Unit 6 – Finance

I. Currency

A. Money

1. Three Uses of Money

a) Medium of exchange (Barter) - Exchanging goods & services without use of set values.

b) Unit of Account.

c) Store of Value.

2. Currency.

B. Six Characteristics of Money

1. Durability – withstands wear & tear.2. Portability – Easily transported from place to

place.3. Divisibility – Easily divided into smaller

denominations. 4. Uniformity – Every unit must be the same for

counting & measuring. 5. Limited Supply – The lower amount available,

the value is more. 6. Acceptability – Everyone must be willing to

accept the goods.

C. Sources of Money’s Value

1. Commodity Money.

2. Representative Money.

3. Fiat Money.

D. Bank

1. Early Republic 2. Federalists: Alexander Hamilton

supported a centralized gov’t & national bank.

a) Single currency for the entire nationb) Manages government’s fundsc) Monitors other banks.

3. Anti-federalists: Thomas Jefferson wanted a decentralized system.

E. First Bank of the United States

1. 1791 – Bank given 20 year charter

2. Great success in bringing order to banking

3. Anti-federalists argued it was unconstitutional & let charter run out in 1811.

F. Chaos Ensues

1. States issued notes without backing.

2. Chartered many banks without credibility.

3. Prices rose, different types of currency produced.

G. Jacksonian Era

1. Second Bank of the United States

2. 1816 – 20 year charter

3. Jackson opposed centralized government & opposed re-chartering of the bank.

H. Free Banking

1. Bank runs2. Wildcat Banks – established on the

frontier & were unreliable.3. Fraud – Banks issued notes, collected

gold & silver, then vanished.4. Currency – Different states, cities,

banks, businesses, & other organizations issued currency-creating chaos.

I. Civil War & Reconstruction

1. North attempted stability.a. Greenbacks – national currency

b. Nation Banking Acts of 1864 & 1865

c. Power to charter banks.

d. Power to require banks to hold gold & silver to back notes

2. South issued its own currency based on cotton, but became worthless.

J. Gold Standard .

1. Definite value for the dollar.

2. Government issued currency only if it had gold to back it.

K. Progressive Era

1. Bank chaos

2. Centralized system for currency, but not banking.

3. Panic of 1907 – Banks did not have enough reserves to back up $, banks failed, businesses stopped expanding.

L. Federal Reserve System

1. Central Bank.2. Member Banks.3. Federal Reserve Board – Appointed by

President of the USA to supervise banks.

4. Loans – Fed banks loaned money for short term needs to prevent bank failures.

5. Federal Reserve Notes.

THE MEANING OF MONEY

• Money is the set of assets in an economy that people regularly use to buy goods and services from other people.

The Functions of Money

• Money has three functions in the economy:– Medium of exchange– Unit of account– Store of value

The Functions of Money

• Medium of Exchange– A medium of exchange is an item that buyers

give to sellers when they want to purchase goods and services.

– A medium of exchange is anything that is readily acceptable as payment.

The Functions of Money

• Unit of Account– A unit of account is the yardstick people use

to post prices and record debts.

• Store of Value– A store of value is an item that people can

use to transfer purchasing power from the present to the future.

The Functions of Money

• Liquidity– Liquidity is the ease with which an asset can

be converted into the economy’s medium of exchange.

The Kinds of Money

• Commodity money takes the form of a commodity with intrinsic value.– Examples: Gold, silver, cigarettes.

• Fiat money is used as money because of government decree.– It does not have intrinsic value.– Examples: Coins, currency, check deposits.

Money in the U.S. Economy

• Currency is the paper bills and coins in the hands of the public.

• Demand deposits are balances in bank accounts that depositors can access on demand by writing a check.

THE FEDERAL RESERVE SYSTEM

• The Federal Reserve (Fed) serves as the nation’s central bank.– It is designed to oversee the banking system.– It regulates the quantity of money in the

economy.

THE FEDERAL RESERVE SYSTEM

• The Fed was created in 1914 after a series of bank failures convinced Congress that the United States needed a central bank to ensure the health of the nation’s banking system.

THE FEDERAL RESERVE SYSTEM

• The Structure of the Federal Reserve System:– The primary elements in the Federal Reserve

System are:• 1) The Board of Governors• 2) The Regional Federal Reserve Banks• 3) The Federal Open Market Committee

The Fed’s Organization

• The Fed is run by a Board of Governors, which has seven members appointed by the president and confirmed by the Senate.

• Among the seven members, the most important is the chairman. – The chairman directs the Fed staff, presides

over board meetings, and testifies about Fed policy in front of Congressional Committees.

The Fed’s Organization

• The Board of Governors– Seven members – Appointed by the president – Confirmed by the Senate– Serve staggered 14-year terms so that one

comes vacant every two years.– President appoints a member as chairman to

serve a four-year term.

The Fed’s Organization

• The Federal Reserve System is made up of the Federal Reserve Board in Washington, D.C., and twelve regional Federal Reserve Banks.

The Fed’s Organization

• The Federal Reserve Banks– Twelve district banks– Nine directors

• Three appointed by the Board of Governors.• Six are elected by the commercial banks in the

district.

– The directors appoint the district president, which is approved by the Board of Governors.

The Federal Reserve System

Copyright©2003 Southwestern/Thomson Learning

The Fed’s Organization

• The Federal Reserve Banks– The New York Fed implements some of the

Fed’s most important policy decisions.

The Fed’s Organization

• The Federal Open Market Committee (FOMC)– Serves as the main policy-making organ of

the Federal Reserve System.– Meets approximately every six weeks to

review the economy.

The Fed’s Organization

• Monetary policy is conducted by the Federal Open Market Committee.– Monetary policy is the setting of the money

supply by policymakers in the central bank– The money supply refers to the quantity of

money available in the economy.

The Federal Open Market Committee

• Three Primary Functions of the Fed– Regulates banks to ensure they follow federal

laws intended to promote safe and sound banking practices.

– Acts as a banker’s bank, making loans to banks and as a lender of last resort.

– Conducts monetary policy by controlling the money supply.

The Federal Open Market Committee

• Open-Market Operations– The money supply is the quantity of money

available in the economy.– The primary way in which the Fed changes

the money supply is through open-market operations.

• The Fed purchases and sells U.S. government bonds.

The Federal Open Market Committee

• Open-Market Operations– To increase the money supply, the Fed buys

government bonds from the public.– To decrease the money supply, the Fed sells

government bonds to the public.

BANKS AND THE MONEY SUPPLY

• Banks can influence the quantity of demand deposits in the economy and the money supply.

BANKS AND THE MONEY SUPPLY

• Reserves are deposits that banks have received but have not loaned out.

• In a fractional-reserve banking system, banks hold a fraction of the money deposited as reserves and lend out the rest.

BANKS AND THE MONEY SUPPLY

• Reserve Ratio– The reserve ratio is the fraction of deposits

that banks hold as reserves.

Money Creation with Fractional-Reserve Banking

– When a bank makes a loan from its reserves, the money supply increases.

– The money supply is affected by the amount deposited in banks and the amount that banks loan.

• Deposits into a bank are recorded as both assets and liabilities.

• The fraction of total deposits that a bank has to keep as reserves is called the reserve ratio.

• Loans become an asset to the bank.

Money Creation with Fractional-Reserve Banking

• When one bank loans money, that money is generally deposited into another bank.

• This creates more deposits and more reserves to be lent out.

• When a bank makes a loan from its reserves, the money supply increases.

The Money Multiplier

• How much money is eventually created in this economy?

The Money Multiplier

• The money multiplier is the amount of money the banking system generates with each dollar of reserves.

The Fed’s Tools of Monetary Control

• The Fed has three tools in its monetary toolbox:– Open-market operations– Changing the reserve requirement– Changing the discount rate

The Fed’s Tools of Monetary Control

• Open-Market Operations– The Fed conducts open-market operations

when it buys government bonds from or sells government bonds to the public:

• When the Fed buys government bonds, the money supply increases.

• The money supply decreases when the Fed sells government bonds.

The Fed’s Tools of Monetary Control

• Reserve Requirements– The Fed also influences the money supply

with reserve requirements.– Reserve requirements are regulations on the

minimum amount of reserves that banks must hold against deposits.

The Fed’s Tools of Monetary Control

• Changing the Reserve Requirement– The reserve requirement is the amount (%) of

a bank’s total reserves that may not be loaned out.

• Increasing the reserve requirement decreases the money supply.

• Decreasing the reserve requirement increases the money supply.

The Fed’s Tools of Monetary Control

• Changing the Discount Rate– The discount rate is the interest rate the Fed

charges banks for loans.• Increasing the discount rate decreases the money

supply. • Decreasing the discount rate increases the money

supply.

Problems in Controlling the Money Supply

• The Fed’s control of the money supply is not precise.

• The Fed must wrestle with two problems that arise due to fractional-reserve banking.– The Fed does not control the amount of money

that households choose to hold as deposits in banks.

– The Fed does not control the amount of money that bankers choose to lend.

M. Great Depression

1. Economic decline starts 1929. 2. Banks loaned large sums of $ in the 20’s that

businesses could not pay back.3. Crop failures & dropping prices mean farmers

unable to pay debts. 4. Stock market crash -1929 created panics in

market & banks across nation.5. FDR established bank holiday so banks would

close & give time for people to calm down & the industry to regain footing.

6. FDIC established.

N. Deregulation and the Reagan Era

1. Deregulation was sought by banks & was given by Republicans and Democrats.

2. Several industries were deregulated.

3. Savings & Loans also deregulated although they had been closely watched since Great Depression.

O. Conflicting Progress

1. Congress passed legislation to restrict S&L’s.

2. Glass-Steagall Act passed that allows banks to sell stocks and bonds.

3. Bank mergers became extremely popular.

4. From the evidence you have seen in this set of notes and the reading, should the government be involved in the banking industry? Why or why not?

II. Modern Banking

A. Money Supply – all $ USA.

1. M1

2. Liquidity - money that people can gain access to easily and immediately

3. (Traveler’s checks)

4. M2 = assets that cannot be used as cash within a short period of time. (Deposits in savings accounts).

B. Managing Money

1. Storing – fireproof vaults and protected by the FDIC

2. Saving accounts3. Checking accounts4. Money market accounts- Save and write a

limited number of checks. Interest is high, but variable.

5. Certificates of Deposit – Guaranteed rate of interest over a period of time, in which you are not allowed to withdrawal unless you pay a fee.

C. Loans

1. – banks let borrowers take money, as longs as they pay it back with interest.

2. Mortgages. 3. Credit Cards. 4. Simple and Compound Interest5. Simple interest – $ made off of original borrowed sum.6. Compound interest – $ made of original sum and

previous interest. 7. Profit- banks make more $ off interest from $ they

loaned out than the interest they pay to accounts.

D. Financial Institutions

1. Commercial Banks – usually for businesses, play largest role in economy. 1/3 belong to Fed and are national banks.

2. Savings and Loans- Members deposited money into a general fund and borrowed money to buy homes.

3. Savings Banks- banking available to individuals. Depositors owned shares of banks.

4. Credit Unions- Organized for specific groups of people, with low interest rates, and loans for automobiles and homes.

5. Finance Companies – Provide installment loans for large purchases. People are more likely to fail paying these back and so interest rates are high.

III. Investments

A. Financial System1. Flow of Savings – from savers to financial

institutions to investors.

2. Intermediariesa. Bank

b. Life Insurance Companies – provides financial protection for families. Company collects premiums from customers and lends to investors.

c. Pension Funds – receives income after working a certain number of years or reaching a certain age. Pension funds invest money in stock, bonds, or other assets.

B. Financial Assets

1. Bonds a. Coupon Rate.b. Maturity. c. Par Value (face value or principal). d. Yield. e. Discounts – occur when bonds are sold at less

than par value. f. Ratings – Similar to academic grading. Two

firms provide grade for bonds. Standard and Poor’s and Moody’s bond rates go from AAA/Aaa to D.

2. Stock Market

A. Stock or equities are shares of ownership in a corporation.

B. Dividends – payments to stockholders from the profits of a corporation. Usually paid four times a year.

C. Stock Exchange – Markets for buying and selling stock.

1. NYSE – New York Stock Exchange (1792) represents the largest/most respected companies in the nation. Largest companies are known as blue chips. Blue chips profit over the long run.

2. NASDAQ –Mostly trading technology and energy stocks, this exchange deals with smaller and riskier companies

3. OTC Market –New and growing companies have stock traded here and usually offer no dividends.

D. History

1. Investors panicked and 16.4 million shares sold on 10/29/29 (Black Tuesday) compared to a normal 4 to 8 million.

2. Fed limits money supply to discourage lending. Little money was available for recovery.

3. Americans were cautious about stock until 1990’s. Almost half of households own mutual funds.