1. 34
Money, Banking, and Financial
Institutions
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Copyright © 2012 McGraw-Hill Companies, Inc. All rights reserved.
Copyright © 2012 by Theby The McGraw-Hill Companies, Inc. All rights reserved.

2. 13 - 1
•Money In a World War II
Prisoner of War Camp
During World War II,
cigarettes were used as
money in some prisoner-ofwar camps.
2 of 37

3. Functions of Money
• Medium of exchange
• Used to buy/sell goods
• Unit of account
• Goods valued in dollars
• Store of value
• Hold some wealth in money form
• Money allows us to transfer purchasing power
•
LO1
from present to future
Money is liquid
• It is the most liquid (spendable) of all assets,
a convenient way to store wealth.

4. What Is Money and Why Do We Need It?
What Can Serve As Money?
What makes a good suitable to use as a medium of exchange?
There are five criteria:
The good must be acceptable to/usable by most traders.
It should be of standardized quality, so that any two units are
identical.
It should be durable, so that value is not lost by spoilage.
It should be valuable relative to its weight so that amounts large
enough to be useful in trade can be easily transported.
The medium of exchange should be divisible because different
goods are valued differently.
4 of 37

5. 13 - 2
•Money without a Government?
The Strange Case of the Iraqi Dinar
Many Iraqis continued to
use currency with
Saddam’s picture on it,
even after he was forced
from power.
5 of 37

6. Money Definition
M1
 Currency
 Checkable deposits
Institutions offering
checkable deposits:
• Commercial banks
• Savings & loan assoc.
• Mutual savings banks
• Credit unions
Note:
Currency & checkable deposits held by
the federal govt, Federal Reserve, or
other financial institutions are not
included in M1.
LO1
M2
M1 plus near-monies
 Savings deposits including
money market deposit
accounts (MMDA)
 Small-denominated time
deposits
 Money market mutual
funds (MMMF) balances,
which can be redeemed by
phone calls, checks, or
through the Internet

7. Money Definition
Narrow definition of money, M1 includes:
•Currency (coins + paper money) held by public.
a. Is “token” money, which means its intrinsic value
is less than actual value. The metal in a dime is
worth less than 10¢.
a. All paper currency consists of Federal Reserve
Notes issued by the Federal Reserve
• Checkable Deposits
can be spent almost as readily as currency and can
easily be changed into currency.

8. Money Definition
M1
January 2008
Currency
Checkable Deposits
Small Time Deposits
Money Market Mutual
Funds Held By Individuals
Savings Deposits,
Including Money Market
Deposit Accounts
Source: Federal Reserve System
Totals
+
+
+
M2
56%
M1
44%
18%
16%
14%
+
52%
+
$1,365
Billion
$7,499
Billion

9. How Do We Measure Money Today?
M1: The Narrowest Definition of the Money Supply
13 - 1
Measuring the Money
Supply, September 2005
9 of 37

10. What “Backs” the Money Supply?
• Guaranteed by government’s ability to
keep value stable
• Money as debt
• Why is money valuable?
•Acceptability
•Legal tender
•Relative scarcity
LO2

11. WHAT GIVES MONEY ITS VALUE?
• Acceptability
money is accepted as payment for goods and services.
It is accepted as is serves the function as medium of
exchange
• Legal Tender
Money is also accepted as payment for debts. Govt
mandates through law that debt can be settled with
paper money. (checks are not mandate as money but
demand deposits do)
• Relative Scarcity
Money must be relatively scarce. Its value or
purchasing power is determined by supply of money
controlled by the Federal Reserve System

12. What “Backs” the Money Supply?
•
•
•
LO2
Prices affect purchasing power of money
Hyperinflation renders money unacceptable
Stabilizing money’s purchasing power
• Intelligent management of the money
supply – monetary policy
• Appropriate fiscal policy

13. What Backs the Money Supply?
Stable Value!
through...
1. Appropriate Fiscal Policy
2. Intelligent Management of the Money Supply
– Monetary Policy

14. Stabilizing Money’s Purchasing Power
through...
1. Appropriate Fiscal Policy
government needs to be prudent in its spending and
taxing actions to that it does not reduce the value of
money by running large budget deficits when
economy is at full employment
2. Monetary policy
used to control money supply . If too much money is
available the value of money for a given level of
production of goods and services it can lead to
inflation and value of money

15. MONEY SUPPLY
Two key points about the money supply to keep in
mind are:
1. The MS consists of both currency and
balances in checking accounts.
2. Because balances in checking accounts are
included in the MS, banks play an important
role in the process by which the MS increases
and decreases.

16. WHAT ABOUT CREDIT CARDS?
•
Credit cards are not money, but their use involves
short‑ term loans;
•
It represent the ability to get instant loan for
exchange of goods and services.
•
At one point the loan must be paid with money.
•
their convenience allows you to keep M1 balances
low because you need less for daily purchases.

17. Federal Reserve - Banking System
•
•
•
Historical background
Board of Governors
12 Federal Reserve Banks
• Serve as the U.S. central bank
• Quasi-public banks
• Banker’s bank

18. Federal Reserve – Banking System
Board of Governors
Federal Open Market Committee
12 Federal Reserve Banks
Commercial Banks
Thrift Institutions
(Savings and Loan Associations,
Mutual Savings Banks,
Credit Unions)
The Public
(Households and
Businesses)

19. Federal Reserve – Banking System
The 12 Federal Reserve Banks
LO3

20. Federal Reserve – Banking System
• Federal Open Market Committee
• Aids Board of Governors in setting monetary
policy
• Conducts open market operations
• Commercial banks and thrifts
• 6,800 commercial banks
• 8,700 thrifts

21. Federal Reserve Functions
• Issuing Currency
• Setting Reserve Requirements & Holding
Reserves
• Lending Money to Banks & Thrifts
•Discount Rate
• Providing for Check Collection service for banks
• Acting as Fiscal Agent
• Supervising Banks
• Controlling the Money Supply-Monetary Policy

22. Federal Reserve Independence
• Established by U.S. Congress as an independent
agency
• Protects the Fed from political pressures
• Enables the Fed to take actions to increase interest
rates in order to stem inflation as needed

23. Financial Institutions
World’s 12 Largest Financial Institutions, 2009
0
Assets (Trillions of U.S. Dollars)
1.5
2.5
3.5
Royal Bank of Scotland (UK)
Barclays (UK)
Deutsche Bank (Germany)
BNP Paribas (France)
HSBC Holdings (UK)
JPMorgan Chase (US)
Credit Agricole (France)
Citigroup (US)
Mitsubishi UFJ (Japan)
UBS (Switzerland)
ING Group (Netherlands)
Bank of America (US)
Source: Forbes Global 2000, www.forbes.com

24. The Financial Crisis of 2007 and 2008
• U.S. Mortgage Default Crisis. Many causes
• Government programs that encouraged home
ownership
• Declining real estate values
• Bad incentives provided by mortgage-backed bonds
• Securitization: the process of slicing up and
bundling groups of loans into new securities.As
loans defaulted, the system collapsed
• “Underwater” homeowners abandoned homes and
mortgages
LO5

25. Recent Developments
Globalization of Financial markets
Significant integration of world financial markets is
occurring and recent advances in computer and
communications technology.
Electronic transactions: Internet buying and selling,
electronic cash, and “smart cards”.
. Unlike currency, E‑cash is “issued” by private
firms rather than by government. To control the
money supply the Fed will need to find ways to
control the total amount of E‑cash, including
that created through Internet loans.

26. medium of exchange
unit of account
store of value
M1, M2, M3
token money
Federal Reserve Notes
checkable deposits
commercial banks
thrift institutions
near-monies
savings account
money market deposit account
(MMDA)
time deposits
Copyright McGraw-Hill/Irwin, Inc. 2005
money market mutual fund
(MMMF)
legal tender
transactions demand
asset demand
total demand for money
money market
Federal Reserve System
Board of Governors
Federal Open Market
Committee (FOMC)
Federal Reserve Banks
financial services industry
electronic transactions
BACK
END

27. Checklist:
 After completing this chapter, students should be able to
 List and explain the three functions of money.
 Define the money supply, M1 and near‑monies, M2, and M3.
 State three reasons why currency and checkable deposits are
money and why they have value.
 Identify two types of demand for money and the main
determinant of each.
 Describe the relationship between GDP and the interest rate
and each type of money demand.
 Explain what is meant by equilibrium in the money market
and the equilibrium rate of interest.
 Explain the relationship between bond prices & the money
market.
 Describe seven functions of the Federal Reserve System and
point out which role is the most important.

28. Coming up next...
How Banks and Thrifts
Create Money

29. MONEY AND PRICES
PURC HAS ING POWER OF MONEY
•The amount a dollar will buy varie s inve rs e ly with the pric e le ve l:
•D= 1/
Pric e Le ve l
•The re is a re c iproc al re lations hip be twe e n the pric e le ve l and the
purc has ing powe r of the dollar
•Whe n C PI or ‘c os t of living’ ris e the value of dollar goe s down, vic e
ve rs a
•Highe r pric e lowe r value of dollar as we ne e d more to buy a
partic ular amount of goods , s e rvic e s of re s ourc e
•Eg If pric e double s , the dollar value falls by one half.
Value of the dollar $V
$V=1/P
Expressed as index no in hundredths
If P level = 1 then V=1
If P rise to 1.20, V falls to 1/1.20=0.833
Thus increase in price by 20 percent cause value of dollar to falls by
16.67 percent

30. Inflation
1. Inflation may significantly depreciates the value of money
between the time it is received and the time it is spent
2. Rapid decline if value of money makes it cease its
function as medium of exchange.
3. Business and household refuse to accept paper money
as of loss of value that will occur
4. Economy may go back to barter system
5. Alternatively more stable foreign currencies are use as
mode of payment

31. Inflation and Acceptability
Other problems:
1.Money cannot be used as store of value due to
serious inflation
2.Money cannot be used as unit of account when its
purchasing power unstable. Thus price do not reflect
to value of goods, services and resources.
3.Terms of trade are difficult to be determined