Chapter 14

Money and Our Banking System

Money is whatever people generally accept Functions of Money

• Medium of Exchange – payment for goods and services• Barter – trading a good for a good

• Coincidence of wants

• Reduces transactions costs

• Unit of Account – allows us to compare values• Liquidity – ease at which something can be converted into cash

What backs our money?• Nothing

• Fiduciary Monetary System – based on the public’s faith that the currency can be exchanged for goods

• Currency and checkable deposits

• Fiat Money – not backed by anything

Depository institutions – accepts deposits from savers and lends to borrowers

• Banks• Savings and Loans• Credit Unions

Money Supply – Money in circulation• M1 = Currency (bills and coins) + Checking deposits + Traveler’s

checks• M2 = M1 + Savings deposits + Money Market Deposit accounts +

Small time deposits + Money Market Mutual Funds• Savings deposits – interest bearing savings accounts• Small denomination time deposits – less than $100,000 with maturity

dates• Money market mutual funds – pools of funds used to buy short term

financial assets

Federal Reserve System (FED) 1913 – central bank of the US

• Organization• Board of Governors – 7 appointed by the President and approved by the

Senate to 14 year terms• 12 District banks• Federal Open Market Committee – determines our money supply

• 7 Board of Governors• New York District Bank president• 4 other district bank presidents (rotating)

• Functions• Regulates the Money Supply

• Monetary Policy• Supplies economy with paper currency and coins• Provides check clearing and collection• Supervises banks• Holds reserves of financial depository institutions• Bank’s bank• U.S. Government’s bank

Money Creation, Reserves and the Money Multiplier• Fractional Banking System

• Reserve requirement – percentage of deposits that can not be loaned• held in FED or their own vaults• 10%

• Expanding the Money Supply• Excess reserves – funds that can be loaned• Money Multiplier = 1 / rr

• rr = reserve requirement

• Example E – Money

• Smart Cards – electronic cash cards• Debit cards• Store specific cards