Chapter 24
Money and the Federal Reserve System
Key Concepts
Summary
Practice Quiz
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©2000 South-Western College Publishing
In this chapter, you will learn to solve these economic puzzles:
Why do nations use money?
Is “plastic money” really money?
What does the Federal Reserve bank do?
What is Barter?
The direct exchange of one good for another good, rather than for money
What is the problem with Barter?
It requires a coincidence of wants
What is Money?
Anything that serves as a medium of exchange, unit of account, and store of value
What is the Advantage of Money?
The use of money simplifies and therefore increases market transactions
What are the Functions of Money?
Medium of exchange
Unit of account
Store of value
What is a
Medium of Exchange?
The primary function of money to be widely accepted in exchange for goods and services
What is a
Unit of Account?
The function of money to provide a common measurement of the relative value of goods and services
What does it mean that Money is Liquid?
It is available to spend in exchange for goods and services without any additional expense
Are Credit Cards Money?
No, credit cards fail to meet the store-of-value criterion and are therefore not money
What is the best level of Scarcity for Money ?
The supply of money must be great enough to meet ordinary transactions needs, but not be so plentiful that it becomes worthless
What are other Properties of Money?
Money must be …
portable
divisible
uniform
acceptable
What is
Commodity Money?
Anything that serves as money while having market value in other uses
Is our Money backed up by Gold or Silver?
No, our paper money was exchangeable for gold until 1934, and in 1963 Congress removed the right to exchange $1 bills for silver
What is Fiat Money?
Money accepted by law and not because of redeemability or intrinsic value
What makes our Dollar Bills Fiat Money?
All our bills claim that “This note is legal tender for all debts public and private”
What does
Legal Tender mean?
Legally dollar bills cannot be refused as payment for a debt
What is Currency?
Money, including coins and paper money
What are
Checkable Deposits?
The total of checking account balances in financial institutions convertible to currency “on demand” by writing a check without advance notice
What is M1?
The narrowest definition of the money supply. It includes currency, traveler’s checks, and checkable deposits
What is M2?
The definition of the money supply that equals M1 plus near monies, such as savings deposits and small time deposits of less than $100,000
What is M3?
The definition of the money supply that equals M2 plus large time deposits of $100,000 or more
What distinguishes M1 from M2 and M3?
M1 is more liquid than M2 or M3
What is the Federal Reserve System?
The 12 central banks that service banks and other financial institutions within each of the Federal Reserve districts
What is the Board of Governors of the Fed?
The seven members appointed by the President and confirmed by the . Senate
How long does a Board Member serve?
They serve for a non-renewable fourteen-year term
What is the responsibility of the Board?
To supervise and control the money supply and the banking system of the .
What is the Chairman of the Board of Governors?
The President designates one member of the Board to serve as chair for a renewable four-year term
Who is Alan Greenspan?
Chairman of the Board of Governors of the Fed
What is the Federal Open Market Committee?
The FOMC is the Fed’s committee that directs the buying and selling of . government securities
What is the purpose of the FOMC?
To increase the money supply if we have unemployment and decrease it if we have inflation
What is the Federal Advisory Council?
12 prominent commercial bankers who council board members but who do not have voting rights
How many Commercial Banks are members of the Fed?
About 6,000 of the 15,000
What percent of all deposits reside in Member Banks?
About 70%
Board of Governors
Regional Fed Banks
. Banking System
The Fed’s Organization
What does a Federal Reserve Bank do?
Controls the money supply
Clears checks
Supervises and regulates banks
Maintains and circulates currency
Protects consumers
Maintains federal government checking accounts and gold
What is the Federal Deposit Insurance Corporation?
The FDIC is a government agency established in 1933 to insure commercial bank deposits up to a specified limit
What is the
Monetary Control Act?
A 1980 law that gave the Fed greater control of nonmember banks and makes all financial institutions more competitive
Key Concepts
Key Concepts
What is Barter?
What is Money?
What are the Functions of Money?
What does it mean that Money is Liquid?
What are other Properties of Money?
What is Commodity Money?
Is our Money backed up by Gold or Silver?
Key Concepts cont.
What is Fiat Money?
What is Currency?
What is M1?
What is M2?
What is M3?
What is the Federal Reserve System?
What is the Board of Governors?
Key Concepts cont.
What is the Chairman of the Board of Governors?
What is the Federal Open Market Committee?
What is the Federal Advisory Council?
What does a Federal Reserve Bank do?
What is the Federal Deposit Insurance Corporation (FDIC)?
Summary
Money can be anything that meets these three tests. Money must serve as (1) a medium of exchange, (2) a unit of account, and (3) a store of value. Money facilitates more efficient exchange than barter. Other desirable properties of money include scarcity, portability, divisibility, and uniformity.
Medium of exchange is the most important function of money. This means that money is widely accepted in payment for goods and services.
Unit of account is another important function of money. Money is used to measure relative values by serving as a common yardstick for valuing goods and services.
Store of value is the property of money to hold its value over time. Money is said to be highly liquid, which means it is readily usable in exchange.
Credit cards are not money. Credit cards represent a short-term loan and therefore fail as a store of value.
Commodity money is money that has a marketable value, such as gold and silver. Today, the . uses fiat money, which must be accepted by law, but is not convertible into gold, silver, or any commodity.
M1 is the narrowest definition of money, which equals currency plus traveler’s checks plus checkable deposits. M2 is a broader definition of money, which equals M1 plus near monies, such as savings deposits and small time deposits. M3 is an even broader definition of money, which equals M2 plus large time deposits of more than $100,000 or more.
Chapter 24 Quiz
©2000 South-Western College Publishing
1. Which of the following is a problem with barter?
a. Individuals will not exchange goods.
b. Individuals’ wants must coincide in order for there to be exchange.
c. Goods can be exchanged, but services cannot.
d. None of the above is a problem.
B. Finding coincidence of wants complicates and therefore decreases market transactions.
2. Which of the following is not a characteristic of money?
a. It provides a way to measure the relative value of goods and services.
b. It is always backed by something of high intrinsic value such as gold or silver.
c. It is generally acceptable as a medium of exchange.
d. It allows for saving and borrowing.
B. Gold or silver backing for . paper money was removed in 1934.
3. Which of the following is not a store of value?
a. Dollar.
b. Money market mutual fund share.
c. Checking account balance.
d. Credit card.
D. Credit cards are a prearranged short-term loan which can be canceled by the credit card company.
4. The easier it is to convert an asset directly into goods and services without loss, the
a. less secure it is.
b. more secure it is.
c. more liquid it is.
d. less liquid it is.
C. Money is the most liquid form of wealth because it can be spent directly in the marketplace.
5. M1 refers to
a. the most narrowly defined money supply.
b. currency held by the public plus checking account balances and traveler’s checks.
c. the smallest dollar amount of the money-supply definitions.
d. all of the above.
D. M1 is the narrowest definition of the money supply.
6. The M1 definition of the money supply includes
a. coins and currency in circulation.
b. coins and currency in circulation, checkable deposits, and traveler’s checks.
c. Federal Reserve notes, gold certificates, and checkable deposits.
d. Federal Reserve notes and bank loans.
B. Answers a is incomplete and c and d are not answers because gold certificates and bank loans are not included in M1.
7. Which of the following items is not included when computing M1?
a. Coins in circulation.
b. Currency in circulation.
c. Savings accounts.
d. Checking account entries.
C. Savings accounts are included in M2.
8. Which of the following is part of the M2 definition of the money supply, but not part of M1?
a. Traveler’s checks.
b. Currency held in banks.
c. Currency in circulation.
d. Money market mutual shares.
D. Note that M1 is part of M2.
9. Which of the following is not part of M1?
a. Checking accounts.
b. Coins.
c. Credit cards.
d. Traveler’s checks
e. Paper currency.
C. Credit cards are not considered money. They fail to meet the store of value characteristic.
10. Which definition of the money supply includes credit cards, or “plastic money”?
a. M1.
b. M2.
c. M3.
d. All of the above
e. None of the above.
E. Credit cards are not money because they fail to serve as a store of value.
11. Which of these institutions has the responsibility for controlling the money supply?
a. Commercial banks.
b. Congress.
c. The . Treasury Department.
d. The Federal Reserve System.
D. The Federal Reserve System is our central bank.
12. Which of the following is not one of the functions of the Federal Reserve?
a. Clearing checks.
b. Printing currency.
c. Supervising and regulating banks.
d. Controlling the money supply.
B. The . Treasury prints our currency.
13. Which of the following is in charge of the buying and selling of government securities by the Fed?
a. The president.
b. The Federal Open Market Committee.
c. The Congress.
d. None of the above.
B. Selling . securities (Treasury bills, notes, and bonds) is one of the major tools for controlling the money supply.
14. The major protection against sudden mass attempts to withdraw cash from banks is the
a. Federal Reserve.
b. Consumer Protection Act.
c. deposit insurance provided by the FDIC.
d. gold and silver backing the dollar.
C. The FDIC is a government agency established by Congress in 1933 to insure commercial bank deposits up to $100,000 per bank account.
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