Transcript Money and Banking

Money and Banking
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Chapter 10: Money and Banking
KEY CONCEPT
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Money provides a low-cost method of trading one good or service for
another. It makes the system of voluntary exchange efficient.
WHY THE CONCEPT MATTERS
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Money is important to everyone in our society. What were the last
three economic transactions you completed using money? Imagine
what it would have been like to make those purchases without paper
bills and coins.
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Money: Its Functions
and Properties
Functions of Money
KEY CONCEPTS
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Money—anything people will accept as a medium of exchange
– over time, cattle, grain, metals, shells, other objects used as
money
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Functions of Money
Function 1: Medium of Exchange
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Medium of exchange—means through which products can be
exchanged
Barter—exchanging goods or services for other goods or services
– inefficient: both people must want what the other one has to
exchange
Money convenient: allows for precise and flexible pricing of products
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Functions of Money
Function 2: Standard of Value
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Money serves as a standard of value:
– measure of economic worth of goods, services in the exchange
process
In United States, the dollar is the standard of value of all products
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Functions of Money
Function 3: Store of Value
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Money acts as a store of value:
– holds its value over time
– can set aside for later use because will be accepted in future
Does not function well as store of value when there is significant
inflation
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Properties of Money
KEY CONCEPTS
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Item used as money must possess certain properties
– physical properties are characteristics of item itself
– economic properties are linked to role money plays in the market
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Properties of Money
Property 1: Physical
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Durability—sturdy enough to last through many transactions
Portability—small, light, easy to carry
Divisibility—divisible so change can be made
– allows for flexible pricing
Uniformity—distinctive features and markings make it recognizable
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Properties of Money
Property 2: Economic
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Stability of value—purchasing power should be relatively stable
Scarcity—must be scarce to have any value
Acceptability—users must agree that it is valid medium of exchange
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Types of Money
KEY CONCEPTS
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Money derives value from one of three sources
Commodity money—value based on the material from which it is
made
Representative money—paper money backed by something tangible
Fiat money—declared by government to have value, accepted by
citizens
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Types of Money
Type 1: Commodity Money
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Items have value in themselves apart from their value as money
– includes gold, precious stones, salt, olive oil; scarce or useful
Coins most common; precious metal in them worth their face value
If item becomes too valuable, people hoard, don’t circulate
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Types of Money
Type 2: Representative Money
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Can be exchanged for something else of value
Beginnings in Middle Ages: people issued promises to pay in metal
– often unsafe or inconvenient to transport gold and silver
Later, governments regulated amount stored of metal needed to back
paper
Value changes with metal supply, price; causes inflation, deflation
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Types of Money
Fiat Money
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Value based on government fiat, or order, saying the money has
value
Coins have token amount of precious metal; paper money has no
intrinsic value
Government maintains value by controlling supply—keeping it scarce
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Money in the United States
KEY CONCEPTS
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Narrowest sense, money is item used immediately for transactions
Currency—paper money and coins
Demand deposits—checking accounts; funds become currency on
demand
Near money—savings accounts, time deposits; funds become cash
easily
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Money in the United States
Money in the Narrowest Sense
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Money in narrowest sense sometimes called transactions money
Currency is about half of transactions money used
Demand deposits are mostly noninterest-bearing checking accounts
– traveler’s checks are small part
– negotiable order of withdrawal (NOW), other checkable deposits
are rest
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Money in the United States
Are Savings Accounts Money?
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Near money cannot be used directly to make transactions
Savings account: funds can be moved to checking account,
withdrawn
Time deposits:
– funds deposited for specific period to receive higher interest
– include certificates of deposit (CDs), money market accounts
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Money in the United States
How Much Money?
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Most often cited instruments for measuring money are M1, M2
M1—currency, demand deposits, other checkable deposits
– called liquid assets
M2—M1, savings accounts, small time deposits, money market
accounts
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Reviewing Key Concepts
Explain the difference between the terms in each of these
pairs:
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standard of value and store of value
commodity money and representative money
demand deposits and near money
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The Development of U.S. Banking
The Origins of Banking
KEY CONCEPTS
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Late Middle Ages, Italian merchants stored people’s money; made
loans
American colonial merchants followed same practice
Private banks insecure: if merchant’s business failed, deposits lost
After revolution, state banks chartered by state governments
– many banks issued own currency, not backed by gold or silver
held
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Alexander Hamilton: Shaping a Banking
System
The First Bank of the United States
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In 1789, became first Secretary of the Treasury; proposed national
bank
Against strong opposition, First Bank of the United States chartered
in 1791
– issued national currency
– controlled money supply by refusing state bank money not backed
– loaned money to federal government, state banks, businesses
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19th-Century Developments
KEY CONCEPTS
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1811, Congress refused to renew charter of First Bank of the U.S.
– government had difficulty financing War of 1812
– state banks again issued currency not linked to gold, silver
reserves
– increased money supply led to inflation during the war
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19th-Century Developments
The Second Bank of the United States
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1816, Congress chartered Second Bank of the United States
– more resources than First Bank; made money supply more stable
Opponents thought bank too powerful, too close to wealthy
– 1832, President Andrew Jackson vetoed renewal of charter
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19th-Century Developments
Wildcat Banking
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Second Bank’s charter lapsed in 1836; no federal oversight of
banking
All banks state banks; issued own paper currency called bank notes
States passed free banking laws; resulted in wildcat banks
– susceptible to bank runs leading to panics, economic instability
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19th-Century Developments
The Struggle for Stability
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In 1863, National Banking Act created national banks chartered by
U.S. government
– created national currency backed by U.S. Treasury bonds
– required minimum amount of capital for national banks, to back
currency
– taxed state bank notes issued after 1865, taking them out of
circulation
1900, United States adopted gold standard—made dollar equal a set
amount of gold
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20th-Century Developments
KEY CONCEPTS
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National banks, gold standard initially brought stability to banking
Economy still experienced inflation, recession, financial panics
United States needed central decision-making body to manage
money supply
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20th-Century Developments
A New Central Bank
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1913, Federal Reserve System created; consists of 12 regional
banks, one decision-making board
– provides financial services to federal government
– makes loans to banks that serve the public
– issues Federal Reserve notes as national currency
– regulates money supply
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20th-Century Developments
The Great Depression and the New Deal
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1929, many banks failed due to bank runs
Banking Act of 1933 part of President Franklin Roosevelt’s New Deal
– regulated interest rates banks paid; prohibited sale of stocks by
banks
– Federal Deposit Insurance Corporation (FDIC) insured people’s
savings
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20th-Century Developments
Deregulation and the S&L Crisis
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1980, 1982 laws lifted federal limits on savings interest rates
Savings and loans associations now operating like commercial banks
– made riskier loans
Many S&Ls failed; Congress funded industry restructuring
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Financial Institutions in the United States
KEY CONCEPTS
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Bank: commercial banks, savings and loan associations, credit
unions
State, federal governments charter financial institutions, regulate
– amount of money owners must invest in a bank
– size of reserves a bank must hold
– ways loans may be made
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Financial Institutions in the United States
Type 1: Commercial Banks
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Privately owned commercial banks are oldest type of banks
– initially created to provide business loans
– today, checking and savings accounts, loans, investments, credit
cards
All national, about 16 percent of state commercial banks belong to the
Fed
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Financial Institutions in the United States
Type 2: Savings Institutions
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S&Ls first chartered by states in 1830s
– took savings deposits; provided home mortgage loans
– today, provide many of same services as commercial banks
Since 1933, federal government also charters S&Ls
– many federally chartered S&Ls call selves savings banks
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Financial Institutions in the United States
Type 3: Credit Unions
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In 1909, first credit union chartered; 1934, federal system created
– offer savings and checking accounts; specialize in auto, mortgage
loans
– deposits insured by National Credit Union Association (NCUA)
Credit unions have membership requirements
– cooperatives: nonprofit organizations owned by, operated for
members
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Reviewing Key Concepts
Use each of the terms in a sentence that illustrates the
meaning of the term:
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state bank
national bank
gold standard
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Innovations in Modern Banking
What Services Do Banks Provide?
KEY CONCEPTS
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Banks are like stores where money is bought (borrowed), sold (lent)
Customers can store money, earn money, borrow money
Banks earn money by charging interest or fees
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What Services Do Banks Provide?
Service 1: Customers Can Store Money
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Banks store currency in vaults; insured against theft, other loss
Customers also store
– money in bank accounts; insured against bank failure
– papers and valuables in safe deposit boxes
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What Services Do Banks Provide?
Service 2: Customers Can Earn Money
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Savings accounts, some checking accounts pay interest
Money market accounts, CDs pay higher interest rate
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What Services Do Banks Provide?
Service 3: Customers Can Borrow Money
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Banks lend money through fractional reserve banking
– percent of deposit banks must keep is set by Fed
Banks make loans to customers it approves
– loans have set time period and interest rate; property is collateral
Credit card purchases are loans; interest charged after one month
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Banking Deregulation
KEY CONCEPTS
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Before 1980s, government regulated interest rates paid and charged
– required banks to operate in one state; some states limited
branches
In 1980s, 1990s, deregulation ended restrictions, changed banking
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Banking Deregulation
Bank Mergers
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Deregulation led to mergers; no more restrictions on interstate
banking
Advantages: more competition meant low interest rates, more
services
– also more branches; economies of scale, especially for technology
Disadvantages: fewer banks to choose from
– fear larger banks uninterested in small customers, local
communities
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Banking Deregulation
Banking Services
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Financial Services Act of 1999 lifted last restriction on banks
Banks, insurance companies, investment companies compete
– sell stocks, bonds, insurance, traditional banking services
Customers continue to use different companies for different services
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Technology and Banking
KEY CONCEPTS
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Technology has led to electronic banking
Automated teller machines (ATMs)—use special cards
– customers make transactions without bank officers
Debit cards—used to withdraw cash or make purchases
Stored-value cards—represent money holder has on deposit with
issuer
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Technology and Banking
Automated Teller Machines
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ATMs—data terminals linked to a bank’s computer network
– customer needs personal identification number (PIN)
– check balances, make deposits, withdrawals, transfers, loan
payments
All ATM networks connected; some banks charge fees
Save banks money: cheaper than human tellers; more “bank”
locations
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Technology and Banking
Debit Cards
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Debit cards are linked to a bank account
Can be used at ATM machines to make transactions
Can be used to make purchases at retail outlets; also called check
cards
– price of purchase is immediately deducted from the account
– unlike credit cards, can only spend as much as have in account
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Technology and Banking
Stored-Value Cards
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Also called prepaid cards—pay for card, use it to pay for products
– include transit fare cards, gift cards, telephone cards
– convenient: no need to have exact change
Need to compare to cost of checking account or check-cashing
service
Not always covered by FDIC insurance that protects customer
deposits
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Technology and Banking
Electronic Banking
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Electronic banking transactions performed through the Internet
– direct deposit, transaction review, transfers, bill paying
Information security and identity theft are problems for banks
– must reveal privacy policies; let customers decide what data is
shared
– developing more sophisticated information security systems
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Reviewing Key Concepts
How are these three terms related? How are they
different?
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automated teller machine
debit card
stored-value card
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Student Loans
Background
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The high cost of a college education forces 10 million students and
800,000 parents to take out loans to pay for at least part of college.
Federally guaranteed loans are the main source of funding for
college, not banks, S&Ls, or credit unions.
What’s the Issue?
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What is the current situation with student loans? What are the future
ramifications of the increasing cost of paying for college?
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Student Loans {continued}
Thinking Economically
1. Compare the financial news presented in documents A and C. What
bearing do you think the information in document A might have on
what you learned from document C?
2. Document B humorously points to the prominence of student loans in
U.S. higher education. Specifically, what parts of documents A and C
support this view?
3. In document A, what does the federal government seem to be saying
about who should pay for a college education? With this in mind,
what does Figure 10.7 mean for students and parents?
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