Money and Banking

MONEY AND BANKING

Chapter 24

What is Money?• Three functions of money

1. Serves as a medium of exchange- trade money for goods and services

2. Store of value- hold it until we are ready to use it, and it does not lose value

3. Measure of value- used to assign value to a good or service

What is Money?• Anything that people are willing to accept

in exchange for goods is money• Three characteristics of money

A. Portable

B. Divisible

C. Durable

• Currency is both coins and paper money• We accept money because we are sure

that someone else will accept its value as well

What is Money?• The Financial System• Why banks?

1. Used as a safe place to store money

2. Money is put to work by lending it to people or businesses• Financial institutions make a profit from the interest they charge on loans

3. Act to bring savers and borrowers together• Types of Financial institutions• Commercial banks

• Provide full banking services to businesses and individuals• Most important part of our financial system

• Savings and Loans• Traditionally loan money to people buying homes and real estate

• Credit Unions• Work on a not for profit basis• Often sponsored by certain business groups• Give workers a financial institution with low costs

What is Money?• Keeping our financial system safe• Two factors that make the U.S. banking system safe• Regulation• One of the most regulated industries in the country• Required to follow rules to minimize risk• Insurance• When banks fail the federal government insures their deposits up to $250,000• Federal Deposit Insurance Corporation (FDIC) federal corporation that

insures accounts• Makes customers feel safe wherever they deposit their money

The Federal Reserve System• Federal Reserve is the central bank of the US• When banks need money they borrow from the Fed• US divided into 12 Federal Reserve districts• Federally chartered commercial banks are required to be

members of the Fed• Member banks own stock in the Fed and earn dividends from

it

The Federal Reserve System• Fed was established in 1913

• To raise money they sold stock and required largest banks to buy it

• The president, with the approval of the Senate, appoints the seven members of the Board of Governors

• The president appoints one board member as the chairman who serves a four year term

• Board is independent of politics because they do not rely on Congress for appropriations for operating expenses

The Federal Reserve SystemAdvisory Councils report on

• the condition of the economy in each district• financial institutions• issues related to consumer loans

Major policy making group is the Federal Open Market Committee (FOMC)• Makes decisions by manipulating the money supply

Regulatory functions of the Fed• Banking regulation

• Oversees large commercial banks and regulates mergers• Regulates American connections with foreign banks and

foreign banks in the US

• Consumer borrowing• Requires lenders to spell out terms of loans• Specifies what information lenders must provide

The Federal Reserve SystemActing as the Government’s Bank

1. Holds the governments money

2. Sells US Bonds and Treasury Bills• These help fund government activity• When they reach maturity after a period of time they can be exchanged

for cash with interest

3. Fed issues the nations currency and controls its circulation

The Federal Reserve SystemConducting Monetary Policy• Controls the supply of money and the cost of borrowing money

Ways the Fed manipulates the monetary supply

A. Can raise or lower the discount rate• The rate the Fed charges member bans for loans• Stimulate economy= lower discount rate• Slow down the economy= raises the discount rate

B. Can raise or lower the reserve requirement for banks• Banks have to keep certain percentage of total deposits in Federal

Reserve Banks• If they raise requirement banks have less money to lend

C. Can change money supply through open market operations• The purchase and sale of government bonds and Treasury bills puts

money in the hands of investors and the government

The Federal Reserve System• Monetary policies are effective because

A. They are made by relatively few people

B. Decisions can be made quickly if one policy does not work

C. They are free of the constraints of politicians

How Banks Operate• Banks are started by investors

• Pool money, property and certificates of deposit to capitalize bank

• Banks need to attract depositors

a) Offer checking accounts

b) Savings accounts• pay interest based on how much money customer

has deposited

c) Certificates of deposit• customer gives money to bank for specific time and

bank pays interest at the end of the time period• CDs pay higher interest than savings accounts

• Making loans• This is how banks make a profit• Loan money to businesses and consumers• Can increase the supply of money

GOVERNMENT FINANCESChapter 25

The Federal Government• Each year the federal government creates a budget

• Blueprint of how the government will spend its money

• Created by the president and Congress• Budget year is called a fiscal year (FY), lasts from Oct. 1 –Sept. 30

The Federal GovernmentBudget Process• President presents a proposed budget to Congress• Congress passes a budget resolution

• Sets targets for revenues and spending and how much will be spent in each category

Categories of spending• Mandatory spending does not need annual approval

• Social security, interest payments on government debt

• Discretionary spending government expenditures that need to be approved each year• Military, highway construction, agriculture subsidies, etc.

• Appropriations Bills• Law that approves spending for a particular activity• 13 separate appropriations bills• Each must be approved by both houses of Congress and the

president

The Federal Government• Federal Revenues• Income tax provides nearly half

of all government revenue• Some paid by April 15th of each year

and some is withheld from paychecks

• Corporations pay taxes on their profits

• Payroll Taxes- second largest source of federal income• Taxes deducted from workers

paychecks to fund Social Security and Medicare

The Federal Government• Excise taxes- paid when

consumers purchase gasoline, tobacco, alcohol, telephone services

• Estate Taxes- paid when wealthy people die and pass money on to their heirs

• Other federal revenues –fees paid at national parks, fees paid by companies to extract natural resources from government property

The Federal Government• Forms of Taxation• Proportional tax- takes same

amount from everyone regardless of how much someone earns• Sales tax is an example

• Progressive tax- taxes increase as income increases• Federal income tax is an example

• Regressive tax- percentage paid goes down as your income rises

The Federal Government• Federal Expenditures• Social Security is the largest

expenditure by the federal government (22.4 cents on every dollar)• Will grow in the future as the population

ages

• National defense is the second largest category of federal spending (16.3 cents for every dollar)

• Each year the government spends a portion of the budget to pay the interest on money the government has borrowed

• Education, highways and foreign aid account for billions of dollars in spending, but less than most people think

State and Local Governments• State and local governments have their own budget approval

process, revenues and expenditures• State Governments• Most important state revenues are intergovernmental

revenues (money one level of government receives from another)• Federal government gives money to states for highways, education,

healthcare, etc.

• Most states depend on sales tax as a source of revenue• Tax levied on consumer purchases of all products• Collected by business owners and turned over to state on a regular basis• Not all states have sales taxes

• Third largest source is comes from contributions state employees make to pension and retirement plans

• State Income tax is the fourth largest source• Not all states have state income tax

State and Local Governments• Local Governments• Also depend on intergovernmental revenues

• Most of the money is provided by the state

• Second largest source of local revenue is property tax

• Taxes paid on land, houses and property owned• Real property- land and buildings• Personal property- stocks, bonds, cars

• Most local governments tax only on real property

• Property taxes based on assessed (estimated) value

• Revenue from utility companies, sales taxes, fees and fines are other sources of local revenue

State and Local Governments• Expenditures• Entitlement programs are an important state

expenditure• States try to provide and maintain basic health and living

conditions• Entitlement programs provide health, nutritional or payment

programs to people meeting eligibility requirements

• States spend money on higher education• States subsidize college education to keep costs reasonable

• Highway construction • States have to maintain local highways and roads

• Employee retirement, hospitals, education, corrections equal a relatively small amount of state expenditures

State and Local Governments• Local Government Expenditures• Education

• Local tax revenue goes to pay for public education

• Accounts for one-third of local government spending

• Police and Fire Protection• Water Supply

• Local governments usually in charge of maintaining local water supply (Lake Maumelle)

• Sewage and Sanitation• Responsible for sewage and solid waste

disposal• Local governments maintain sewage treatment

plants and landfills

Managing the EconomySurplus when the government

collects more than they spendDeficit when the government spends

more than they collectDeficit for 2009 was 1.42 trillion dollars

When federal government needs to borrow money they sell bonds

All money borrowed and not paid back is the government's debt

Huge budget deficits of 1980s, early 90’s and last few years have increased federal debtEach person in the US now owes $46,000

per person

Managing the Economy• Balanced budget is when spending

equals revenue• Federal government is not required by

law to have a balanced budget• Many state and local governments are

required by law to balance their budgets (Arkansas is required)

• When revenues go down states are required to make cuts

• Revenue often goes down during bad economic times, when states need to spend more on entitlements

• Many states try to maintain an emergency fund to help budget shortfalls

Managing the Economy• In theory federal government can stimulate the

economy by increasing spending and cutting taxes• This increases deficits , drives up debt and creates

problems in the future

• When economy grows government can reduce spending, increase taxes to increase revenue and lower government debt

• Politics make cutting spending, spending money and raising taxes difficult, if times are good or badA. Most people want lower taxes and no cuts in

government services

B. It takes time to pass appropriations bills

Managing the Economy• Government action sometimes takes a long time to take

effect or sometimes do not have the desired effect• The economy has automatic stabilizers to stimulate the

economy1. Unemployment insurance

2. Welfare programs

3. Progressive income tax structure

These programs provide income during hard economic times

• Automatic stabilizers go into effect faster than discretionary spending measures