Econ Chapter 14 Quiz

Flashcard maker : Marie Florence
People used things that were easily available and
valued by others as a form of money
As a result, money came in
a variety of forms, shapes and sizes
The use of money developed because it makes
life easier for people and serves everyone’s best interests
-money has become a social convention (like general acceptance of laws and gov.)
Most money issued by the
Federal Reserve System (Fed)
privately owned, publicly controlled central bank of the US
Fed issues paper currency known as
Federal Reserve Notes (paper currency issued by Fed in use today)
-key part of our money supply
Barter economy
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\”)
Life is simpler in an economy with
Tea leaves compressed into \”bricks\” comprised
money in ancient China
Compressed cheese was used in early
Russian trade
In early colonial America,
corn and even animal pelts were used as form of money
Today, this money would be classified as
commodity money (money that has an alternative use as an economic good, or commodity)
Fiat money
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)
Money used by early settlers in American colonies was similar to that
found in early societies
-some consisted of commodity money and some as fiat money
Many products, such as
corn, hemp, gunpowder, and musket balls served as commodity money (could settle debts and make purchases) and colonists could consume these products if necessary
A commonly accepted commodity money was
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
1637 Massachusetts est. a monetary value for
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
Americans used other forms of money as times passed. In some cases, state laws allowed individuals to print their own
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.
The Continental Congress issued
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.
Colonists also used modest amounts of
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
The most popular coin in the colonies was the
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
The \”triangular trade\” between the colonies, Africa and the Caribbean bought
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
Pesos were known as
\”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\”
Monetary unit, or
standard unit of currency, in the U.S. money system
The study of early money is useful because it helps us
understand the characteristics that give money its value
-any substance can serve as money if it possesses four main characteristics
First characteristic of money:
-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
Second characteristic of money:
-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
Third Characteristic of money:
-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
Fourth Characteristic of money:
-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)
First Function of Money:
-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
Second Function of Money:
-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
Third Function of Money:
-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
Modern money:
-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.
Fed uses different definitions for the money supply. The first is M1, which includes
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
A broader definition is M2, which includes
M1 along with savings deposits, time deposits, and money market funds -all of which relate to money’s function as a store of value
Our money now shares the same fundamental characteristics and
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)
Today, some of our money circulates as paper currency, but most of it exists in the form of
electronic bookkeeping entries
-neither is backed by gold or silver
-accepted because we have faith in it
The United States experimented with many different kinds of money before it
created the Federal Reserve System
At one time, banking was
virtually unregulated -problems with money supply eventually required the intervention of government
During the revolutionary war, nearly 250 million
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
Banking became popular after the Revolution b/c the
new Constitution allowed private banks to issue paper currency
State bank
bank that receives its operating charter from a state gov.
-banks issue own currency by printing their notes at local printing shops
At first, most banks printed only the amount of currency they could reasonably back with their gold and silver reserves. Others, were
not as honest and printed large amounts of currency in remote areas to make it difficult for people to redeem their currency.
Problems arose even with honest banks: each bank issued its own currency in
different sizes, colors and denominationss
2. tempted to issue too many notes
3. counterfeiting became a major problem (would make new ones)
Politically powerful local bankers, however, resisted change until an event
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
Congress decided to print paper currency for the
first time since the Constit.
In 18611, Congress authorized the printing of $60 million in the new currency. Although it had
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)
People feared greenbacks might
become worthless
COngress enacted the
National currency act, which created a National Banking system (NBS) made up of national banks
National bank
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
In the same year the NBS was created, the gov. issued
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
In 1878, the gov. introduced
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)
The national banking system was having difficulty providing enough currency for the growing nation. second,
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.
Reform came in 1913 when congress created the
Federal Reserve system, or Fed, as the nation’s central bank.
Central bank =
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
The Fed issued its own currency, called
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
At the start of the Depression, about 25,500 banks existed- none of which had
deposit insurance for their customers
Concern about the safety of bank deposits often caused a
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
On march 5, 1993, President Roosevelt announced a
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
When banks failed during the Great Depression, depositors lost
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
If a bank is in danger of collapse today, the FDIC can seize the bank and
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
Member bank reserve (MBR)- a
deposit a member bank keeps at the Fed to satisfy reserve requirements
Excess reserves=
legal reserves beyond the reserve requirement
This expansion will continue as long as the bank has excess reserves to
lend and as long as lenders deposit part or all of that money
Total MBRS/Reserve requirement
Fractional Reserve banking allows the DDA component of the money supply to grow several times larger than
the total amount of member bank reserves
The US economy reached a milestone in early 2006 when Alan Greenspan ended
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
The new chairman is
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
One of unique features of the Fed is that
it is privately owned by its member banks
Member banks
a commercial bank that is a member of, and holds shares of stock in, the Fed
National Banks (those chartered by the
national gov.) = must belong to the Fed
State banks – those receiving their charters from
state gov.- have the choice to belong or not
The original decision to make the Fed a stock corporation was
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
The Fed is directed by a
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
The Fed was originally intended to operate as a system of
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
The Federal Open Market Committee (FOMC) makes decisions about the
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
3 advisory committees advise the
Board of Governors
-The Federal Advisory Council, The Consumer Advisory Council, Thrift Instit. Advisory Council
Member banks contribute funds (through stocks) to the
12 district banks
Fed can conduct
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)
The fed changes interest rates by changing the size
of money supply
Easy money policy: the Fed
expands the money supply, causing interest rates to fall (Stimulates economY) -people borrow more at lower interest rates
Tight money policy:
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
1st tool: Reserve Requirment
-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
2nd tool: Open Market Operations
-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
The result is that whenever the Fed buys gov. securities,
excess reserves are created and the money supply expands
When a buyer takes money out of the banking system to pay for the secur., member bank reserves
go down, forcing the money supply to contract
-smaller money supply raises interest trates
Whenever the Fed sells gov. secur., excess
reserves contract and the money supply contracts
3rd tool: Discount Rate – As a central bank, the Fed makes loans to
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)
The discount rate is the price of credit for an instit. that borrows from
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)
CHanges cna directly affect the
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)
The money supplu affects the general price level –
if for long time, would have too many dollars (would lead to inflation)
Quantity theory of money=
hypothesis that the supply of money directly affects price levels over the long run
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
Bureau of the MInt produces
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)
Next to cash, checks are the most popular form of payment in US
-also changed: now only electronic images of check are returned to issuer
The Fed is charges with watching over
foreign branches of its own member banks, as well as US branches of foreign-owned banks
Bank holding companies=
firms that own and control one or more banks
Under Regulation Z, the Fed
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)
Fed also maintains accounts for the
-any check written to US treasury is deposited by the Fed
-another ex. social security payment comes from accounts held at the Fed
A final Fed function is the range of
financial services it provides to the federal gov. and its agencies
-the fed serves as the gov.’s bank
FED created
Easy money policy –
money supply expands, interest rates fall.
Tight money policy –
money supply contracts, interest rates rise.
Reserve requirement to
control money supply.
Open market operations
-FED buys government securities, excess reserves created, money supply expands.
-FED sells government securities, excess reserves contract, money supply contracts.
Quantity theory of money –
demand-pull inflation.
Other FED responsibilities
-Maintaining money supply
-Maintaining the payments system
-Regulating and supervising banks
-Preparing consumer legislation (i.e. Truth in Lending Act)
Acting as
the Government’s bank.

Get instant access to
all materials

Become a Member