Warm UpWarm UpAccording to your textbook on page 492,

the ideal money should have 7 characteristics? What are they? And do you think our “money” fulfills those 7 criteria? Explain!

The Ideal Money is…The Ideal Money is…• Durable• Portable• Divisible• Uniform quality• Has a low opportunity cost• Does not fluctuate widely in value• In limited supply

Unit 7Unit 7Money, Banking, and Money, Banking, and

Monetary PolicyMonetary Policy

The Function of BanksThe Function of BanksDiscuss with a partner:

• How do banks make a profit????

History of BankingHistory of Banking1. 1st bankers were Goldsmiths where people

deposited gold to vaults for a fee2. Goldsmiths gave a receipt to a depositor and this

became $$$ (money)3. Used a 100% Reserve System in the beginning,

meaning paper money was completely backed by gold

4. Then, they realized that they didn’t need to keep all the gold.

5. The Goldsmiths began loaning out some portion of the money they had (Interest Earning Loans). This is called a Fractional Reserve System.

Create a Flow Map explaining the history of banking

**You may include sub-steps below**

What is Money???What is Money???• Money is anything that is generally

accepted as final payment for goods and services

The 3 Functions The 3 Functions of Moneyof Money

• Medium of Exchange: it can be used to purchase goods and services

• Unit of Account: it can be used to compare the value of different goods and services

• Store of Value: It can be held to buy something in the future

Tree MapTree Map• Create a Tree Map describing the three

functions of money!• (Include term, definition, & visual)

Three Functions of $$

Why Our Money Has Why Our Money Has Value:Value:

• Acceptability--Throughout the world, $$$ are

accepted as form of money• Legal Tender--$$$ accepted for money because

government says so• Relative Scarcity--”Money doesn’t grow on trees”

Money Supply (MS)Money Supply (MS)• M1--Includes currency & checkable

deposits• M2--M1+Non-checkable Savings

Deposits+Money Market Deposit Accounts+Small Time Deposits (Under 100k)+Money Market Mutual Funds

• M3—M2+Large Time Deposits (100k+)

Bank TerminologyBank Terminology

• Actual Reserves—total deposits banks have

• Legal Reserves—deposits bank cannot use to make a profit

• Excess Reserves—deposits banks can use to make a profit

• Vault Cash—cash reserves on hand-2%

THE FEDERAL RESERVE – “The Fed”: (The U.S. central banking system)

• Created in 1914 after a series of bank failures.The Fed Board of Governors: • 7 members appointed by the President, with

confirmation by the Senate• Board members serve 14 year terms• President appoints the chairperson (Ben Bernanke) to a

4 year term.12 Regional Federal Reserve Banks: • Regional banks are located in major cities around the

country• Each bank has a president chosen by the bank’s board

of directors• The board of directors is typically drawn from the local

business and banking community

The Federal ReserveThe Federal Reserve=The U.S. Central banking system

One of the functions of the Fed is to

control the money supply through monetary policy. Monetary policy works by encouraging or discouraging banks from making loans.

What are the two What are the two extremes of the business extremes of the business

cycle???cycle???Recession

• TOO ______ SPENDING

Inflation

• TOO _____ SPENDING

Recession:Recession:Too little spending!!!Too little spending!!!

• Try to correct this problem with your partner!

• Example: – Let’s say you have only $1 in your wallet right

now. Name something you would be able to buy for a $1.

– Now, let’s say that your Money Supply (MS) went up…and now you have $5. What would you be able to buy now???

– When your supply of money increased, what happened to your total spending. Did it go up or down???

Why Increasing the MS is Why Increasing the MS is Good to Fight a RecessionGood to Fight a Recession

• If you increase the money supply, there is more money circulating in the U.S. economy, which means more money for people to spend.

• When people spend more money, you are slowly helping the economy come out of a recession.

Inflation:Inflation:Too Too MUCHMUCH spending!!! spending!!!

• Now, think of this new economic problem when spending is too high.

• With a partner, discuss your answer for the following questions.

• If there is too much spending in the U.S. economy during a period of high inflation, what needs to happen to the Money Supply to help pull the U.S. out of a recession???

• How does decreasing the MS help us get out of a period of high inflation???

Possible AnswersPossible Answers• If you decrease the money supply,

there is less money circulating in the U.S. economy, which means less money for people to spend.

• This will result in an overall decrease in spending…which will allow prices to slowly go back down a bit

What are the two extremes What are the two extremes of the business cycle???of the business cycle???

Recession

• TOO little SPENDING

• The Fed needs to increase the money supply

Inflation

• TOO much SPENDING

• The Fed needs to decrease the money supply

Monetary PolicyMonetary Policy• Changes in the money supply, intended

to maintain stable prices, full employment and economic growth (3 Macro Econ Goals!)

• If the Fed is fighting unemployment and declining GDP (recession), it wants to increase the money supply.

• If the Fed is fighting inflation, it wants to decrease the money supply.

Read ‘The Tools of The Fed’Read ‘The Tools of The Fed’

Problem: Recession

The MS needs to ____

Problem: Inflation

The MS needs to ____ Reserve Requirement

RR: ______Explain how this specific action will get the economy out of a recession.

RR: ______Explain how this specific action will get the economy out of an inflationary problem.

Discount Rate

DR: _____Explain how this specific action will get the economy out of a recession.

DR: _____Explain how this specific action will get the economy out of an inflationary problem.

Open-Market Operations OMO: _____Explain how this specific action will get the economy out of a recession.

OMO: ______Explain how this specific action will get the economy out of an inflationary problem.

After you are done reading, complete the chart below…

3 Tools of The Fed3 Tools of The Fed• RESERVE REQUIREMENT• DISCOUNT RATE• OPEN MARKET OPERATIONS

3 Tools of The Fed3 Tools of The Fed• Reserve Requirement

– The absolute lowest % that all banks must keep of their actual reserves

• Discount Rate– The interest rate that the Fed charges on

commercial banks – (Wells Fargo, Wa-Mu, B of A)

• Open-Market Operations– Gov’t bonds (IOUs) that can be bought and sold in

the open market

Reserve RequirementsReserve Requirements• The reserve requirement is the minimum

percent of deposits that banks must keep on reserve in their banks

• When the Fed lowers the reserve requirement, banks have _____ money to lend and the money supply ____________

• When the Fed raises the reserve requirement, banks have ________ money to lend and the money supply ___________

Discount RateDiscount Rate• The discount rate is the interest rate that the

Fed charges on loans to banks.• When the Fed lowers the discount rate,

banks are encouraged to make ______ loans and the money supply ____________.

• When the Fed raises the discount rate, banks are discouraged from making loans and the money supply ____________.

Open Market OperationsOpen Market Operations• When the Fed buys or sells U.S. govt. bonds

(IOUs) to influence the money supply• When the Fed buys bonds, bank deposits

_________, banks have _______ money to lend, and the money supply _____________

• When the Fed sells bonds, bank deposits __________, banks have ________ money to lend, and the money supply _____________.

When Fighting When Fighting Recession:Recession:

MS needs to _______ MS needs to _______• __________ Monetary

Policy Using a Money Market Graph

• To ___ the MS, the Fed can:– RR: _____– DR: _____– OMO: _____

When Fighting When Fighting Recession:Recession:

MS needs to _______ MS needs to _______• __________ Monetary

Policy Using AD and AS Analysis

• RR______• DR___ MS____

i_____ I & C ___ AE_____ AD____ PL/OE_____

• OMO_____

When Fighting When Fighting Inflation:Inflation:

MS needs to _______MS needs to _______• __________ Monetary

Policy Using a Money Market Graph

• To ___ the MS, the Fed can:– RR: _____– DR: _____– OMO: _____

When Fighting When Fighting Inflation:Inflation:

MS needs to _______MS needs to _______• __________ Monetary

Policy Using AD and AS Analysis

• RR______• DR____ MS____

i_____ I & C ___ AE_____ AD____ PL/OE_____

• OMO_____

Wrap-Up: True or Wrap-Up: True or FalseFalse

1. For a given money demand curve, an increase in money supply results in a decrease in interest rates.

2. Monetary policy is carried out by adjusting taxes and government spending.

3. One necessary characteristic of money is that it must be unlimited in supply.

4. Money is anything that is widely accepted for goods and services.

5. The MS needs to decrease in order to fight inflation.