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Chapter 24 Money and the Federal

Reserve System• Key Concepts• Summary• Practice Quiz• Internet Exercises

©2000 South-Western College Publishing

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In this chapter, you will learn to solve these economic puzzles:

Why do nations use money?Is “plastic money” really money?

What does the Federal Reserve bank do?

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What is Barter?The direct exchange of one

good for another good, rather than for money

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What is the problem with Barter?

It requires a coincidence of wants

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What is Money?Anything that serves as

a medium of exchange, unit of account, and store of value

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What is the Advantage of Money?

The use of money simplifies and therefore increases market transactions

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What are the Functions of Money?• Medium of exchange• Unit of account• Store of value

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What is aMedium of Exchange?

The primary function of money to be widely accepted in exchange for goods and services

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What is aUnit of Account?

The function of money to provide a common measurement of the relative value of goods and services

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What does it mean that Money is Liquid?

It is available to spend in exchange for goods and services without any additional expense

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Are Credit Cards Money?No, credit cards fail to

meet the store-of-value criterion and are therefore not money

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What is the best level of Scarcity for Money ?

The supply of money must be great enough to meet ordinary transactions needs, but not be so plentiful that it becomes worthless

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What are other Properties of Money?

Money must be …• portable• divisible• uniform• acceptable

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What isCommodity Money?

Anything that serves as money while having market value in other uses

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Is our Money backed up by Gold or Silver?

No, our paper money was exchangeable for gold until 1934, and in 1963 Congress removed the right to exchange $1 bills for silver

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What is Fiat Money?Money accepted by

law and not because of redeemability or intrinsic value

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What makes our Dollar Bills Fiat Money?

All our bills claim that “This note is legal tender for all debts public and private”

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What doesLegal Tender mean?

Legally dollar bills cannot be refused as payment for a debt

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What is Currency?Money, including coins

and paper money

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What areCheckable Deposits?

The total of checking account balances in financial institutions convertible to currency “on demand” by writing a check without advance notice

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What is M1?The narrowest definition of

the money supply. It includes currency, traveler’s checks, and checkable deposits

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What is M2?The definition of the

money supply that equals M1 plus near monies, such as savings deposits and small time deposits of less than $100,000

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What is M3?The definition of the money

supply that equals M2 plus large time deposits of $100,000 or more

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What distinguishes M1 from M2 and M3?

M1 is more liquid than M2 or M3

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The Money Supply

42%

58%

Currency

Traveler's checks -checkable deposits

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The Money Supply

25%

53%

22%

M1

Savings deposits

Small timedeposits

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The Money Supply

74%

26%

M2

Large timedeposits

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What is the Federal Reserve System?

The 12 central banks that service banks and other financial institutions within each of the Federal Reserve districts

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What is the Board of Governors of the Fed?

The seven members appointed by the President and confirmed by the U.S. Senate

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How long does a Board Member serve?

They serve for a non-renewable fourteen-year term

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What is the responsibility of the Board?

To supervise and control the money supply and the banking system of the U.S.

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What is the Chairman of the Board of Governors?The President designates

one member of the Board to serve as chair for a renewable four-year term

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Who is Alan Greenspan?Chairman of the Board of

Governors of the Fed

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What is the Federal Open Market Committee?

The FOMC is the Fed’s committee that directs the buying and selling of U.S. government securities

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What is the purpose of the FOMC?

To increase the money supply if we have unemployment and decrease it if we have inflation

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What is the Federal Advisory Council?

12 prominent commercial bankers who council board members but who do not have voting rights

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How many Commercial Banks are members of the Fed?

About 6,000 of the 15,000

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What percent of all deposits reside in Member Banks?

About 70%

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Board of Governors

Regional Fed Banks

U.S. Banking System

The Fed’s Organization

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What does a Federal Reserve Bank do?

• Controls the money supply• Clears checks• Supervises and regulates banks• Maintains and circulates currency• Protects consumers• Maintains federal government

checking accounts and gold

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What is the Federal Deposit Insurance

Corporation?The FDIC is a government

agency established in 1933 to insure commercial bank deposits up to a specified limit

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What is theMonetary Control Act?

A 1980 law that gave the Fed greater control of nonmember banks and makes all financial institutions more competitive

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Key Concepts

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Key Concepts

• What is Barter?

• What is Money?

• What are the Functions of Money?

• What does it mean that Money is Liquid?

• What are other Properties of Money?

• What is Commodity Money?

• Is our Money backed up by Gold or Silver?

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Key Concepts cont.

• What is Fiat Money?

• What is Currency?

• What is M1?

• What is M2?

• What is M3?

• What is the Federal Reserve System?

• What is the Board of Governors?

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Key Concepts cont.• What is the Chairman of the Board of Gove

rnors?

• What is the Federal Open Market Committee?

• What is the Federal Advisory Council?

• What does a Federal Reserve Bank do?

• What is the Federal Deposit Insurance Corporation (FDIC)?

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Summary

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Money can be anything that meets these three tests. Money must serve as (1) a medium of exchange, (2) a unit of account, and (3) a store of value. Money facilitates more efficient exchange than barter. Other desirable properties of money include scarcity, portability, divisibility, and uniformity.

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Medium of exchange is the most important function of money. This means that money is widely accepted in payment for goods and services.

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Unit of account is another important function of money. Money is used to measure relative values by serving as a common yardstick for valuing goods and services.

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Store of value is the property of money to hold its value over time. Money is said to be highly liquid, which means it is readily usable in exchange.

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Credit cards are not money. Credit cards represent a short-term loan and therefore fail as a store of value.

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Commodity money is money that has a marketable value, such as gold and silver. Today, the U.S. uses fiat money, which must be accepted by law, but is not convertible into gold, silver, or any commodity.

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M1 is the narrowest definition of money, which equals currency plus traveler’s checks plus checkable deposits. M2 is a broader definition of money, which equals M1 plus near monies, such as savings deposits and small time deposits. M3 is an even broader definition of money, which equals M2 plus large time deposits of more than $100,000 or more.

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The Money Supply

42%

58%

Currency

Traveler's checks -checkable deposits

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The Money Supply

25%

53%

22%

M1

Savings deposits

Small timedeposits

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The Money Supply

74%

26%

M2

Large timedeposits

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Chapter 24 Quiz

©2000 South-Western College Publishing

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1. Which of the following is a problem with barter?a. Individuals will not exchange goods.b. Individuals’ wants must coincide in order

for there to be exchange.c. Goods can be exchanged, but services

cannot.d. None of the above is a problem.

B. Finding coincidence of wants complicates and therefore decreases market transactions.

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2. Which of the following is not a characteristic of money?a. It provides a way to measure the relative

value of goods and services.b. It is always backed by something of high

intrinsic value such as gold or silver.c. It is generally acceptable as a medium of

exchange.d. It allows for saving and borrowing.

B. Gold or silver backing for U.S. paper money was removed in 1934.

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3. Which of the following is not a store of value? a. Dollar.b. Money market mutual fund share.c. Checking account balance. d. Credit card.

D. Credit cards are a prearranged short-term loan which can be canceled by the credit card company.

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4. The easier it is to convert an asset directly into goods and services without loss, the a. less secure it is.b. more secure it is.c. more liquid it is.d. less liquid it is.

C. Money is the most liquid form of wealth because it can be spent directly in the marketplace.

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5. M1 refers to a. the most narrowly defined money supply. b. currency held by the public plus

checking account balances and traveler’s checks.

c. the smallest dollar amount of the money-supply definitions.

d. all of the above.

D. M1 is the narrowest definition of the money supply.

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6. The M1 definition of the money supply includes a. coins and currency in circulation.b. coins and currency in circulation,

checkable deposits, and traveler’s checks.c. Federal Reserve notes, gold certificates,

and checkable deposits.d. Federal Reserve notes and bank loans.

B. Answers a is incomplete and c and d are not answers because gold certificates and bank loans are not included in M1.

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7. Which of the following items is not included when computing M1? a. Coins in circulation.b. Currency in circulation.c. Savings accounts.d. Checking account entries.

C. Savings accounts are included in M2.

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8. Which of the following is part of the M2 definition of the money supply, but not part of M1? a. Traveler’s checks.b. Currency held in banks.c. Currency in circulation.d. Money market mutual shares.

D. Note that M1 is part of M2.

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9. Which of the following is not part of M1?a. Checking accounts.b. Coins.c. Credit cards.d. Traveler’s checkse. Paper currency.

C. Credit cards are not considered money. They fail to meet the store of value characteristic.

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10. Which definition of the money supply includes credit cards, or “plastic money”?a. M1.b. M2.c. M3.d. All of the abovee. None of the above.

E. Credit cards are not money because they fail to serve as a store of value.

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11. Which of these institutions has the responsibility for controlling the money supply?a. Commercial banks.b. Congress.c. The U.S. Treasury Department.d. The Federal Reserve System.

D. The Federal Reserve System is our central bank.

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12. Which of the following is not one of the functions of the Federal Reserve?a. Clearing checks.b. Printing currency.c. Supervising and regulating banks.d. Controlling the money supply.

B. The U.S. Treasury prints our currency.

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13. Which of the following is in charge of the buying and selling of government securities by the Fed?a. The president.b. The Federal Open Market Committee.c. The Congress.d. None of the above.

B. Selling U.S. securities (Treasury bills, notes, and bonds) is one of the major tools for controlling the money supply.

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14. The major protection against sudden mass attempts to withdraw cash from banks is the a. Federal Reserve.b. Consumer Protection Act.c. deposit insurance provided by the FDIC.d. gold and silver backing the dollar.

C. The FDIC is a government agency established by Congress in 1933 to insure commercial bank deposits up to $100,000 per bank account.

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END