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Money and Banking


MONEY AND BANKING Chapter 10 MONEY Money is anything that serves as a medium of exchange, unit of account or store of value Medium of exchange- determines value ... – PowerPoint PPT presentation

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Title: Money and Banking

Money and Banking
  • Chapter 10

  • Money is anything that serves as a medium of
    exchange, unit of account or store of value
  • Medium of exchange- determines value during
    exchange of goods and services
  • Without money goods and services acquired through
  • As economy becomes more specialized bartering
    becomes too difficult and time consuming
  • Money as a unit of account- provides means of
    comparing value of goods and services (dollars,
    Euros, rubles, pesos)
  • Money as a store of value- keeps value if you
    decide not to spend it, always recognized as a
    medium of exchange
  • Exception is when there is inflation, does not
    work well as a store of value

Six Characteristics of Money
  • Currency- coins and paper bills used as money
  • Various objects through human history used as
  • Six Characteristics
  • Durability- must withstand wear and tear
  • Portability- needs to be easily carried
  • Divisibility- easily divided into smaller units,
    needs various denominations
  • Uniformity- needs to be the same in terms of what
    it will buy, be able to count and measure
  • Limited Supply- too much in circulation, it
    looses value
  • Acceptability- must be able to be exchanged for
    goods and services

Sources of Moneys Value
  • Commodity Money- objects that have value in and
    of themselves (salt, cattle, precious stones) and
    have other uses as well
  • Not portable, durable or divisible
  • Only works in simple economies
  • Representative Money- objects with value because
    they can be exchanged for something else
  • Paper receipts that could be exchanged for gold
    or silver were an early form of money
  • Fiat Money- money valuable because government
    said it can be redeemed for debt
  • Has value and is limited in supply

American Banking
  • Early banks in US were unstable, money was
  • Banks were independent, many worried that
    government would own banks (American tradition of
    distrust of central government)
  • Late 1800s gold standard gave money value
  • It was in limited supply and paper money could be
    redeemed for it at any time
  • Panic 1907 occurred because not enough gold to
    back currency in circulation, showed economy
    needed central banking system to avoid system in
    the future

Federal Reserve System
  • 1913 Federal Reserve Act passed
  • Federal Reserve System served as nations first
    central bank and reorganized banking system
  • Created regional banks that store cash reserves
    for member banks
  • Regional feds loan money to member banks to
    prevent bank panics
  • Created national currency and allowed Federal
    Reserve to regulate money supply
  • Federal Reserve Board supervises all banks in the
  • Unable to prevent Great Depression (kept money
    supply too low to prevent inflation)
  • 1933 banking reform passed during the New Deal
  • Glass Stegall Act separated banking and finance
    industries, regulated interest rates
  • Established Federal Deposit Insurance Corporation
    that covered losses if banks fail up to a certain
    amount (200,000 today)

Banking in the Later 20th Century
  • Banks closely regulated from 1930s-1960s
    restrictions on interest rates and loans to
  • Late 1970s and early 80s banks became
  • Contributed to Savings and Loan (SLs) crisis in
    the late 1980s
  • SLs unprepared to deal with lack of regulation
  • 1980s interest rates went up and SLs had too
    many low interest loans
  • Made risky loans
  • Many made bad loans to failed businesses
  • 1999 Glass-Stegall Act repealed it allowed banks
    to buy and sell stocks and bonds and established
    new privacy rules for banks

Banking Today
  • Money supply- all the money in the US economy
  • Divided into several categories, two main
    categories M1, M2
  • M1- represents money people have easy access to
  • Consists of assets that have liquidity (assets
    that can be directly converted into cash)
  • 48 is held by people outside of bank vaults
  • Money in checking accounts is M1 money
  • M2- all assets in M1 and additional assets
  • Additional funds called near money (deposits in
    savings accounts, money market mutual funds)

Functions of Financial Institutions
  • Banks and financial institutions essential to
    managing money supply, largest source income from
    interest received from loans
  • Storing Money- provide safe place to store money
  • Saving money- savings accounts, checking
    accounts, money market accounts, certificates of
  • Money market accounts and CDs pay higher rate of
    interest than other accounts
  • Loans- banks make profit lending deposits to
    borrowers and charging interest
  • Fractional reserve banking (keeps a fraction of
    funds on hand and lends rest out) banks today
    operate under this principle

Functions of Financial Institutions
  • Loans- more money banks lend out more money they
  • Failure to payback loan called default and bank
    loses money
  • Mortgage- specific type of loan used to buy real
  • Terms of loan 15-30 years
  • Credit cards- entitles holders to but goods and
    services based on promise to pay for them
  • Simple and Compound Interest- interest is price
    paid for borrowed money
  • Simple interest paid only on principal
  • Compound interest paid on principal and
    accumulated interest

Types of Financial Institutions and Electronic
  • Commercial banks- provide wide variety of
    services from checking and savings accounts to
  • Most are regulated by the federal government
  • One third are part of the federal reserve system
  • Savings and loan associations- originally
    chartered to provide funds to members for home
  • Credit Unions- cooperative lending associations
    for employees of a specific group
  • Finance companies- make installment loans to
    customers, usually for people with poor credit,
    interest rates are high
  • Electronic Banking
  • Use of computers has increased dramatically in
    banking since 1970s
  • ATMs, debit cards, internet banking, automatic
    clearing houses (automatic draft from bank
    accounts to pay bills), stored value cards (gift