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People used things that were easily available and

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valued by others as a form of money

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As a result, money came in

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a variety of forms, shapes and sizes

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The use of money developed because it makes

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life easier for people and serves everyone's best interests -money has become a social convention (like general acceptance of laws and gov.)

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Most money issued by the

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Federal Reserve System (Fed)

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Fed

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privately owned, publicly controlled central bank of the US

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Fed issues paper currency known as

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Federal Reserve Notes (paper currency issued by Fed in use today) -key part of our money supply

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Barter economy

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a moneyless economy that relies on trade -without money, would be difficult b/c products some people have to offer are not always acceptable or easy to divide for payment (unless there is a \"mutual coincidence of wants\")

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Life is simpler in an economy with

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money

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Tea leaves compressed into \"bricks\" comprised

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money in ancient China

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Compressed cheese was used in early

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Russian trade

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In early colonial America,

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corn and even animal pelts were used as form of money

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Today, this money would be classified as

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commodity money (money that has an alternative use as an economic good, or commodity)

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Fiat money

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money by government decree, such as tiny metallic coins used in Asia Minor in the 7th century B.C. (served as money b/c gov. said they were money)

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Money used by early settlers in American colonies was similar to that

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found in early societies -some consisted of commodity money and some as fiat money

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Many products, such as

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corn, hemp, gunpowder, and musket balls served as commodity money (could settle debts and make purchases) and colonists could consume these products if necessary

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A commonly accepted commodity money was

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tobacco, for which the governor of colonial Virginia set a value of 3 english shillings per pound in 1618 -2 years later, colonists used some of this money to bring wives to the colonies

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1637 Massachusetts est. a monetary value for

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wampum, a form of currency the Wampanoag Native Americans made out of white and purple mussel shells (Wampanoag and settlers used these shells in trade) -white shells more plentiful than purple shells (would dye them to have more value) -english penny was made to equal 6 white or 3 purple shells

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Americans used other forms of money as times passed. In some cases, state laws allowed individuals to print their own

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paper currency. Usually backed by gold and silver deposits in banks, it served as currency for the immediate area. States even printed money in the form of anticipation notes and used them to pay salaries, buy supplies, and meet other expenditures until they received taxes and redeemed the notes.

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The Continental Congress issued

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paper money to finance the Revolutionary War. In 1775 it printed Continental dollars, a form of fiat paper currency with no gold or silver backing. By the end of the war, nearly one-quarter billion Continental dollars had been printed- a volume so large that it was virtually worthless by the end of the revolution.

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Colonists also used modest amounts of

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specie (or money in the form of silver or gold coins). -included English shillings, austrian talers, and various European coins that immigrants had brought to the colonies -coins were the most desirable form of money, not only because of their mineral content, but b/c they were in limited supply

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The most popular coin in the colonies was the

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Spanish peso that came to America through trade and piracy -Spanish mining silver in Mexico, they melted the silver into bullion (ingots or bars of precious metals) or minted it into coins for shipment to Spain -Spanish treasure ships often became victims of Caribbean pirates who spent their stolen treasure in America's southern colines

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The \"triangular trade\" between the colonies, Africa and the Caribbean bought

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more pesos to America -traders took molasses and pesos from the Caribbean to the colonies, sold molasses to be made into rum and spent their pesos on other goods, the rum was shipped to Africa, where it was traded for enslaved Africans, the enslaved Africans were taken to the Caribbean to be sold for pesos and more molasses and pesos were taken to the colonies

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Pesos were known as

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\"pieces of eight\" because they were divided into 8 subparts known as \"bits\" -pesos resembled the Austrian talers, they were nicknamed \"talers\" which sounds similar to the word dollars -term became so popular that the dollar became the basic monetary unit -decided into tenths (easier to understand) -a 25-cent coin (one quarter of a dollar- \"two bits\"

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Monetary unit, or

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standard unit of currency, in the U.S. money system

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The study of early money is useful because it helps us

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understand the characteristics that give money its value -any substance can serve as money if it possesses four main characteristics

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First characteristic of money:

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-portable: or easily transferred from one person to another, to make the exchange of money for products easier -most money in early societies was very portable -shells, wampum, tobacco, compressed blocks of tea

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Second characteristic of money:

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-durable: does not deteriorate when it is handled -most was durable -even the fiat paper money of the colonial period was durable in the sense that it could be easily replaced by new bills when old ones became worn

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Third Characteristic of money:

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-divisible into smaller units so that people can use only as much as they need for a transaction -would cut blocks of tea or cheese -bundles of tobacco leaves could be easily be broken apart -even pesos were cut with a knife into eights to make \"bits\" for payment

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Fourth Characteristic of money:

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-must be available, but only in LIMITED SUPPLY -stones were used for Yap islands (carried in open canoes- 400 miles away- only 1 in 20 completed the round-trip making it limited -money loses its values whenever there is too much of it -wampum even lost its value when settlers used industrial dyes to turn white shells into purple (thereby doubling their value)

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First Function of Money:

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-medium of exchange: something accepted by all parties as payment for goods and services -have used gold, silver, and even salt -in ancient Rome, salt was so valuable that each soldier received an annual salt payment called a \"salarium\"; the modern term for an annual income - salary-is based on this Latin term

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Second Function of Money:

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-measure of value: a common measuring stick that can be used to express worth in terms most individuals understand -what we observe whenever we see a price tag on something -a value that we can use to make comparisons with other products -in US, our measure of value is expressed in dollars and cents

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Third Function of Money:

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-store of value: the quality that allows purchasing power to be saved until needed -goods or services can be converted into money, which is easily stored until needed -this feature of money allows a period of time to pass between earning and spending an income

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Modern money:

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-several different types of money (some is the form of Federal Reserve notes and some in the form of metallic coins issued by the U.S. Bureau of the Mint -other forms of money include demand deposit accounts (DDAs), or funds deposited in a bank that can be accessed by writing a check and without having to secure prior approval of the insit.

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Fed uses different definitions for the money supply. The first is M1, which includes

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coins and currency, traveler's checks, DDAs, and checking accounts held at other depository institution -the def. of money supply relates to money's function as a medium of exchange

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A broader definition is M2, which includes

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M1 along with savings deposits, time deposits, and money market funds -all of which relate to money's function as a store of value

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Our money now shares the same fundamental characteristics and

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functions of money. -portable: light-weight, convenient, easily transferred from one person to another (checks) -durable: metallic coins last about 20 years under normal use; paper currency is also reasonably durable, with a $1 bill lasting about 18 months in circulation; introduction of Sacagawea dollar coin by replacing $1 bill with longer lasting coins -divisible: the penny, the smallest denomination of coin, is small enough for almost any purchase and people can write checks for the extra amount of a purchase -money has an uneven track record when it comes to limited availability and stability in value: grow at 10 to 12 % a year in 1970s and contributed to inflation in 1980s (slowed considerably since then, which has led to a period of price stability)

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Today, some of our money circulates as paper currency, but most of it exists in the form of

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electronic bookkeeping entries -neither is backed by gold or silver -accepted because we have faith in it

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The United States experimented with many different kinds of money before it

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created the Federal Reserve System

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At one time, banking was

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virtually unregulated -problems with money supply eventually required the intervention of government

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During the revolutionary war, nearly 250 million

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Continental dollars were printed -by end of revolution, continental currency had become worthless and people not trust gov. to issue anything except coins -because of clauses not print paper currency until the civil war- instead the printing, distribution, and regulation of paper money supply were left to discretion of privately owned banks

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Banking became popular after the Revolution b/c the

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new Constitution allowed private banks to issue paper currency

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State bank

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bank that receives its operating charter from a state gov. -banks issue own currency by printing their notes at local printing shops

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At first, most banks printed only the amount of currency they could reasonably back with their gold and silver reserves. Others, were

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not as honest and printed large amounts of currency in remote areas to make it difficult for people to redeem their currency.

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Problems arose even with honest banks: each bank issued its own currency in

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different sizes, colors and denominationss 2. tempted to issue too many notes 3. counterfeiting became a major problem (would make new ones)

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Politically powerful local bankers, however, resisted change until an event

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came along that would change commercial banking in the US forever- the Civil War (both Union and Confederacy needed to raise enormous sums to finance the war) -congress tried to borrow money by selling bonds, but not enough

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Congress decided to print paper currency for the

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first time since the Constit.

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In 18611, Congress authorized the printing of $60 million in the new currency. Although it had

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no gold or silver backing, it was declared legal tender (fiat currency that must be accepted in payments for debts) -these new notes were soon dubbed \"greenbacks\" b/c the reverse sides of notes were printed with green ink (distinguished from old state notes- usually blank)

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People feared greenbacks might

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become worthless

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COngress enacted the

answer

National currency act, which created a National Banking system (NBS) made up of national banks

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National bank

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a privately owned bank that receives its operating charter from the fed gov. -issued own notes called national currency that were backed with bonds that the banks bought from the fed gov. -hoped people would gain confidence in money (with rigorous bank inspections and other high standards) -only a few-chartered banks joined the system b/c easier to print their money at local printers -then placed 10% tax on all privately issued bank notes -shifted from entirely privately issued to being entirely publicly issued

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In the same year the NBS was created, the gov. issued

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gold certificates (paper currency backed by gold placed on deposit with the US Treasury) -at first printed in large denominations for use exclusively by banks

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In 1878, the gov. introduced

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silver certificates (the paper currency backed by silver dollars and bullion placed on reserve with the Treasury) -used to be bulky size - made them inconvenient -when silver dollars were used as backing, the certificates became more popular and increased the demand for silver (appeased both the silver miners and the public who wanted an alternative to the bulky silver dollars)

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The national banking system was having difficulty providing enough currency for the growing nation. second,

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checking accounts were becoming popular (banking system not designed for this) third, even minor recessions were causing major problems for banks and other lending instit.

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Reform came in 1913 when congress created the

answer

Federal Reserve system, or Fed, as the nation's central bank.

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Central bank =

answer

is a bank that can lend to other banks in times of need -to have membership, all national banks were required, and all state-chartered banks were eligible to become \"members\" -or part owners-of the Fed -

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The Fed issued its own currency, called

answer

Federal reserve notes, which eventually replaced all other types of federal currency -because the Fed had the resources to lend the Fed became the nation's first true central bank

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At the start of the Depression, about 25,500 banks existed- none of which had

answer

deposit insurance for their customers

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Concern about the safety of bank deposits often caused a

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bank run (a rush by depositors to withdraw their funds from a bank before it failed) -this made the situation worse, causing more banks to fail

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On march 5, 1993, President Roosevelt announced a

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bank holiday (a brief period during which every bank in the country was required to close) -several days later, Congress passed legislation to strengthen the banking industry, most banks were allowed to reopen, but more closed

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When banks failed during the Great Depression, depositors lost

answer

all their savings -The Banking Act of 1933 (Glass-steagall act) was passed to strengthen the banking industry -also created the Federal Deposit insurance corporation (FDIC), which initially insured customer deposits to a max. of $2500 in the event of a bank failure

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If a bank is in danger of collapse today, the FDIC can seize the bank and

answer

either sell it to a stronger one or liquidate it and pay off the depositors -if the sale is done, it is done in secrecy

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Member bank reserve (MBR)- a

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deposit a member bank keeps at the Fed to satisfy reserve requirements

question

Excess reserves=

answer

legal reserves beyond the reserve requirement

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This expansion will continue as long as the bank has excess reserves to

answer

lend and as long as lenders deposit part or all of that money

question

Equation:

answer

Total MBRS/Reserve requirement

question

Fractional Reserve banking allows the DDA component of the money supply to grow several times larger than

answer

the total amount of member bank reserves

question

The US economy reached a milestone in early 2006 when Alan Greenspan ended

answer

his tenure of over 18 years as Chairman of the Federal Reserve System's board of Governors -position is imp. because has immense influence over the economy

question

The new chairman is

answer

Ben Bernanke -unusual degree of independence -can change interest rates to try to speed up the economy when it is growing too slowly, or try to slow it down when it is growing too fast -will be concerned about economic instability, recessions, and inflation

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One of unique features of the Fed is that

answer

it is privately owned by its member banks

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Member banks

answer

a commercial bank that is a member of, and holds shares of stock in, the Fed

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National Banks (those chartered by the

answer

national gov.) = must belong to the Fed

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State banks - those receiving their charters from

answer

state gov.- have the choice to belong or not

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The original decision to make the Fed a stock corporation was

answer

a matter of necessity b/c the gov. did not have enough money to set p a new banking system -banks required to purchase shares when they joined (became part-owners) -private indiv. cant buy shares in the Fed although they become indirect owners by buying shares of stock in a Fed-member bank

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The Fed is directed by a

answer

7 member Board of Governors -each member appointed by president of US and approved by Senate to serve 14-year term of office -appointments are staggered (becomes vacant every two years) -PUBLIC INTEREST - \"privately owned, but publicly controlled\" -the board basically has regulations for banks, make policies that affect interest rates and general avail. of credit

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The Fed was originally intended to operate as a system of

answer

12 independent and equally powerful banks -each reserve bank responsible for districts -12 Federal Reserve district banks and their branches are strategically located to be near the instit. they serve -many of same functions as banks

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The Federal Open Market Committee (FOMC) makes decisions about the

answer

level of interest rates -12 voting members -meets 8x a year to review economy and to evaluate factors such as trends in construction, wages, prices, employment, production, and consumer spending -decisions have direct impact on cost and avail. of credit -while decisions made in private- announced almost immediately -is the Fed's primary monetary policy-making body

question

3 advisory committees advise the

answer

Board of Governors -The Federal Advisory Council, The Consumer Advisory Council, Thrift Instit. Advisory Council

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Member banks contribute funds (through stocks) to the

answer

12 district banks

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Fed can conduct

answer

monetary policy (changes in the money supply in order to affect the availability and cost of credit) -based on supply and demand -demand curve has usual shape, which illustrates that more money will be demanded when the interest rate (or price of credit to a borrower) is low -supply curve not have usual shape- vertical slope (supply of money is fixed at any given time)

question

The fed changes interest rates by changing the size

answer

of money supply

question

Easy money policy: the Fed

answer

expands the money supply, causing interest rates to fall (Stimulates economY) -people borrow more at lower interest rates

question

Tight money policy:

answer

the fed restricts the size of the money supply -contraction of the money supply drives the cost of borrowing up (slow economic growth b/c higher interest rates normally encourage everyone to borrow and spend less -3 different tools to direct monetary supply

question

1st tool: Reserve Requirment

answer

-can change requirement for all checking, time, and savings accounts -can change percent reserve requirement applied to DDAs (make it 10% instead of 20%) -hesitant to use this tool as others work better

question

2nd tool: Open Market Operations

answer

-the buying and selling of gov. securities in financial markets -most popular tool -can influence short-term interest rates -if want to expand money supply, buy a bond from an investor and pay for it with a check drawn on itself- bank will have additional excess reserves and loan expansion process can begin

question

The result is that whenever the Fed buys gov. securities,

answer

excess reserves are created and the money supply expands

question

When a buyer takes money out of the banking system to pay for the secur., member bank reserves

answer

go down, forcing the money supply to contract -smaller money supply raises interest trates

question

Whenever the Fed sells gov. secur., excess

answer

reserves contract and the money supply contracts

question

3rd tool: Discount Rate - As a central bank, the Fed makes loans to

answer

other depository insit. -discount rate (the interest the Fed charges on loans to financial instit.) -only financial instit. can borrow from the Fed (private indiv. and companies are not allowed)

question

The discount rate is the price of credit for an instit. that borrows from

answer

the Fed -if goes up, fewer banks will have fewer excess reserves avail. to laon out -if wants to expand money supply, might lower the rate to encourage additioanl borrowing (increasing excess reserves)

question

CHanges cna directly affect the

answer

prime rate (the lowest rate of interest commercial banks charge their best customers) -at large banks, prime rate is linked to other interest rates (so banks usually adjust it)

question

The money supplu affects the general price level -

answer

if for long time, would have too many dollars (would lead to inflation)

question

Quantity theory of money=

answer

hypothesis that the supply of money directly affects price levels over the long run

question

currency=

answer

the paper component of the money supply, is made up of Federal reserve notes that are printed by US Bureau of Engraving and Printing -distributed in Fed's district banks for storage until it is needed by the public

question

Bureau of the MInt produces

answer

coins (metallic forms of money) -after minted, shipped to the Fed district banks for storage -if cannot be used, etc., returned to the Fed for replacement (destroys old money so not put back in circulation)

question

Next to cash, checks are the most popular form of payment in US

answer

-also changed: now only electronic images of check are returned to issuer

question

The Fed is charges with watching over

answer

foreign branches of its own member banks, as well as US branches of foreign-owned banks

question

Bank holding companies=

answer

firms that own and control one or more banks

question

Under Regulation Z, the Fed

answer

has the authority to extend truth-in-lending disclosures to millions of indiv. who borrow from retail stores, auto dealers, banks, and lending instit. -regulation z: provision extending truth-in-lending disclosures to consumers -disclosures: size of down payment, number and size of monthly payments, and total amount of interest over the life of loan (determined by Fed)

question

Fed also maintains accounts for the

answer

gov. -any check written to US treasury is deposited by the Fed -another ex. social security payment comes from accounts held at the Fed

question

A final Fed function is the range of

answer

financial services it provides to the federal gov. and its agencies -the fed serves as the gov.'s bank

question

1913:

answer

FED created

question

Easy money policy -

answer

money supply expands, interest rates fall.

question

Tight money policy -

answer

money supply contracts, interest rates rise.

question

Reserve requirement to

answer

control money supply.

question

Open market operations

answer

-FED buys government securities, excess reserves created, money supply expands. -FED sells government securities, excess reserves contract, money supply contracts.

question

Quantity theory of money -

answer

demand-pull inflation.

question

Other FED responsibilities

answer

-Maintaining money supply -Maintaining the payments system -Regulating and supervising banks -Preparing consumer legislation (i.e. Truth in Lending Act)

question

Acting as

answer

the Government's bank.

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