CHAPTER 14 MONEY BANKING AND FINANCIAL INSTITUTIONS the functions of money medium of exchange usable for buying and selling goods and services allows society to escape the complications of barter unit of account resources store of value yardstick for measuring relative worth of a variety of goods services and define debt obligations determine taxes owed calculate nation s GDP transfer purchasing power from present to future can also hold assets in real estate stocks bonds precious metals collectibles liquidity the ease with which an asset can be converted quickly into cash the more liquid an asset it the more quickly it can be converted into cash levels of liquidity cash perfectly liquid large assets can take a long time to convert to cash the components of money money is anything widely accepted as a medium of exchange M1 currency checkable deposits currency coins and paper money coins issued by US Treasury paper issued by Federal Reserve System US central bank coins made by US Mint paper printed by Bureau of Engraving and Printing checkable deposits deposits in commercial banks or savings institutions on which checks of any size can be drawn checks are more convenient and more secure checks are a way to transfer ownership of deposits in banks can convert checkable deposits into cash on demand token money the face value is unrelated to the intrinsic value institutions that offer checkable deposits commercial banks primary accept deposits of households and businesses keep money safe until it is demanded by checks use money to make loans thrift institutions savings and loan associations mutual savings banks credit unions S Ls and mutual savings banks accept deposits and use them to finance housing mortgages and to provide other loans credit unions accept deposits and lend to members usually a group of people the same company who work for exclude this money when counting money supply to avoid double counting M2 M1 savings deposits small denominated time deposits MMMFs held by individuals near monies highly liquid financial assets that do not function directly or fully as a medium of exchange but can be readily converted into currency or checkable deposits savings deposits including money market deposit accounts easily withdrawn or transferred to a checkable account MMDA are interest bearing accounts containing a variety of interest bearing short term securities MMDAs have a minimum balance requirement and a limit on withdrawals small denominated less than 100 000 time deposits time deposits funds become available at their maturity higher interest rate money market mutual funds held by individuals mutual fund companies use combined funds of individual shareholders to bearing short term credit instruments like certificates of deposit buy interest and US government securities offer interest on MMMF accounts of the shareholders Money as Debt major components of the money supply are debts paper money is circulating debts of the federal reserve banks and thrift institutions if the government backed the currency with something tangible like gold the supply of money would vary with the supply of gold no money backing no constraint and freedom to provide as much money as it wants aka the government has the ability to manage the country s money moral of the story money is only exchangeable for money Value of Money acceptability money is money because people accept is as money consumer confidence that money will do its job legal tender this note is legal tender for all debts public and private aka money is a legal and valid means of payment up to 250 000 are insured by the Federal Deposit Insurance Corporation FDIC and the National Credit Union Administration NCUA relative scarcity value of money relies on supply and demand demand total dollar volume of transaction amount of money individuals and businesses want to hold for future transactions purchasing power Money and Prices purchasing power the amount of goods and services a unit of money will buy the purchasing power of the dollar V 1 P the amount a dollar can buy varies inversely with the price level as the cost of living index goes up the value of the dollar goes down lower prices increase the purchasing power of the dollar fewer dollars needed inflation and acceptability hyperinflation occurred when the government issued too much paper currency that the purchasing power was undermined depreciate the value between time it is received and time it is spent in extreme situations a country may adopt a foreign currency to counter hyperinflation stabilizing money s purchasing power rapid inflation and loss of purchasing power usually result from imprudent economic policies stabilization of purchasing power requires stabilization of price level regulation of money supply interest rates and appropriate fiscal policy The Federal Reserve and the Banking System monetary authorities board of governors of the Fed directs activities of the 12 federal reserve banks banks control the lending of the nation s banks and thrift institutions historical background decentralized unregulated banking had made for inconvenient and confusing in banking often times too little or too much money banking crisis when individuals and businesses lost confidence all tried to withdraw their money 1907 banking crisis National Monetary Commission Federal Reserve Act of 1913 board of governors central authority of US money and banking system 7 board members appointed by the president 14 year terms new member every 2 years chairperson and vice chairperson from the 14 members 4 year terms the 12 Federal Reserve Banks blend private and public control central banks most countries have one central bank 12 banks with policies coordinated by the Fed San Francisco Minneapolis Kansas City Dallas Chicago St Louis Atlanta Cleveland Richmond Philadelphia New York Boston quasi public banks fed banks owned by private commercial banks in the district board of governors sets basic policies in practice public not for profit bankers banks perform the same functions for banks and thrifts that banks and thrifts perform for the public become the lender of last resort and can lend out as much as needed to ensure banks and thrifts meet their cash obligations issue currency FOMC Federal Open Market Committee 12 individuals 7 members of Board of Governors president of the New York Fed 4 remaining Fed presidents on 1 year rotating basis regularly meets to direct purchase and sale of government