The document discusses the history of money and banking in the United States. It describes how the money supply was originally controlled by individual banks through the issuance of bank notes and loans. The Federal Reserve System was later created in 1913 to centralize control of the money supply and act as a lender of last resort for commercial banks. The Federal Reserve can directly control the monetary base but has indirect influence over the broader money supply aggregates through tools like reserve requirements and the discount window.

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2. Remember the story of Goldilocks and the three
bears?
“ Papa bear’s bed was too
hard…..Mama bear’s bed was too
soft…..but baby bear’s bed was
just right!

3. Baby bear’s bed and the supply of
money…
Without enough money, it
becomes difficult to conduct
commerce…transactions slow
down and the economy falls
into recession
Like any commodity, excess
supply lowers the value of
money….too much money
creates inflation.
We need to find a balance
between the two…

4. The Constitution grants the
federal government the
power "to coin Money,
regulate the Value thereof...”

5. The US began minting US coins shortly
after the constitution was ratified
Half Cent
(Copper)
One Cent
(Copper)
Two Cents
(Copper)
Three Cents
(Nickel/Copper)
Nickel/Half Dime
(Silver/Copper)
Twenty Cents
(Silver)
Quarter Dollar
(Silver)
Dime
(Silver/Copper

6. Production of gold coins ceased in 1934. Silver
coins were minted until 1964.
One Dollar
(Silver)
One Dollar
(Gold)
2 ½ Dollar
(Quarter Eagle)
Three Dollar Five Dollar
(Half Eagle)
Ten Dollar
(Eagle)
Twenty Dollar
(Double Eagle)
Half Dollar
(Silver)

7. CCuurrrreenntt UUSS CCooiinnss
99% Zinc, 1%Copper
Annual Production: 6.8M
75% Copper, 25% Nickel
Annual Production: 1.4B
75% Copper, 25% Nickel
Annual Production: 2.5B
75% Copper, 25% Nickel
Annual Production: 2.4B
75% Copper, 25% Nickel
Annual Production: 5.8M
88% Copper, 6% Zinc, 3%
Magnesium, 3% Nickel
Annual Production: 5.3M

8. Paper money was initially
issued by commercial
banks as claims to their
deposits of gold and silver
(coins or bars)
Northampton Bank
Assets Liabilities
$500 (Gold)
$1,000 (Loans)
$300 (Deposits)
$1,000 (Notes)
$200 (Equity)
The supply of money was
determined by the
individual bank’s profit
motive - they created loans
by issuing bank notes
Bank notes were only redeemable (for gold/silver) at the issuing bank

9. Assets Liabilities
$1,000 (Gold) $10,000 (T-Bills)
$20,000 (US Notes)
The US began issuing
Greenbacks in 1862 after
passing the legal tender act.
US Notes were fractionally
backed by gold, but were
“legal tender for all debts
public and private
United States notes were
printed until 1963, but
were a small fraction of
total money
1910: one tenth
1960: one hundredth
US Treasury

10. Gold/Silver Certificates were 100% backed by gold/silver reserves at
the US Treasury, but were not legal tender
Assets Liabilities
$1,000 (Gold) $1,000 (Gold Notes)
$10,000 (Silver Notes)
Gold notes were printed
until 1934.
All $1 bills in the US were
silver certificates until
1963 and were still
convertible to silver until
1968
US Treasury
$10,000 (Silver)

11. The National Banking Act of 1863 allowed Nationally chartered banks to
distribute bank notes (deemed legal tender) secured by US Debt (banks
could issue notes equal to 90% of their US debt holdings)
National notes were
convertible to T-Bills at
any national bank
National Bank notes were
issued until 1934
1st National Bank of Forest City
Assets Liabilities
$50,000 (T-Bills)
$50,000 (Loans)
$25,000 (Deposits)
$45,000 (Notes)
$30,000 (Equity)

12. The Federal Reserve was created in 1913 to essentially take over the money
supply role of national banks.
The Federal Reserve
could issue new currency
by purchasing US Debt
either in private markets
or directly from the
Treasury
Federal Reserve notes
were convertible to gold
until 1934 (individuals)
1971 (Central Banks)
Federal Reserve Bank
Assets Liabilities
$50,000 (T-Bills) $60,000 (Notes)
$10,000 (Gold)

13. Denominations of $500, $1,000, $5,000, and
$10,000 were no longer printed after 1946 for
fear of German counterfeiting

14. The Largest denomination ever printed was a
$100,000 gold certificate. It was never circulated,
but was used for inter-bank transfers

15. Credit Channels
under the
National/State
Banking System
National banks who were short of funds would
borrow from money center banks
Larger State banks who were short of
funds would borrow from National banks
Small State banks who were short of
funds would borrow from larger state
banks
Money center banks
were the “root source”
of credit

16. Credit Channels
under the
National/State
Banking
System

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18. Credit Channels
under the
Federal
Reserve
System
Federal Reserve
= Federal Funds Market
= Discount Window

19. The Federal Reserve System Divides the country into
12 Districts numbered 1 - 12 from east to west

20. The Chairman is elected from the Board for a renewable 4 year term
Alan
Greenspan
(1992)
Roger
Ferguson
(2001)
Edward
Gramlich
(1997)
Ben
Bernanke
(2003)
Susan
Bies
(2001)
Mark
Olsen
(2001)
Donald
Kohn
(2002)
The Federal Reserve board is headquartered in Washington DC. The
Board Consists of 7 “Governors” appointed by the President and
confirmed by the Senate for 14 Year Non-Renewable terms

21. Each district has a Federal Reserve Bank with a bank president
elected by the bank’s board of directors for 4 year renewable
terms
Bank President
Board of Directors
Class A (4) Class B (4) Class C (4)
Member Banks Local Business Federal Reserve
Board

22. The Federal Open Market Committee (FOMC) is the policymaking
group of the Federal Reserve System. They meet approximately 8
times per year. Policies are determined by majority vote
Board of
Governors (7)
NY Fed
President (1)
Regional Fed
Presidents (4)
Generally, all 12 bank presidents are present at the meeting, but
only 5 can vote. The NY Fed president has a permanent vote while
the remaining presidents vote on a revolving basis.

23. Controlling the Supply of Money
Money can be anything that satisfies:
•Store of Value
•Unit of account
•Medium of exchange
Lots of things satisfy these properties

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25. The Federal Reserve can perfectly control the monetary
base (cash + bank reserves)
MB
M1 M2 M3
Once those reserves enter the banking sector, they are used as the basis
for creating loans. These loans make up the rest of the money supply.
The fed can’t control this, but can influence it

26. Money Supply iinn tthhee UUSS
((iinn BBiilllliioonnss))
732
1,269
6,015
8,760
690
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
Cash MB M1 M2 M3

27. MMoonneeyy SSuuppppllyy iinn tthhee UUSS
0
2000
4000
6000
8000
10000
12000
14000
1/1/1959
1/1/1962
1/1/1965
1/1/1968
1/1/1971
1/1/1974
1/1/1977
1/1/1980
1/1/1983
1/1/1986
1/1/1989
1/1/1992
1/1/1995
1/1/1998
M3
M2
M1
MB

28. The Reserve Requirement is the least used of the Fed’s
policy tools. A Bank is required to keep a minimum
percentage of its deposits either as cash or on deposit
at the federal reserve (reserve deposits pay no interest)
Federal Reserve Acme National Bank
Assets Liabilities Assets Liabilities
$ 2,500 (Cash)
$ 2,500 (Reserves)
$45,000 (T-Bills)
$50,000 (Deposits)
$100,000 (Equity)
$100,000(Loans)
$ 2,500 (Reserves)
Acme currently has 10% of its
deposit liabilities on Reserve
(Cash + Reserves)/Deposits
Reserve Accounts are
liabilities of the Fed

29. Suppose Acme Bank wanted to create a $30,000 loan.
This is done by establishing a line of credit (i.e.
creating a new checkable deposit)
Acme National Bank
Assets Liabilities
$ 2,500 (Cash)
$ 2,500 (Reserves)
$45,000 (T-Bills)
$50,000 (Deposits)
$100,000 (Equity)
$100,000(Loans)
Acme’s reserve ratio drops
to 6.25% (5/80)
$30,000 (Loan)
$30,000 (Deposit)
The loan shows up on
both sides of the
balance sheet

30. Reserves and cash are components of M0 while the
newly created loans are components of M1 or M2
Acme National Bank
Assets Liabilities
$ 2,500 (Cash)
$ 2,500 (Reserves)
$45,000 (T-Bills)
$50,000 (Deposits)
$100,000 (Equity)
$100,000(Loans)
$30,000 (Loan)
$30,000 (Deposit)
Monetary Base
•Cash in Circulation
•Bank Reserves
M1
•Cash in Circulation
•Checking Accounts
M2
•M1
•Savings Accounts

31. Type of Liability Reserve Requirement
Transaction Account
$0 - $7M 0%
$7M - $47.6M 3%
More than $47.6M 10%
Time Deposits 0%
Eurocurrencies 0%
The Reserve Requirement has no impact on the
monetary base, but it restricts the ability of banks to
create loans – this influences the broader aggregates.

32. The discount window was the primary policy tool of the
federal reserve when it was first established in 1913.
Discount window loans are collateralized by the assets
of the bank (equal to around 90% of the loan)
Federal Reserve Acme National Bank
Assets Liabilities Assets Liabilities
$ 2,500 (Cash)
$ 2,500 (Reserves)
$45,000 (T-Bills)
$80,000 (Deposits)
$50,000 (Equity)
$130,000(Loans)
$ 2,500 (Reserves)
Res. Req. = 5%
This bank would like to create
$70,000 loan, but doesn’t have
the reserves to back it up
$ 2,500 (Reserves)
A $2,500 loan from the discount
window would raise reserves to
the required 5%
$ 2,500 (Reserves)
$ 2,500 (Loan)
$ 2,500 (Disc. Loan)

33. Type of Credit Interest Rate
Primary (No Questions
Asked)
Fed Funds + 1% (3.5%)
Secondary (Additional
Financial Information
Required)
Fed Funds + 1.5% (4.0%)
Seasonal (Must demonstrate
reoccurring seasonal liquidity
needs, <$500M in Deposits)
Fed Funds + .2% (2.7%)

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Bond Dealer
Federal Reserve
Dealers Buy/Sell
bonds from the Fed
The Fed
debits/credits the
reserve account of
the dealer’s bank
Most transactions are done with repurchase agreements (Repos). These
are purchases/sales along with an agreement to reverse the transaction
at a later date

36. Currently, open market operations are the primary
policy tool of the Fed. Trading takes place in NYC
Federal Reserve Acme National Bank
Assets Liabilities Assets Liabilities
$ 2,500 (Cash)
$ 2,500 (Reserves)
$ 2,500 (Reserves)
- $ 2,500 (T- Bills)
$45,000 (T-Bills)
$80,000 (Deposits)
$50,000 (Equity)
$130,000(Loans)
$ 2,500 (Reserves)
Res. Req. = 5%
$ 2,500 (Reserves)
$ 2,500 (T- Bills)
An open market purchase increases the reserves of the banking
sector – this raises M0

37. Federal Reserve Banking Sector
Assets Liabilities Assets Liabilities
$ 54B (Cash)
$ 46B (Reserves)
$ 2,000 (T-Bills)
Loans
$ 1B (Discount)
$1,000B (Equity)
$ 2,701 (Mortgage)
$ 3,000 (Other)
$ 700B (Currency)
Res. Req. = 5%
Reserves
$700B (T- Bills)
$ 1B (Loans)
$25B (Gold)
$20B (Other)
$ 44B (Required)
$ 1B (Excess)
$ 1B (Borrowed)
MB = $746B
$ 800B (Checking)
$ 4,500B (Saving)
$ 1,500B(Fed Funds)
Loans
M1
MB = 2.01 M2
M1 = $700B + $800B = 1,500B
M2 = $700B + $800B + $4,500B = $6,000B
MB
= 8.04

38. The Money multipliers describe the relationship between a
change in the monetary base (controlled by the Fed) and the
broader aggregates
$ Change in M1 = mm1 * $ Change in MB
mm =
1 +
Cash
Deposits
Cash
Deposits
Reserves
+ Deposits
$ Change in M2 = mm2 * $ Change in MB
mm2 =
Cash
Deposits
Cash
Deposits
1 +
M2-M1
Deposits
+
Reserves
+ Deposits
The Fed can influence total bank reserves, which affects the multipliers!

39. Fed Policy from start to finish….
Staff economists at each
federal reserve bank brief
the president of
local/national economic
conditions
Bank Presidents/Governors
present policy
recommendations to the
FOMC – A vote is taken.
The monetary base is to be
increased by $100M
This order is passed to the trading
desk in NYC
Trading desk calls bond dealers
and asks for bids

40. Fed Policy from start to finish….
Acme National Bank
Assets Liabilities
+$100M (Reserves) + $100M (Deposits)
The dealers with the winning
bids deliver the bonds. Their
bank’s reserve accounts are
credited
The bank must keep approximately 5% (reserve requirement) of the new
deposit on reserve, but is free to loan out the remaining $95M. Some of
this will be loaned to business customers, some finds its way into the
Federal Funds market
Reserves
FF Rate
5%
Excess supply of
reserves pushes down
the Fed Funds Rate
Supply

41. Fed Policy from start to finish….
Fed Funds Market
Through the Fed Funds
Market, the reserves are
distributed throughout
the banking sector
Each bank uses its new reserves to create additional loans

42. As banks increase the supplies of the various
aggregates, their rates drop as well
M1
M1 Rate
6%
Supply
M2
M2 Rate
7%
Supply
$ Change
in M1 = mm1 * $100M
$ Change
in M2 = mm2 * $100M
2 8
These newly created loans are used to purchase labor,
materials, consumer goods, etc.

43. Eventually, this newly created demand will
influence prices…
Hours
Wages
Demand
GDP
Prices
Demand
Higher demand for goods and services drive up their prices
(wages and prices)
Increases in
inflation raise
the nominal
interest rate
Nominal
Interest
Rate
=
Real
Interest
Rate
+ Expected
Inflation

44. If all goes well, the open market
purchase of securities (an increase in
the monetary base) will raise
employment and GDP in the short run,
but raise prices in the long run.
However, the economy can always
through a wrench in the Fed’s plans!