
and earn interest on these loans. This pattern continued for
2. US banking: After the Revolutionary War, many state
banks were chartered by state governments. Many
issued their own currency. What are some problems
that may arise from this practice?
• Bc there was few currencies backed by gold or silver,
nothing to give money its value
• A system with multiple currencies can be confusing
and chaotic
To fix these problems, the Constitution allows only the
national government to print/ coin money
3. Founding Father Alexander Hamilton proposes a
national bank, which becomes the First Bank of the
United States. The Bank would 1) help bring stability to
the economy, 2) establish credit for the new nation, 3)
establish a useful national currency.
The First Bank was chartered in 1791, but Congress
refused to renew its charter in 1811.
4. Problems that arose after the non-renewal of
the national bank:
• It was difficult to fund the War of 1812
• States returned to the practice of issuing its
own currency not necessarily backed up by
gold or silver
• This increase in the money supply leads to
5. These problems lead to the creation of The Second
National Bank in 1816. This leads to more stability but
there are many opponents, including President Andrew
Jackson. Opponents say the Bank is too powerful and
too closely aligned with the wealthy.
Jackson vetoes the Bank’s charter renewal in 1836.
6. After the charter is not renewed again, there is
no national oversight (“Free Banking Era”) and
wildcat banks spring up.
Wildcat banks were banks set up in remote
locations where those banks themselves were the
only places where their notes were redeemable.
7. Free Banking Era ended in 1863 with the
passage of National Banking Act to issue a
common currency, finance the war effort, and
stabilize the economy.
Provisions of the Act:
• Create a common currency
• Regulated the minimum amount of capital and
reserves a bank has to have in order to
• Heavily taxed state notes, thus driving them
out of business
8. In 1900, the US adopts the gold standard: a
system in which the basic monetary unit is
exchangeable for a certain amount of gold.
Money is now uniform and backed by something
with intrinsic value.
9. The gold standard brings more stability to the
country, but the US still experiences periods of
inflation and recession. Why? Due to the fact
there was no central institution to manage the
money supply in a flexible way to meet country’s
10. To fix these economic issues, the US passes the
Federal Reserve Act in 1913, which creates the Federal
Reserve System (the Fed).
The Fed’s functions:
• The national govt’s bank
• Makes loans to other banks
• Issues the national currency
• Regulates the money supply
11. 1929: The Great Depression. Many banks
failed due to bank runs, where people panicked
and withdrew their money.
Part of Roosevelt’s New Deal program was the
Banking Act of 1933. It created the FDIC-Federal
Deposit Insurance Corporation which provides
federal insurance to back up a bank’s deposits.
Begins federal regulation of banks.
12. In the early 1980s, Congress reduces
regulations on savings and loans institutions.
Banks could now take more risks in loans bc of
the ease on interest rate regulation.
As a result, many S&Ls lost their depositors’
Despite the S&L crisis, the US continued its
policy of deregulation.
Types of banking institutions
Role of banks:
1. Take deposits
2. Make loans
3. Manage customers’ money
GOAL of banks:
1. Make a profit
Types of banking institutions, cont.
A. Commercial banks• provide basic banking services
• checking and savings
• make loans
• FDIC insured
Types of banking institutions, cont.
B. Savings and Loans• originally chartered by states as
“mutual societies”
• take savings deposits
• provide home mortgage services
• today, they also offer many
commercial services
Types of banking institutions, cont.
C. Credit Unions
• offer many of same services as commercial
• most specialize in mortgages and auto loans
• Cooperative= membership requirement and