With every deposit, there is an increase in the lending power of the bankThus, the monetary value of one deposit will have lending power well beyond its value
Unit 5 student
Unit 5 Notes
What is money? • Task! • What is money? • What is the function of money?• What has served as money throughout history?
It’s Complicated…• “What is money, nowadays”- New York Times July 20, 1975• Mr. A.F. Davis mailed a ten dollar Federal Reserve Note to the Treasury Department, asking that it be redeemed for “lawful money” as the note stated• In response, they sent him 2 $5 bills bearing a similar promise to pay• “…I am enclosing one of the $5 notes which you sent to me. I note that it states on the face, “The United States of America will pay to the bearer on demand five dollars.” I am hereby demanding five dollars.
• One week later, he received a letter from the acting Treasurer, M.E. Slindee:• Dear Mr. Davis, • Receipt is acknowledged of your letter transmitting one $5 United States note with a demand for payment of five dollars. You are advised that the term “lawful money” has not been defined in federal legislation…• The phrases “…will pay to the bearer on demand” and “…is redeemable in lawful money” were deleted from our currency altogether in 1964
Money• Money has Three Basic Functions: • 1. Medium of Exchange- enables us to carry out trade and commerce easily • 2. Standard of Value- allows us to measure and compare value using one scale • 3. Store of Value- it (usually) holds its value over time
Money• Money also has Six Main Characteristics: • 1. Acceptability- in order for you to buy something, the seller must be willing to accept what you offer as payment • 2. Scarcity- needs to be scarce enough to be valued by buyers and sellers
• 3. Portability- in order to be convenient as a medium of exchange it must be portable • 4. Durability- if money is to serve as a store of value, it must be durable
• 5. Divisibility- to be useful as a medium of exchange, money must be easily divided into smaller amounts• 6. Uniformity- a dollar is a dollar is a dollar. We take for granted that each dollar is the same as the next.
What Serves as Money? • Throughout history, many items such as: salt, shells, cattle, beads, fur, tobacco, gold, and silver have served as money • These are called commodity money• Gold and silver have generally been preferred because they hold many of the characteristics of money
What about today?• However, our money is no longer backed by precious metals such as gold and silver• Fiat money- paper money decreed as legal tender, but not representing anything of intrinsic worth • Rather, money is accepted solely because we believe that it is worth something, and is backed by the “full faith and credit” of the United States government Trust me!
What is Currency and Money Supply?• Currency- the bills and coins currently in circulation in the economy • However, currency is only a part of the total money supply in the country• Task! Take one minute to discuss with your partner what else makes up the money supply
M1& M2 Money Supply• M1 Money Supply is made up of: • Coins and bills (currency) • Checkable deposits (liquid assets) • Travelers Checks• M2 Money Supply is made up of: • All of M1 • Less liquid assets such as savings deposits, etc.
• So how is that money (M1 and M2) transferred between people? • By banks!
The Banking System in a Nutshell:• Fractional Reserve Banking- a system whereby banks keep a fraction of deposits in reserves but loan out the rest to businesses and consumers• **In a sense, as banks continuously lend money that is not in reserves they are “creating money”. This lending is increasing the flow of money that ordinarily wouldn’t be able to happen!**
How much do banks need to keep onreserves? LOAN Dave’s $640 LOAN Kim’s $800 Kim’s $800 Pat’s $1000 Pat’s $1000 Pat’s $1000
Monetary Policy- what is it?• Monetary Policy- central bank policy aimed at regulating interest rates and the amount of money in circulation to influence the health and direction of the economy
The Federal Reserve (Fed)• The Federal Reserve is America’s central bank, established in 1913• Congress gave the Fed enough power to act independently in regards to monetary policy
Structure of the Fed• 1. Board of Governors • 7 member board that oversees the Fed from Washington D.C. • Appointed by the president and confirmed by the Senate for one 14 year term in office • President selects one governor to serve as chairman for 4 years • Responsible for the overall direction of monetary policy
Structure of the Fed• 2. Regional Federal Reserve Banks • 12 regional banks • Carry out many of the day-to-day duties • Each regional bank overseen by a president
Structure of the Fed• 3. Federal Open Market Committee (FOMC) • Consists of: • All 7 governors from the Board of Governors • 5 rotating regional fed presidents • **But always New York’s president • FOMC is the policymaking body of the Fed • Study economic information and decide what changes (if any) to make to monetary policy
How does the Fed influence monetarypolicy?• Task! Take one minute to discuss: • How you think the Federal Reserve can influence monetary policy (money supply and interest rates) in the U.S? • What might the effects be of those actions?
3 Main Tools of the Fed• 1. Open Market Operations- the buying and selling of government securities in the bond market (most used tool) • Easy-Money Policy (Expansionary) : • Fed bond traders buy government securities, which increases the money supply • Tight-Money Policy (Contractionary) : • Fed bond traders sell government securities, which decreases the money supply
• 2. Reserve requirement- the minimum percentage of deposits that banks must keep in reserve at all times (least used tool) • Lowering the ratio would lead to banks lending and “creating” more money • Expansionary policy • Raising the ratio would lead banks to stop lending and keep more cash in reserve, decreasing the money supply • Contractionary policy
• 3. The Discount Rate- the interest ratethe Fed charges on loans to private banks(last tool in their toolbox) • This tool leads to the Fed being known as the “lender of last resort” • Controlled by the Board of Governors • Expansionary policy: • A low rate makes it less costly for banks to borrow, increasing money supply • Contractionary policy: • A higher rate makes it more costly for banks to borrow, decreasing the money supply
The Fourth “Tool”• 4. Federal Funds Rate- the rate that banks charge one another for quick (overnight) loans • Because the Fed cannot control this, it is not considered one of its 3 tools • However, the Fed sets a target Fed. Funds Rate and does its best to use open market operations in order to achieve that rate • The Federal Funds Rate affects the interest rate on everything: credit cards, mortgages, savings accounts, bonds, etc.
Fiscal Policy• Fiscal policy- government policy regarding taxing and spending
Taxes• Tax- a mandatory payment to the government• How should we be taxed? • 1. Ability-to-pay: citizens should be taxed according to their wealth/income • 2. Benefits-received: those who benefit from a particular government program should pay for it• Task! What are taxes used for?
Tax Terms you need to know• Tax Base: the thing that is taxed • Could be real estate property, personal income, or a consumer good• Tax Rate: percentage of income—or of the value of a good, service, or asset—that is taxed
3 Ways We Can be Taxed• 1. Proportional Tax- a tax that takes the same share of income at all income levels
• 2. Progressive tax- a tax that takes a larger share of income as income increases (based on ability-to-pay principle)
• Regressive tax- a tax that takes a smaller share of income as income increases
Types of Taxes• 1. Personal Income Tax- a progressive tax for the federal government taken from our income
• Payroll Tax- taxes deducted directly from employee paychecks• The 2 largest payroll taxes fund Social Security and Medicare
• Property tax- taxes levied on the value of real property, such as land and homes, or on personal property such as cars and boats
• Sales Tax- a tax on the sale of goods, paid by the customer at the time of purchase• Most states and many cities have a general sales tax• Task! What is PA’s sales tax percentage?
• Corporate Income Tax- a progressive tax on company profits
• Excise tax- tax on the sale of certain goods the government wants to limit (sin taxes)• Luxury tax- tax on the sale of more expensive items bought primarily by the wealthy
• User Fees and Tolls- taxes charged for the use of public facilities and services and for permits and licenses
• Estate or inheritance Tax- tax on the assets left to heirs by someone who dies (progressive)
Aggregate Supply and Demand• Aggregate supply = total supply of goods and services produced in the nation’s economy• Aggregate demand = total demand for goods and services in the nation’s economy
Fiscal Policy Part II: Government Spending• Main sources of Government revenue: • Individual income tax • Payroll taxes • Corporate income taxes • Excise taxes
What does the government spend moneyon?• Mandatory spending- fixed by law (interest on the debt, Medicare, Social Security, etc)• Discretionary spending- can be raised or lowered as Congress sees fit (defense, healthcare, education, foreign aid, infrastructure)
Deficit Spending• Deficit- the difference between what you spend and what you take in during one year• Debt- the total accumulation of previous deficits ( total money owed from borrowing)• So the national debt is the total of all of America’s previous deficits• Deficit spending- when the government consistently spends more than it takes in
Why does America love to deficit spend?? • Mandatory transfer payments to Baby Boomer’s (we have to) • Economic stimulus • To protect ourselves (national defense) • Habit—it’s easy!
What are the effects of deficit spending?• Rapidly skyrocketing national debt• Inflation• High tax burden = discouraged citizens• Crowding out effect-• Unease about foreign owned debt
Major Economic Theories:• 1. Classical Economics- an economic philosophy that focused on how free markets and market economies work; it held that capitalism was self-regulating and required few government controls • Founder: Adam Smith • Legacy: Dominated economic thinking until the Great Depression of the 1930s
• 2. Keynesian economics- a school of thought holding that government intervention in the economy is necessary to ensure economic stability • Founder: John Maynard Keynes • Legacy: Has dominated economic thinking since the Great Depression
• 3. Monetarism- a school of thought which holds that changes in the money supply are the main cause of inflation and of economic expansions or contractions • Founder- Milton Friedman • Many economists admit the Fed should have done more to prevent the Great Depression by expanding the money supply to increase spending and lead to expansion!
• Demand side economics- ensure economic growth by stimulating demand by putting more money in the hands of consumer (increase spending or cut taxes) • **Bigger gov’t role in the economy!• Supply side economics- ensure economic growth by stimulating overall supply by cutting taxes on businesses and high-income taxpayers; producers and investors will use their tax savings to expand production and thereby stimulate the economy • ***Smaller gov’t role in the economy!