Pump Primer

1. Pump Primer List the functions of money & the desirable characteristics of money

2. “ECONOMICS for Christian Schools” Unit IV: Economics of the Financial Market By Alan J. Carper Bob Jones University Press. 1998

3. Chapter 10 “Money & Banking”

4. Objectives: Explain the definitions of money used in the United States. Describe the properties of money. List the functions of money & the desirable characteristics of money Identify the different kinds of money Name the four designations given to measurements of the money supply Describe the banking activity of goldsmiths that led to an expansion of the money supply Describe a commercial bank Describe the existing dual banking system List the functions of commercial banks Explain the concept of near-monies.

5. Biblical Integration: We are to be good stewards of the money God has given unto us. (Luke 16:11) Money is a tool to be used for His service to provide for one's family, feed the needy & spread the gospel.

6. Money? Proverbs 23: 4-5 - The uselessness of seeking riches Luke 16:11 – the necessity of being good stewards of the money we have 2 Cor. 8:9 – the source of true riches.

7. Proper Use of Money: “The proper use of money allows man to provide for his family, to purchase clothing for the destitute, to obtain food for the hungry, to care for the sick, and to spread the gospel to the nations of the world. Money is a tool to be used for God’s service.” (Carper, 129)

8. Introduction • The properties of money, the functions of money the definitions of money are important concepts for you to understand. • Money has existed for a long time, and a wide range of commodities have served as money in different countries and at different times. • Before money, economies used a barter system. • The principle problem with a barter system is the double coincidence of wants required for success. • Double coincidence of wants means that you must find someone who wants what you want to trade and has what you want! • Time-consuming and limiting!

9. Money • Properties of any commodity used as money: • Portability • Uniformity • Durability • Stability in value • Acceptability • Commodities that have served as money: • Cigarettes and chocolate bars in prisoner war camps • Wampum (sm. Beads woven into colorful strips by the Indians)

10. Functions of Money: • Medium of exchange • Eliminates the need of the double coincidence of wants • Store of value • Permits money to be held for use at a later time • Unity of Account, or standard-of-value • There is an agreed-to measure for starting the prices of goods and services. (This simplifies price comparisons.)

11. “Money”Activity 34 & 35 by Advanced Placement Economics Teacher Resource Manual. National Council on Economic Education, New York, N.Y

12. Activity 34: Money • Use the table to evaluate how well each item would perform the functions of money in today’s economy. • If an item seems to fulfill the function, put a “+” sign in the box; • If it does not fulfill a function in your opinion, place a “–” sign in the box. • Put a “?” Sign in the box if you are unsure whether the item fulfills the functions of money • The item with the most + signs would be the best form of money for you. • In the space below the table, list the top six forms of money, according to your evaluation.

13. - - - - + - - - - + + + + + + - - - + + + - - - ? + + + + + + - + - - - - - - - - - + + + + + + My top six items: Gold, copper coins, personal checks, debit card, $1 bill and $100 bill

14. After you finish the evaluation in Question 1, rate the various items in the table below. • Evaluate how well they meet the characteristics of money. • Again, if an item seems to fit a characteristic, use a “+” sign; • If the item does not seem to fit a characteristic, use a “-” sign; • If there is a difference of opinion or if you are uncertain, use a “?”. • The item with the most “+” signs would best fit the characteristics of money. • In the space below the table, list your six top items.

15. - + + - + - - - + + - - - ? - + + ? + - + + ? + - - - + + ? + + ? + + + - - + + + - + ? ? + + + + + + + + + + - - - - + + - - - - - - - - - + + + + + + + + + + My top six items: Gold, copper coins, personal checks, debit card, $1 bill and $100 bill

16. Why might factors such as ease of storage, difficulty in counterfeiting and security of electronic transfer of funds also be characteristics that you might use in evaluating money? For an item to be a good medium of exchange, you would want to minimize the costs of holding or storing it. Counterfeiting and security affect the item’s underlying value and might affect acceptability.

17. Check A check is an authorization to pay a designated amount of money out of an established account. (Carper, 136)

18. Negotiable Check: (1)   In writing (2)  Signed by the maker (3)  Payable to the bearer or to the order of a specific person (4)  Ordering the bank to pay a specified sum of money (5) Bearing a date no older than six months. (Carper, 136)

19. Checks “Many corporations will use a stamp signature instead of signing each individual check.” “On most checks the writer writes out the amount of the check in both words and in numerals. If the two do not agree, the written amount in words is the legal amount of the check.” “Checks older than six months are considered “stale” dated and by law cannot be cashed. It is also illegal to “post” date a check (date a check for time in the future).” (Carper, 136)

20. Measuring the Money Supply • How much money exists in the United States? • This is not an easy question to answer, since money represents purchasing power and it greatly depends on how it is measured. • M-I • M-2

21. M-1 • Economists refer to first method of measuring the money supply as M-1 • “currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; • traveler's checks of nonbank issuers; • demand deposits at commercial banks (excluding those amounts held by depository institutions, the U.S. government, and foreign banks and official institutions) less cash items in the process of collection and Federal Reserve float; and • other checkable deposits (OCDs), consisting of negotiable order of withdrawal (NOW) and automatic transfer service (ATS) accounts at depository institutions, credit union share draft accounts, and demand deposits at thrift institutions. Seasonally adjusted M1 is constructed by summing currency, traveler's checks, demand deposits, and OCDs, each seasonally adjusted separately.” (“Money Stock…”)

22. M-2 • A broader measure of the money supply is referred to as M-2: • Includes M-1 money plus all money available to spend after a short delay: • Savings deposits (including money market deposit accounts); • Small-denomination time deposits (time deposits in amounts of less than $100,000), less individual retirement account (IRA) and Keogh balances at depository institutions; and • Balances in retail money market mutual funds, less IRA and Keogh balances at money market mutual funds. Seasonally adjusted M2 is constructed by summing savings deposits, small-denomination time deposits, and retail money funds, each seasonally adjusted separately, and adding this result to seasonally adjusted M1.” (“Money Stock…”)

23. M-3 • The broadest measure of the money supply is known as M-3 – no longer published by Federal Reserve as of March 16, 2006. • Includes M-1 & M-2 • “Balances in institutional money market mutual funds; • Large-denomination time deposits (time deposits in amounts of $100,000 or more); • Repurchase agreement (RP) liabilities of depository institutions, in denominations of $100,000 or more, on U.S. government and federal agency securities; and • Eurodollars held by U.S. addressees at foreign branches of U.S. banks worldwide and at all banking offices in the United Kingdom and Canada. Large-denomination time deposits, RPs, and Eurodollars exclude those amounts held by depository institutions, the U.S. government, foreign banks and official institutions, and money market mutual funds. Seasonally adjusted M3 is constructed by summing institutional money funds, large-denomination time deposits, RPs, and Eurodollars, each adjusted separately, and adding this result to seasonally adjusted M2.” (“Discontinuance of M3 “)

24. THE BANKING SYSTEM • The banking system consists of • The Federal Reserve • The banks and other financial institutions that accept deposits and that provide the services that enable people and businesses to make and receive payments.

25. THE BANKING SYSTEM The Federal Reserve regulates and influences the activities of the commercial banks, thrift institutions, and money market funds, whose deposits make up the nation’s money.

26. Financial Institutions “Is the collection of organizations that assist house-holds in channeling their money to businesses and government.” “CommercialBanksare “full service” institutions offering a wide range of services for both individuals and businesses. Account for nearly half of all assets held by financial institutions. Also, it is important to know that all commercial banks are chartered.” (Carper 140, 143)

27. THE BANKING SYSTEM • Commercial Banks • A commercial bank is a firm that is licensed by the Comptroller of the Currency in the U.S. Treasury (or by a state agency) to accept deposits and make loans. • About 7,400 commercial banks operate in the United States in 2006. • Because of mergers, this number is down from 13,000 a few years ago.

28. THE BANKING SYSTEM Types of Deposits • A commercial bank accepts three types of deposits: • Checkable deposits • Savings deposits • Time deposits

29. THE BANKING SYSTEM Profit and Prudence: A Balancing Act • The goal of a commercial bank is to maximize the long-term wealth of its stockholders. • To achieve this goal, a bank must be prudent in the way it uses its depositors’ funds and balance security for the depositors against profit for its stockholders.

30. THE BANKING SYSTEM Cash Assets • A bank’s cash assets consist of its reserves and funds that are due from other banks as payments for checks that are being cleared. • A bank’s reserves consist of currency in the bank’s vaults plus the balance on its reserve account at a Federal Reserve Bank. • The Fed requires the banks and other financial institutions to hold a minimum percentage of deposits as reserves, called the required reserve ratio.

31. THE BANKING SYSTEM Interbank Loans • When banks have excess reserves, they can lend them to other banks that are short of reserves in an interbank loans market. • The interbank loans market is called federal funds market and the interest rate on interbank loans is the federal funds rate. • The Fed’s policy actions target the federal funds rate.

32. THE BANKING SYSTEM Securities and Loans • Securities held by banks are bonds issued by the U.S. government and by other large, safe, organizations. • A bank earns a moderate interest rate on securities, but it can sell them quickly if it needs cash. • Loans are the funds that banks provide to businesses and individuals and include outstanding credit card balances. • Loans earn the highest interest rate but cannot be called in before the agreed date.

33. THE BANKING SYSTEM Bank Deposits and Assets: The Relative Magnitudes • In 2007, checkable deposits at commercial banks in the United States, included in M1, are about 7 percent of total commercial bank deposits. • The other 63 percent of deposits are savings deposits and small time deposits, which are part of M2.

34. Financial Institutions • Functions include: • (1)Accepting Deposits. (Primary source of money for loans) • (2)Extending Loans (3) Provision of Miscellaneous Services (Carper 140, 141)

35. Creating A Bank Obtain a Charter - Apply to the “Comptroller of the Currency” (federal charter) or state treasurer’s office (state charter) Raise Financial Capital - selling shares Buying Equipment Accepting Deposits (Blade et al. 524)

36. Establishing A Reserve Account - “The bank’s required reserves equal the required reserve ratio multiplied by the amount of deposits.” - “Excess reserves equal actual reserves minus required reserves. The bank can loan only its excess reserve.” Clearing Checks Buying Government Securities - “Government securities provide a bank with an income and are a safe asset that is easily converted back into reserves when necessary.” Making Loans - Generates the primary income for the institution (I.e., interest). (Blade et al. 524)

37. THE BANKING SYSTEM • Thrift Institutions • Three types of thrift institutions are savings and loan associations, savings banks, and credit unions. • A savings and loan association (S&L) is a financial institution that accepts checkable deposits and savings deposits and that makes personal, commercial, and home-purchase loans. • A savings bank is a financial institution that accepts savings deposits and makes mostly consumer and home-purchase loans.

38. THE BANKING SYSTEM • A credit union is a financial institution owned by a social or economic group, such as a firm’s employees, that accepts savings deposits and makes mostly consumer loans. • Like commercial banks, thrift institutions hold reserves and must need minimum reserve ratios set by the Fed.

39. Contractual Savings Institutions Institutions who operate under contract to receive regular payments or premiums, invest the funds, and return stipulated amounts prescribed by the contract – insurance companies and pension funds. (Carper 138, 139)

40. Finance Companies Make consumer loans (tend to offer higherrates than commercial banks) (Carper 138, 139)

41. Investment Companies Mutual funds and other investment companies pool shareholders money to purchase stock & return profit to the shareholders. (Carper 138, 139)

42. THE BANKING SYSTEM • Money Market Funds • A money market fund is a financial institution that obtains funds by selling shares and uses these funds to buy assets such as U.S. Treasury bills. • Money market fund shares act like bank deposits. Shareholders can write checks on their money market fund accounts. • There are restrictions on most of these accounts.

43. THE FEDERAL RESERVE SYSTEM • The Federal Reserve System • The Federal Reserve System is the central bank of the United States. • A central bankis a public authority that provides banking services to banks and regulates financial institutions and markets. • The Fed’s main task is to regulate the interest rate and quantity of money to achieve low and predictable inflation and sustained economic growth.

44. Activity 35: “What’s All This About the Ms?” Medium of exchange, a standard of value (unit of account), and a store of value. • What are the three basic functions of money? • Why is it important for the Fed to know the size and rate of growth of the money supply? • What are the effects if the money supply grows too slowly? • What are the effects if the money supply grows too rapidly? The size of the money supply and the rate at which it is growing can have a significant impact on the economic well being of the country. If the money supply is growing too slowly, the likelihood of recession increases because the demand for money will increase, driving interest rates up. As interest rates rise, investment declines, slowing the growth rate of real output. If the money supply is growing too quickly, it could lead to inflation.

45. Currency, coin, debit cards or checkable deposits • Name a type of money that serves primarily as a medium of exchange. • Name a type of money that serves primarily as a store of value. • With the use of credit cards becoming more prominent and the availability of credit broader than ever, why are credit cards not included in the Ms? Savings account or money market mutual fund account. Credit cards are short-term loans. Credit-card bills are not directly subtracted from checking accounts. Instead the credit-card holder pays the bill from a checking or NOW (negotiable order of withdrawal ) account. Not only should loans NOT be counted as money, but if they were and the payment were also counted, one economic transaction would be double-counted in the money supply.

46. Because of the volume of transactions in the United states, which can range into the trillions on a daily basis, getting an accurate measure of each transaction can be an arduous task. The inputs are constantly changing as banks make new loans and people repay loans ahead of schedule. • Why is it difficult for the Fed to get an accurate measure of the money supply? • Why must the fed continue to develop new ways to track the money supply? • Use the data in Figure 35.1 to calculate M1, M2, and M3. Assume that all items not mentioned are zero. Show all components for your answers. Because of technological innovation in the financial services industry and profit maximizing behavior on the part of commercial banks, the Fed must find new measures for tracking the money supply to assist with monetary policy.

47. Figure 35.1: Calculating the Ms Checkable deposits $850 (demand deposits, NOW, ATM and credit union share draft accounts) Currency $200 Large time deposits $800 Non-checkable savings dep. $302 Small time deposits $1,745 Institutional money market mutual funds $1,210 M1 = ____________________________ M2 = ____________________________ M3 = ____________________________ 850 + 200 = 1,050 1,050 + 1,745 + 302 = 3, 097 3,097 + 800 + 1,210 = 5,107

48. Works Cited Blade, Robin, and Michael Parkin. Foundations of Economics: Instructor’s Manual. 2nd ed. Boston: Pearson Education, Inc., 2007. Carper, Alan. Economics for Christian Schools. Greenville: Bob Jones University Press, 1998. “Discontinuance of M3.”Federal Reserve. 9 Mar 2006. 21 Mar 2008. http://www.federalreserve.gov/Releases/H6/20060309/h6.txt “Money Stock Measure.”Federal Reserve StatisticalRelease. 20 Mar 2008. 21 Mar 2008. http://www.federalreserve.gov/releases/h6Current/ "The New King James Version." Logos Bible Software. CD_ROM. ed.2004.