Money, Banking, and the Federal Reserve Bank (Monetary Policy)

1. Money, Banking, and theFederal Reserve Bank(Monetary Policy) Chapter 6

2. MoneyPart I

3. Money Objectives: In this lesson, students will be able to identify characteristic of money and the advantages of money. Students will be able to identify and/or define the following terms: Barter System Medium of Exchange Commodity Money Unit of Account Money Supply Store of Value Money Specie Representative Money Currency Fiat Money

4. Money- History When America was first being settled there was no money system. Colonists used the barter system(people traded for what they needed and didn’t have). Trades are made in goods and services instead of money. 1

5. Money- History Early European settlers in America adopted “wampum” – small shells that American Indians used ceremonially – as a form of currency.

6. Money- History During the colonial period in America, foreign coins from Spain, England, Portugal, Holland, France, and elsewhere were used in the colonies. The most commonly circulated coin was the peso, or Spanish milled dollar which could be divided into halves, quarters, and eights. When divided into eights, the sections were called “pieces of eight” or “bits”- hence the slang “two bits” to mean a quarter of a dollar. The milled edges were designed to prevent people shaving silver off. Peso 2 bits

7. Money- History Commodities were commonly accepted: furs, tobacco, salt, gun powder, fish hooks, etc. These items were known as commodity money, objects that have value in themselves as well as for use as money. Some goods that evolved into money were gold, silver, and copper. 2

8. Money-History Problems with bartering: • Difficult to compare worthor value of things. B. Bartering took a lot of time and effort to find the right person to make an exchange. (This was the main problem.) For bartering to work, “You have to want what the other person wants and visa versa.” 3

9. Money- History In 1789, one of President George Washington’s first challenges was to establish a money supplyfor the new country – a uniform standard currency. There were pesos, shillings, talers, and other European coins in the colonies from which to design a new medium of exchange. Money supply is defined as: All the money available in the United States economy. Consisting of coins, currency and Demand Deposits (also called checking accounts and travelers checks). Money supply is important because it affects prices, loans, jobs, and other things. Money is defined as: A good that is widely accepted for purposes of exchange and in the repayment of debt. 4

10. Money- History The Continental, from American Revolution issued by the Continental Congress. In 1861 the U.S. Treasury issued its first paper currency since the Continental. The official name of the currency was “Demand Deposits,” but people called them greenbacks because the were printed with green ink. (Used during the Civil War). 4B

11. Money-History Later as America developed into a more complex economic system, tobacco, gun powder, and other objects (used as commodity money) were no longer universally accepted as money, and there was a need to build confidence in the banking system. The nation needed a more convenient payment system. The U.S. government issued representative money in the form of silver and gold certificates. Used until 1913. Representative Moneyis defined as: Paper money that has value because the holder can exchange it for something else of value, such as gold or silver also called speciecoins. 5

12. Money-History In the 1870’s the nation adopted a “Gold Standard” – a monetary system in which paper money and coins had the value of certain amounts of gold. (Representative Money) Set Value: 1 oz. gold= $20 5B

13. Our dollars were once backed by gold. You could exchange a dollar for gold and silver. USA Gold Certificate - “In gold coin payable to the bearer on demand” The Government stopped converting paper money in to gold and silver in the 1930’s. At one time you could exchange this for this

14. A $1 Silver Certificate is the only piece of U.S. paper currency (1891) to bear the portrait of a woman: Martha Washington

15. Money-History In 1929, the severe economic decline and the stock market crash lead to widespread bank runs (bank panics in which people raced to their banks to withdraw their deposits). The combination of unpaid loans and bank runs resulted in the failure of thousands of banks across the country. After becoming President, Roosevelt acted to restore public confidence in the nation’s banking system. He declared a “bank holiday” (closed all banks) as the last resort to restore trust in the nation’s financial system. Within a matter of days sound banks began to reopen. Later in 1933, Congress passed the Federal Deposit Insurance Corporation (FDIC) to insure customer deposits if a bank fails. Today, deposits are insured up to $250,000. In an attempt to increase the money supply, Roosevelt also issued an executive order that effectively ended the nation’s gold standard. Going off the gold standard allowed the Federal Reserve to maintain a money supply at adequate levels to support a growing economy (could not increase money supply with limited gold). These actions helped the nation recover somewhat but did not end the Great Depression. 6A

16. From Representative Money to Fiat Money Money-History Today, our money is fiat money. (Fiat is an order or decree.) Fiat Moneyis defined as: Money that has value because the government has ordered or decreed that it is an acceptable means to pay debts, and is called “legal tender”. It remains in limited supply, and therefore valuable, because the Federal Reserve controls its supply. This control of the money supply is essential for a fiat system to work. 6B

17. Quick Review Not All Money is the Same Commodity Money Representative Money Fiat Money Representative Money like this silver certificate could be exchanged for silver. Today, Federal Reserve notes are fiat money, decreed by the federal government to be an acceptable way to pay debts. Objects like this gun powder once served as commodity money.

18. Are You Better Off Living in a Money Economy? People who live in money economies do more specializedworkbecause transaction costs are low. Instead of spending time bartering, they can focus on producing one thing. They can then sell that one thing (EXP: their labor) for money and use the money to buy other goods and services. The extra time savedin a money economy can be used to produce more goods and services, to consume more leisure, or to do both! Residents ofmoney economies are richerin goods, services, and leisure than the residents of barter economies. 7

19. Three Functions of Money 1. Medium of Exchange (Acceptable) 2. Unit of Value (Compares Value) 3.Store of Value (Keeps it’s Value) $30.00 $44.00 Money holds its value even if it is not used immediately to buy goods and services. (Unless very high inflation occurs.) An expensive price tag tells us something about the good’s value. As a medium of exchange, money measures value during the exchange of goods and service. 8

20. Six Characteristics of Money • Acceptable • Portable • Divisible • Durable • Uniform • Scarce 9

21. What gives Money Value ? • Acceptability in exchange gives money its value. • It’s scarce. 10

22. BankingPart 2

23. Banking Objectives: In this lesson, students will be able to identify the first bankers and discuss how banking create money without printing it. Students will be able to identify and/or define the following terms: Bank Fractional Reserve Banking Money Supply M1 and M2 Money Interest Default Required Reserve Excess Reserve Mortgage Credit & Debit Cards

24. Banking A Bank is defined as an institution for receiving, keeping, and lending money. Banks are for individuals and businesses. Types: Commercial Banks, Savings and Loan Associations, Mutual Savings Banks, Credit Unions, State Banks, and Federal Banks. 11

25. Banking - History When money was principally gold coins, carrying it was neither easy nor safe. As a result, people wanted to store their gold in a safe place. Most often, people stored their gold coins with goldsmiths because goldsmiths had safe storage facilities. Goldsmiths were the first bankers. 12

26. Banking - History Goldsmiths would give receipts stating the amount of gold stored. People began using receipts in place of actual gold coinsbecause it was easier to do so. People accepted the gold receipts as moneybecause they trusted the goldsmiths and knew the receipts were fully backed by gold. 13

27. Banking - History Then, some goldsmiths began to lend outsome of the gold they were storing, and collected interest on the loans. However, instead of lending the actual gold, the goldsmiths gave receipts to the borrowers. As a result, there were more receipts than there was actual gold. The goldsmiths’ lending activity increased the supply of money. That is, it increased the number of receipts compared with the actual amount of gold. (Credit increased, not gold.) 14

28. Banking - History The goldsmiths’ activity was the beginning of a process of Fractional Reserve Banking. Under Fractional Reserve Banking, banks are like the goldsmiths of years past. They hold only a fraction of the deposits and lend out the remainder. Fractional Reserve Banking is defined as: a bank keeps only a fraction of deposits on hand and loans out the rest. (See EXP. of money creation next) 15

29. Banking - History 10% or $10 of deposit must be kept in bank’s required reserve. Fractional Reserve Banking– How it works! The availability of credit (or loans), is how banks increase the money supply, “money creation,” without actually printing more money. Raise RRR percentage = decrease in Money Supply Lower RRR percentage= increase in Money Supply $100 90% or $90 is excess reserves that can be loaned outby the bank to customers. $100 is deposited in the bank Required Reserve Ratio is 10%. This is set by the Fed. 16

30. Starts when banks begin to loan out their excess reserves. Money Creation Formula : Deposit \ RR Rate = Increase in money supply. $10,000 \ .20 = $50,000 increase in M.S. $10,000\.10 = 100,000 increase in M.S.

31. Banking Today

32. Banking Today Review of definition “Money Supply” The money supply is all the money available in the United States – coins, cash, demand deposits and travelers checks. The money supply consists of M1 and M2. 17

33. Banking Today M1is money that people can easily use to pay for goods and services – currency, checkingaccounts (call demand deposits), and traveler’s checks (has liquidity). 18

34. Banking Today M2is M1 plussavings accounts, time deposits, and money market accounts. Savings Account– interest-earning account ;some have check-writing privileges. Time Deposits – interest-earning account with a specified maturity date. Penalties for early withdrawal. Money Markets Accounts – interest-earning account; requires minimum balance, limited check writing privileges. Review of definitions 19

35. Banking Today Facts About Interest: • When money is deposited in a bank, the customer receives interest on money. • A person who borrows money must pay interest. • A Bank’s primary revenue is from interest on the loans they make. • Interestis defined as the price of borrowed money. 20

36. Bank’s Revenues and Expenses Most of a Bank’s income comes from interest from bank loans. 20B

37. Banking Today Default: • When a person fails to pay back a loan, he/she has defaulted on the loan. • Defaulting on a loan leads to bad credit and higher interest rates in the future. • By defaulting, a person ruins his/her reputation for repaying a loan. 21

38. Banking Today Credit Cards are not money. Credit Cards create loans. Loans place people in debt. To get out of debt, people have to repay the loan with money. 22

39. Banking Today Debit Cards are considered demand deposits (checking account). They are included in part of the money supply and as part of M1money. 23

40. Banking Today A mortgage is a loan on real estate. (Learning the language of banking, a person makes better choices.) 24

41. The “Fed”Federal Reserve SystemPart 3 Federal Reserve , Washington, D.C

42. Federal Reserve System Objectives: In this lesson, students will be able to explain how it came into existence, and what it does. Students will be able to identify and/or define the following terms: Bank Panics Federal Reserve Act Federal Reserve System FOMC Lender of Last Resort

43. BANKS and THE FEDERAL RESERVE Review BANKSare -- Institutions for receiving, keeping and lending money. Banks for individuals and businesses. Types: Commercial Banks, Savings and Loans Associations, Mutual Savings Banks, Credit Unions, State Banks and Federal Banks. THE FEDERAL RESERVEis -- The nation’s central banking system. This means that it is the chief authorityon money in the country, commonly referred to as “The Fed”. The U.S.’s bank and a bank’s bank. 25

44. Before the Federal Reserve System Background As stated earlier, banks were informal and not completely safe. After the American Revolution, the leaders of our new nation agreed that one of their main goals must be to establish a safe, stable banking to restore confidence in the bank system. Such a system was also important for increasing trade with other countries and ensuring the economic growth of the new United States. The nation’s leaders did not agree on how these goals should be accomplished. Continued…

45. Before the Federal Reserve System Background The nation’s leaders debated during the 1780’s and 1790’s on banking and the role of the government in our young country. As you may remember from your study of American History, there were two political views on the creation of a National Bank: Anti- Federalist –- led by Thomas Jefferson (against) Federalist ------- led by Alexander Hamilton (for) Continued… 25B

46. Before the Federal Reserve System Background • Thomas • Jefferson • Anti-Federalist • Believed in a bank system run by the States. • He worried that a National Bank would lend to only wealthy people or businesses and ordinary people (farmers) would be refused loans. • Alexander • Hamilton • Federalist • Believed in a strong central Government bank. • He proposed a National Bank with one single national currency, managed by the National Government. 25C

47. Before the Federal Reserve System Background The Federalist were successful (by one vote) and in 1791 Congress set up the first Bank of United States, granting a 20 year charter. This bank brought order and stability. Anti-Federalist pointed that the National Bank was unconstitutional. After the charter expired, state banks began issuing bank notes again. Many state banks were not stable or trustworthy. People lost confidence in banks again. In 1862, Congress passed the National Bank System (with uniform currency that was backed by gold). Continue…

48. Before the Federal Reserve System Background Before the founding of the Federal Reserve, the nation was plagued with financial crises. At times, these crises lead to “bank panics,” in which people raced to their banks to withdraw their deposits. Continued… 26

49. The Federal Reserve System Signing of the Federal Reserve, 1931 President Wilson in signing it. Background A particularly severe panic in 1907 resulted in bank runs that wreaked havoc on the fragile banking system and ultimately led Congress in 1913 to write the Federal Reserve Act, defined as chief authority on money in the U.S and defined as the Federal Reserve System in 1931. (Initially created to address these banking panics, the Federal Reserve is now charged with a number of broader responsibilities, including fostering a sound banking system and a healthy economy.) Continued 27

50. The Federal Reserve System Background Establishing the nation’s first central bank was no simple task. What emerged with the Federal Reserve System was a central bank under pubic/private control, with countless checks and balances. Congress oversees the entire Federal Reserve System. And the Fed must work within the objectives established by Congress. Yet Congress gave the Federal Reserve autonomy (self-rule) to carry out its responsibilities insulated frompolitical pressure. 28