Chapter 13: Money and the Financial System

This chapter is primarily descriptive and will require little class time, but you are responsible for its content.

I. The Evolution of Money

A. Barter and the double coincidence of wants

i. The more specialized an economy the more difficult is barter

ii. The lost of economic efficiency in a barter economy

II. Earliest Money and its functions

A. Money’s three important functions

i. Medium of exchange

ii. Unit of account

iii. Store of value

B. Problems with commodity money

i. Quality difficult to maintain

ii. Tends to be bulky

iii. Difficult to divide into smaller units

iv. Gresham’s Law –“ bad money drives out good money”

v. Opportunity cost of money due to other uses

vi. Demand versus supply as commodity vs. as money

vii. Best money is durable, divisible, of uniform quality, with low opportunity cost, whose supply can be controlled

C. Coins

i. Quality and quantity of precious metals difficult to determine

ii. Coinage to control quality and quantity of gold and silver used as money

iii. Sovereigns had power to coin money

iv. Seigniorage is profit from minting coins when value is greater than cost

v. Token money has value as money greater than value as commodity

D. Money and Banking

i. Originated as deposit with local goldsmiths

ii. Writing instructions to pay people from gold deposits

iii. Fractional reserves as a “breach of faith”

iv. Goldsmiths made loans from excess reserve, creating money

E. Paper Money

i. Bank notes were claims on gold deposits at a bank

ii. Fiduciary money is paper backed by gold or other valuable commodity

iii. Fiat money has no valuable commodity backing it up but is declared legal tender by the government (must be accepted as payment for debts)

F. The value of money

i. Its general acceptance as a medium of exchange

ii. Reflected in its purchasing power

iii. The value of a dollar relative to a base year is found by dividing 100 by the price index for that year

G. When money performs poorly

i. Too much money generates inflation

ii. Its functions as a medium of exchange, store of wealth, or standard of value are more difficult

iii. Some other form of money may evolve to facilitate exchange

III. Financial Institutions and Intermediaries

A. Commercial Banks and Thrifts (Depository Intermediaries)

i. Role as intermediary between savers and borrowers

ii. Originally defined by types of loans made

B. Other financial intermediaries

i. Obtain funds by collecting premiums or borrowing

ii. Insurance companies and finance companies

C. Development of a dual banking system (state banks and federal banks)

D. Birth of the Federal Reserve System

E. Powers of the Federal Reserve System

i. Issue paper money

ii. Check clearing

iii. Bank examination and regulation

iv. Determine the money supply through reserve requirements, loans to banks at discount window, and open market operations to buy and sell U.S. government securities

F. Banking during the Great Depression

G. Roosevelt’s reforms

H. From the Great Depression to deregulation

I. Bank deregulation

J. Bailing out the thrifts and commercial banks

K. The structure of U.S. Banking

L. Banking troubles in Japan

http://hsb.baylor.edu/html/kellyt/Learning%20Fed%20Operations.htm (5 point bonus)