Money and Banking

Chapter 10

Three Uses of Money

Medium of Exchange – anything used to determine value during the exchange of goods and services.

Unit of Account – a way to compare value of goods and services.

Store of Value – keeps its value if you keep it or hang on to it.

What is currency?

Coins and paper bills used as money.

Six Characteristics Economists Use to Judge How Well an Item Serves as Currency

Durable Portable Divisible Uniform Limited supply Acceptable

What is commodity money?

Commodity money consists of objects that have value in themselves and that are also used as money.

Examples: salt, cattle

What is representative money?

Representative money makes use of objects that have value because the holder can exchange them for something else of value.

Ex. Silver certificates exchange for silver; gold certificates exchange for gold.

What is fiat money?

Legal tender. The money is good because the

government says it is. Limited supply. Controlled by the Federal Reserve.

Who was Amadeo P. Giannini? Founded the Bank of Italy in San Francisco

in 1904 when he found out that banks refused to make loans to low-income workers.

Became the first with a statewide system of banking with branch banks throughout California. Bank of Italy was merged into Bank of America.

In 1930’s it was the largest commercial bank – 500 branches and $6 billion in deposits.

Banking Today

All of the money available in the United States economy is known as the money supply.

Economists divide the money supply into two categories M1 Money that people can gain access to easily

and immediately to pay for goods and services.

M1 consists of assets that have liquidity, or the ability to be used as , or directly converted into cash. • currency held by the public, checking accounts also

called demand deposits because checks can be paid on demand;

• checking accounts that pay interest and travelers checks.

M2 All the assets in M1 plus several additional assets. These additional M2 funds cannot be used as cash

directly Can be converted to cash fairly easily. M2 assets are also called near money. Deposits in savings accounts (not counted in M1 because

you cannot hand a clerk your savings account passbook to pay for something)

Money market mutual funds (funds that pool money from small savers to purchase short-term government and corporate securities – they earn interest and can be used to write checks over a certain minimum amount).

Four most common ways banks offer to people to save money:

Savings accounts Checking accounts Money market accounts (pay higher rate of

interest; save and write a limited number of checks; interest rates are not fixed.

Certificates of deposit (CDs) (offer guaranteed rate of interest for specific period of time; can’t be removed early without a penalty)

More Definitions

Fractional reserve banking-a banking system that keeps only a fraction of funds on hand and lends out the remainder.

Default –borrowers fail to pay back their loan

• Tradeoff for the banks between profits and safety – too many bad loans may go out of business)

Mortgage Loan-a specific type of loan that is used to buy real estate.

Loans

What is interest? The price paid for the use of borrowed

money. The amount borrowed is known as the

principal.

A Bank’s Income

What is the largest source of income for banks?• The interest they receive from customers who

have taken loans.