The document discusses money and the functions of central banks. It defines money as anything generally accepted as payment and outlines three main functions of money: as a medium of exchange, a unit of account, and a store of value. The US Federal Reserve System is described as the central bank that regulates money supply and conducts monetary policy to influence economic conditions. Its goals are maximum employment, stable prices, and moderate interest rates.

1. Money, Banking, and Financial
Institutions
Chapter 32
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2. 32-2
Money
• Money: Anything that is generally accepted in
payment for goods or services or in the
repayment of debt
• Important!! Term “money” defined in Economics is different
from commonly used word “money” in everyday
conversation!

3. 32-3
Example of Money
So, what can you use for payment at Wal-Mart, McDonald’s, and
Exxon gas station?
• Currency (cash) including coins and bills
• Cash is an asset. If you have $20 bill, you can spend up to $20 worth
of goods and services (e.g. gasoline).
• Check & debit card (electronic version of check)
• A check is a means of payment, but it is worthless piece of paper
unless you write a payment and sign it.
• Can you write $23,770 check at Toyota dealer to purchase Prius? Yes,
only if you have that amount at your bank.
• You can write a check up to an amount in your checking account
without bouncing your check.
• Your checking account balance is money, not check itself.
• Credit card? Not really.

4. 32-4
Money by Definition
Not every means of payment is money. Money by
definition must be
• An asset (for repayment of debt)
• A credit card is not money because the credit card is a
means of borrowing (not payment, but deferred
payment).
• Once charged, you are expected to pay your credit
card bill by check or cash (a.k.a. money).
• Generally accepted
• If you can use only one or few places, then it is not
money.
• Ex. Disney dollar is not money because it can be used
only at Disney store or Disney World.

5. 32-5
Three Functions of Money
Money has three primary functions in any
economy.
• Medium of Exchange
• Anything used to pay for goods and services
• Unit of Account
• Anything used to measure value in economy
• Store of Value
• A repository of purchasing power over time

6. 32-6
Money as Medium of Exchange
• Every modern economy needs money for efficient
exchange of goods and services among people.
• Monetary exchange: Exchange of goods through
money
Ex. You have fish and want a loaf of bread.
(You) Fish  Money (???)  Bread (???)
• Since money comes between two goods in exchange, it is a
medium of exchange.
• Even though this involves two exchanges, actually it will take
less time for exchanges.
• Money increases efficiency in economy: people can spend
more time for production of goods and services rather than
exchange.

7. 32-7
Examples of Medium of
Exchange
Many commodities have been used as money
in various civilizations in history. Some form
of money is better medium of exchange than
others.
• Yap stone money
• American Indian wampum
• Cigarette in U.S. prisons
• Cowries seashell in the South Pacific and Africa
• Which is better medium of exchange, Yap stone or
metal coin?

8. 32-8
U.S. Dollar Bills
• In modern U.S. economy we use dollar bills and coins as
medium of exchange.
• Dollar bills are called “Federal Reserve Note” because they
are IOU (note payable) issued by the Federal Reserve Banks.
They are assets for holders (households, firms, governments,
and foreigners) of IOUs, but liabilities for issuers (the Federal
Reserves) of IOUs.

9. 32-9
Money and Generally Accepted
• Money must be generally accepted by definition.
• In modern U.S. economy we use worthless paper
money rather than valuable commodity.
• We accept worthless paper money because we
expect they are accepted by others.
• If no one accepts money, money will seize its primary
function in an economy.
• The government guarantees its general acceptance
by making it “legal tender”.

10. 32-10
Money as Unit of Account
• In the U.S. a value (price) of every good and
service is quoted in dollars and cents.
• By using “dollar and cent” as a standard unit of
value, we can easily compare value of one good
with others.
• Ex. How much is a Big Mac? Around $2.19. How
much is a cheeseburger? About 99¢. So, you
know which is more valuable.

11. 32-11
Money As Store of Value
• Money can keep its purchasing power
over time.
• When you receive your paycheck, you
do not need to spend every dollar right
at that moment. You can keep it in
bank account or cash on hand, and
spend it later.
• Money is not unique in this function.
There are many assets (financial assets
and commodity) which can serve as
store of value.

12. 32-12
Money As Store of Value
Any assets can serve as store of value. One
may serve as a better store of value than
another.
− Ex. Any physical and financial assets such as
Yugioh-card, Saving account, bonds, stocks,
gold, house
• Liquidity: the relative ease and speed with which
an asset can be converted into medium of
exchange
− Money is the most liquid store of value.
• Purchasing Power: Amount of goods and services
money can purchase.

13. 32-13
Value of Money
• Prices affect purchasing power of money
• Hyperinflation renders money unacceptable
• Zimbabwe experienced 80 billion percent inflation
rate in 2008
• When there are too many money in public, prices
of goods increase and a purchasing power of
money falls.
• Federal Reserve is responsible for controlling
quantity of money and maintaining a value of
money
LO3

14. 32-14
Evolution of Payment System
• Money is mainly used for making payments.
• Over time, methods of payment evolve as the
technology and economy change.
• Changes in payment system reduces
transactions cost (less time and effort to
exchange) and create even better medium of
exchange.

15. 32-15
Traditional Methods of Payments
• Commodity Money
• Money made up of precious metals or other
valuable commodity
• Physical goods that have a value as a
commodity equal to its value as a medium of
exchange
• Fiat money
• Paper currency decreed by government as legal
tender
• Money which does not have a value as a
commodity equal to its value as a medium of
exchange
• Checks

16. 32-16
Electronic Payment
You can also make payments electronically.
• Debit cards
• Electronic check (conversion)
• Payment by cell phone (Google Wallet, Apple Pay)
• Electronic Funds Transfer (EFT)
• Electronic Bill Presentment and Payment (EBPP)
• Stored-value card (Prepaid card & Smart card)
• Electronic cash (e-cash):

17. 32-17
Measuring Money Supply
• Money supply (Money aggregate): Amount of
money in economy
• Why measuring money supply?
• How people spend is an important factor affecting the
whole economy. How much people spend depends partly
on how much money they have for purchasing (medium of
exchange). Through the monetary policy the Federal
Reserve affects people’s spending by changing the amount
of money in the U.S. economy.
• In order to control money, the Federal Reserve must first
know how much money are in an economy.
Fed → Money → Spending → Economy

18. 32-18
Money Definition M1
• M1 includes
• Currency (bills and coins)
• Checkable deposits
• Institutions offering checkable deposits
• Commercial banks
• Savings and loan associations
• Mutual savings banks
• Credit unions
LO2

19. 32-19
Money Definition M2
• M2 includes
• M1 plus near-monies
• Savings deposits including money market
deposit accounts (MMDA)
• Small-denominated time deposits (CDs)
• Money market mutual funds (MMMF)
LO2

20. 32-20
Money Definitions
LO2

21. 32-21
Functions of Central Bank
• Each country has one central bank which is
responsible for
• Conducting monetary policy.
• Regulating an amount of money supply in economy.
• Supervising banks.
• In addition, a central bank may
• Regulate financial markets and financial institutions other
than banks.
• Control foreign exchanges and foreign reserves.
• Act as the government’s bank.
• Advising the government on the economic policy.

22. 32-22
Federal Reserve System
• In the United States, the federal reserve system (the
Fed) acts as the central bank.
• In most developed countries there is only one central
bank. However, in the U.S. the Fed is divided into
various organizational components for check and
balance.
• The federal government have attempted to establish a
single central bank twice, but due to fear of concentration
of economic and monetary power, the Congress abolished
such institutions.
• In 1931 the Congress established the twelve regional
Federal Reserve banks.

23. 32-23
Mission of Federal Reserve
System
The Federal Reserve System is the central bank of the United States. It was
founded by Congress in 1913 to provide the nation with a safer, more
flexible, and more stable monetary and financial system. Over the years, its
role in banking and the economy has expanded. Today, the Federal
Reserve's duties fall into four general areas:
• conducting the nation's monetary policy by influencing the monetary
and credit conditions in the economy in pursuit of maximum
employment, stable prices, and moderate long-term interest rates
• supervising and regulating banking institutions to ensure the safety and
soundness of the nation's banking and financial system and to protect
the credit rights of consumers
• maintaining the stability of the financial system and containing systemic
risk that may arise in financial markets
• providing financial services to depository institutions, the U.S.
government, and foreign official institutions, including playing a major
role in operating the nation's payments system
From http://www.federalreserve.gov/aboutthefed/mission.htm

24. 32-24
Functions of Federal Reserve System
Like any other central banks, the Federal Reserve
System performs various important functions through
its organizational components.
• Provide financial services to banks
• Clear checks
• Act as government’s bank
• Print new currencies and withdraw old ones
• Maintain government accounts
• Regulate banking and financial industries
• Conduct monetary policy

25. 32-25
Organizational Structure of the
Federal Reserve System
Three main organizational components of the
Federal Reserve System:
• Regional Federal Reserve banks
• Board of Governors
• Federal Open Market Committee

26. 32-26
Federal Reserve – Banking
System
Commercial Banks
Thrift Institutions
(Savings and Loan Associations,
Mutual Savings Banks,
Credit Unions)
The Public
(Households and
Businesses)
12 Federal Reserve Banks
Board of Governors
Federal Open Market Committee
LO4
Federal
Reserve
System

27. 32-27
Regional Federal Reserve Banks
• The U.S. is divided into twelve Federal Reserve
districts.
• Each district has one Federal Reserve bank.
• Ex. Federal Reserve Bank of Richmond covers states of
Maryland, Virginia, North Carolina, and South Carolina.
• By dividing into twelve districts, no one Federal
Reserve bank can dominate in the U.S. economy.
• Federal Reserve Bank of New York covers only the state
of New York, but holds one-quarter of the assets of the
Federal Reserve System.

28. 32-28
Regional Federal Reserve Banks
The 12 Federal Reserve Banks
LO4

29. 32-29
Functions of Regional Federal
Reserve Banks
• Regional Federal Reserve banks act like “bankers’ bank”
• Clearing checks
• Hold deposits of banks as reserves
• Setting a discount rate and making discount loans to banks
in their districts
• Issuing new currency and withdrawing damaged currency
• Examining bank holding companies and state-chartered
member banks
• Acting as liaisons between the business community and the
Federal Reserve System
• Collecting data on local business conditions
• Researching for the conduct of monetary policy

30. 32-30
U.S. Dollar Bills
• U.S. dollar bills are issued by the Federal
Reserve banks.
Emblem of the
Federal Reserve
System
“Federal Reserve Note”
means IOU (note
payable) issued by the
Federal Reserve System.
Federal Reserve Bank
of San Francisco
issued this note.

31. 32-31
Member Banks and Other
Depository Institutions
• All national banks are required to be members of the
Federal Reserve System.
• Currently, about 38% of the commercial banks are
members of the Federal Reserve System.
• Member banks are stockholders of the regional Federal
reserve bank.
• Depository Institutions Deregulation and Monetary
Control Act of 1980
• Requires all depository institutions (member and
nonmember banks) to hold required reserves.
• Makes check-clearing services and the discount window
available for all depository institutions.

32. 32-32
Board of Governors
• The Board of Governors acts like the
headquarter of the Federal Reserve System.
• Located in Washington, D.C.
• Seven members of the Board of Governors are
appointed by the president of the United States
and confirmed by the Senate.
• Each member serves for nonrenewable 14-year
term and comes from different districts.
• Why 14-year term? To avoid political pressure from the
President and the Congress.
• Why from different districts? To prevent one district
over-representing its interest over other districts.

33. 32-33
Chairman of Board of Governors
• The chairman of the Board of Governors is
chosen from the seven governors.
– Serves for renewable
four-year term.
– Acts like the CEO of
the Federal Reserve
System.
– Janet Yellen is the
current chairman.

34. 32-34
Functions of Board of Governors
• Sets the reserve requirement
• Approves the discount rate requested by the Federal Reserve
banks
• Advise the president of the United States, testifies in Congress,
and speaks for the Federal Reserve System for the media.
• Represents the United States in negotiations with foreign
governments on economic matters
• Provides economic analysis for the conduct of monetary policy
• Sets margin requirements
• Approves bank mergers and applications for new activities and
specifies the permissible activities of bank holding companies
• Supervise the activities of foreign banks in the U.S.

35. 32-35
Federal Open Market Committee
• The Federal Open Market Committee
• Meets eight times a year
• Makes decisions regarding the conduct of open market
operations, including setting a target rate on federal funds
• Consists of twelve members: the seven members of the
Board of Governors, the president of the Federal Reserve
Bank of New York, and the presidents of four other
Federal Reserve banks.
• Directed by the chairman of the Board of Governors

36. 32-36
Monetary Policy and FOMC
• The Federal Open Market Committee (FOMC) is the
major body of monetary policy decision-making at
the Federal Reserve.
• Twelve members of FOMC vote for or against the
proposed monetary policy.
• The chairman of the Fed, acting as the chairman of the
FOMC, announces in public about the decision.
• “Tightening of monetary policy” (lowering money supply
growth – “hawkish policy”) is accompanied by a rise in the
federal funds rate, while “easing of monetary policy”
(increasing money supply growth – “dovish policy”) is
done by lowering the federal funds rate.

37. 32-37
Banking System
• Commercial banks and thrift institutions
• 6,000 commercial banks
• 8,500 thrift institutions (Savings & Loans,
Mutual saving banks) and credit unions
• Chartered by the Federal government
(National bank) or state governments (State
bank)
LO4

38. 32-38
Financial Institutions
LO4

39. 32-39
Institution Description Examples
Commercial
Banks
State and national banks that provide checking and savings
accounts and make loans
JP Morgan Chase, Bank
of America, Citibank,
Wells Fargo
Thrifts Savings and loan associations, mutual savings banks, credit
unions that offer checking and savings accounts and make
loans
Charter One, New York
Community Bank
Insurance
Companies
Firms that offer policies through which individuals pay
premiums to insure against lose
Prudential, New York
Life, Northwestern
Mutual, Hartford
Mutual Fund
Companies
Firms that pool customer deposits to purchase stocks or
bonds
Fidelity, Vanguard,
Putnam, Janus, T Rowe
Price
Pension Funds Institutions that collect savings from workers throughout their
working years and then invest the funds to pay retirement
benefits
TIAA-CREF, Teamsters’
Union, CalPERs
Securities Firms Firms that offer security advice and buy and sell stocks and
bonds for clients
Merrill Lynch, Smith
Barney, Charles
Schwab
Investment Banks Firms that help corporations and governments raise money
by selling stocks and bonds
Goldman Sachs,
Morgan Stanley,
Deutsche Bank, Nomura
Securities
Major Categories of Financial Institutions
LO8

40. 32-40
Federal Reserve Independence
• Established by 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
LO5

41. 32-41
The Financial Crisis of 2007 and
2008
• Mortgage Default Crisis
• Many causes
• Government programs that encouraged
home ownership
• Declining real estate values
• Bad incentives provided by mortgage-
backed bonds
LO6

42. 32-42
The Financial Crisis of 2007 and
2008
• Securitization- the process of slicing up and
bundling groups of loans into new securities
(mortgage backed securities)
• As loans defaulted, the system collapsed
• “Underwater” homeowners abandoned
homes and mortgages
LO6

43. 32-43
The Financial Crisis of 2007 and
2008
• Failures and near-failures of financial firms
• Countrywide: second largest lender
• Washington Mutual: largest lender
• Wachovia
• Lehman Brothers: Investment banks which issued a large
number of mortgage banked securities
• Shadow banking: non-bank financial institutions that
provide services similar to commercial banks but
outside normal financial regulations
• AIG (American International Group): Insurance company
which insured mortgage backed securities by CDSs (Credit
default swaps)
LO6

44. 32-44
The Financial Crisis of 2007 and
2008
• Troubled Asset Relief Program (TARP)
• Allocated $700 billion to make emergency
loans
• Saved several large institutions (e.g. Citi
Group, GM, Fannie Mae) from failure (Too
Big to Fail)
LO7

45. 32-45
The Financial Crisis of 2007 and
2008
• The Fed’s lender-of-last-resort activities
• Primary Dealer Credit Facility
• Term Securities Lending Facility
• Asset-Backed Commercial Paper Money Market
Mutual Fund Liquidity Facility
• Commercial Paper Funding Facility
• Money Market Investor Funding Facility
• Term Asset-Backed Securities Loan Facility
• Interest Payments on Reserves
LO7

46. 32-46
Post-Crisis U.S. Financial
Services
• Wall Street Reform and Consumer Protection
Act of 2010
• Passed to help prevent many of the
practices that led to the crisis
• Critics say it adds heavy regulatory costs
LO8