Pump Primer

• List the functions of money & the

desirable characteristics of money
“ECONOMICS for Christian Schools”

Unit IV: Economics of the Financial Market

By Alan J. Carper
Bob Jones University Press. 1998
Chapter 10
“Money & Banking”
 Objectives:
• Explain the definitions of money used in the United States.
• Describe the properties of money.
• List the functions of money & the desirable characteristics of
money
• Identify the different kinds of money
• Name the four designations given to measurements of the
money supply
• Describe the banking activity of goldsmiths that led to an
expansion of the money supply
• Describe a commercial bank
• Describe the existing dual banking system
• List the functions of commercial banks
• Explain the concept of near-monies.
 Biblical Integration:
• We are to be good stewards of the money God
has given unto us. (Luke 16:11)

• Money is a tool to be used for His service to

provide for one's family, feed the needy &
spread the gospel.
 Money?

• Proverbs 23: 4-5 - The uselessness of seeking

riches
• Luke 16:11 – the necessity of being good
stewards of the money we have
• 2 Cor. 8:9 – the source of true riches.
 Proper Use of Money:

• “The proper use of money allows man to

provide for his family, to purchase clothing for
the destitute, to obtain food for the hungry, to
care for the sick, and to spread the gospel to
the nations of the world. Money is a tool to be
used for God’s service.”

(Carper, 129)
 Introduction
• The properties of money, the functions of money the
definitions of money are important concepts for you to
understand.
• Money has existed for a long time, and a wide range of
commodities have served as money in different
countries and at different times.
• Before money, economies used a barter system.
– The principle problem with a barter system is the double
coincidence of wants required for success.
• Double coincidence of wants means that you must find someone
who wants what you want to trade and has what you want!
• Time-consuming and limiting!
 Money
• Properties of any commodity used as money:
– Portability
– Uniformity
– Durability
– Stability in value
– Acceptability

• Commodities that have served as money:

– Cigarettes and chocolate bars in prisoner war camps
– Wampum (sm. Beads woven into colorful strips by the
Indians)
• Functions of Money:
– Medium of exchange
• Eliminates the need of the double coincidence of wants
– Store of value
• Permits money to be held for use at a later time
– Unity of Account, or standard-of-value
• There is an agreed-to measure for starting the prices of
goods and services. (This simplifies price comparisons.)
 “Money”
Activity 34 & 35
by
Advanced Placement Economics Teacher Resource
Manual. National Council on Economic
Education, New York, N.Y
 Activity 34: Money

• Use the table to evaluate how well each item would

perform the functions of money in today’s economy.
• If an item seems to fulfill the function, put a “+” sign
in the box;
• If it does not fulfill a function in your opinion, place a
“–” sign in the box.
• Put a “?” Sign in the box if you are unsure whether the
item fulfills the functions of money
• The item with the most + signs would be the best form
of money for you.
• In the space below the table, list the top six forms of
money, according to your evaluation.
 Item Medium of Exchange Store of Value Standard of Value

Salt - - -
Large stone wheels - + -
Cattle - - -
Gold + + +
Copper coins + + +
Beaver pelts - - -
Personal checks + + +
Savings account passbook - - -
Prepaid phone card ? + +
Debt card + + +
Credit card + - +
Cigarettes - - -
Playing cards - - -
Bushels of wheat - - -
$1 bill + + +
$100 bill + + +
My top six items: Gold, copper coins, personal checks, debit card, $1 bill and $100 bill
2. After you finish the evaluation in Question 1, rate the
various items in the table below.
– Evaluate how well they meet the characteristics of money.
– Again, if an item seems to fit a characteristic, use a “+”
sign;
– If the item does not seem to fit a characteristic, use a “-”
sign;
– If there is a difference of opinion or if you are uncertain,
use a “?”.
– The item with the most “+” signs would best fit the
characteristics of money.
– In the space below the table, list your six top items.
 Item Portability Uniformity Acceptability Durability Stability in Value

Salt + + - + -
Large stone wheels - - - + +
Cattle - - - ? -
Gold
+ + ? + -
Copper coins + + ? + -
Beaver pelts + - - + ?
Personal checks + + ? + +
Savings account passbook + + - - +
Prepaid phone card + ? ? - +
Debt card + + + + +
Credit card + + + + +
Cigarettes + - - - -
Playing cards + - - - -
Bushels of wheat - - - - -
$1 bill + + + + +
$100 bill + + + + +

My top six items: Gold, copper coins, personal checks, debit card, $1 bill and $100 bill
3. Why might factors such as ease of storage,
difficulty in counterfeiting and security of
electronic transfer of funds also be
characteristics that you might use in evaluating
money?
For an item to be a good medium of exchange, you
would want to minimize the costs of holding or
storing it. Counterfeiting and security affect the
item’s underlying value and might affect
acceptability.
 Check

• A check is an authorization to pay a

designated amount of money out of an
established account.

(Carper, 136)
 Negotiable Check:
(1) In writing
(2) Signed by the maker
(3) Payable to the bearer or to the order of a
specific person
(4) Ordering the bank to pay a specified sum
of money
(5) Bearing a date no older than six months.

(Carper, 136)
 Checks
• “Many corporations will use a stamp signature
instead of signing each individual check.”

• “On most checks the writer writes out the amount of

the check in both words and in numerals. If the two
do not agree, the written amount in words is the legal
amount of the check.”

• “Checks older than six months are considered “stale”

dated and by law cannot be cashed. It is also illegal to
“post” date a check (date a check for time in the
future).”
(Carper, 136)
 Measuring the Money Supply
• How much money exists in the United States?
– This is not an easy question to answer, since
money represents purchasing power and it
greatly depends on how it is measured.
• M-I
• M-2
 M-1
• Economists refer to first method of measuring the money
supply as M-1
(1) “currency outside the U.S. Treasury, Federal Reserve Banks,
and the vaults of depository institutions;
(2) traveler's checks of nonbank issuers;
(3) demand deposits at commercial banks (excluding those
amounts held by depository institutions, the U.S.
government, and foreign banks and official institutions) less
cash items in the process of collection and Federal Reserve
float; and
(4) other checkable deposits (OCDs), consisting of negotiable
order of withdrawal (NOW) and automatic transfer service
(ATS) accounts at depository institutions, credit union share
draft accounts, and demand deposits at thrift institutions.
Seasonally adjusted M1 is constructed by summing currency,
traveler's checks, demand deposits, and OCDs, each
seasonally adjusted separately.” (“Money Stock…”)
 M-2
• A broader measure of the money supply is referred to as M-2:
– Includes M-1 money plus all money available to spend after
a short delay:
(1) Savings deposits (including money market deposit accounts);
(2) Small-denomination time deposits (time deposits in amounts of
less than $100,000), less individual retirement account (IRA)
and Keogh balances at depository institutions; and
(3) Balances in retail money market mutual funds, less IRA and
Keogh balances at money market mutual funds. Seasonally
adjusted M2 is constructed by summing savings deposits, small-
denomination time deposits, and retail money funds, each
seasonally adjusted separately, and adding this result to
seasonally adjusted M1.” (“Money Stock…”)
 M-3
• The broadest measure of the money supply is known as M-3 –
no longer published by Federal Reserve as of March 16, 2006.
• Includes M-1 & M-2
(1) “Balances in institutional money market mutual funds;
(2) Large-denomination time deposits (time deposits in amounts of
$100,000 or more);
(3) Repurchase agreement (RP) liabilities of depository institutions,
in denominations of $100,000 or more, on U.S. government and
federal agency securities; and
(4) Eurodollars held by U.S. addressees at foreign branches of U.S.
banks worldwide and at all banking offices in the United
Kingdom and Canada. Large-denomination time deposits, RPs,
and Eurodollars exclude those amounts held by depository
institutions, the U.S. government, foreign banks and official
institutions, and money market mutual funds. Seasonally
adjusted M3 is constructed by summing institutional money
funds, large-denomination time deposits, RPs, and Eurodollars,
each adjusted separately, and adding this result to seasonally
adjusted M2.” (“Discontinuance of M3 “)
 THE BANKING SYSTEM

– The banking system consists of

• The Federal Reserve
• The banks and other financial institutions that accept
deposits and that provide the services that enable people
and businesses to make and receive payments.
 THE BANKING SYSTEM
The Federal Reserve regulates and influences the activities
of the commercial banks, thrift institutions, and money
market funds, whose deposits make up the nation’s money.
 Financial Institutions
• “Is the collection of organizations that assist house-
holds in channeling their money to businesses and
government.”

• “Commercial Banks are “full service” institutions

offering a wide range of services for both individuals
and businesses. Account for nearly half of all assets
held by financial institutions. Also, it is important to
know that all commercial banks are chartered.”

(Carper 140, 143)

 THE BANKING SYSTEM

• Commercial Banks
– A commercial bank is a firm that is licensed by the
Comptroller of the Currency in the U.S. Treasury (or
by a state agency) to accept deposits and make loans.
– About 7,400 commercial banks operate in the United
States in 2006.
– Because of mergers, this number is down from 13,000
a few years ago.
 THE BANKING SYSTEM
Types of Deposits
– A commercial bank accepts three types of
deposits:
• Checkable deposits
• Savings deposits
• Time deposits
 THE BANKING SYSTEM
Profit and Prudence: A Balancing Act
– The goal of a commercial bank is to maximize the
long-term wealth of its stockholders.
– To achieve this goal, a bank must be prudent in the
way it uses its depositors’ funds and balance
security for the depositors against profit for its
stockholders.
 THE BANKING SYSTEM
Cash Assets
–A bank’s cash assets consist of its reserves and
funds that are due from other banks as payments for
checks that are being cleared.
–A bank’s reserves consist of currency in the bank’s
vaults plus the balance on its reserve account at a
Federal Reserve Bank.
–The Fed requires the banks and other financial
institutions to hold a minimum percentage of
deposits as reserves, called the required reserve
ratio.
 THE BANKING SYSTEM
Interbank Loans
–When banks have excess reserves, they can lend
them to other banks that are short of reserves in an
interbank loans market.
–The interbank loans market is called federal funds
market and the interest rate on interbank loans is the
federal funds rate.
–The Fed’s policy actions target the federal funds
rate.
 THE BANKING SYSTEM
Securities and Loans
–Securities held by banks are bonds issued by the
U.S. government and by other large, safe,
organizations.
–A bank earns a moderate interest rate on securities,
but it can sell them quickly if it needs cash.
–Loans are the funds that banks provide to
businesses and individuals and include outstanding
credit card balances.
–Loans earn the highest interest rate but cannot be
called in before the agreed date.
 THE BANKING SYSTEM
Bank Deposits and Assets: The Relative
Magnitudes
– In 2007, checkable deposits at commercial banks
in the United States, included in M1, are about 7
percent of total commercial bank deposits.
– The other 63 percent of deposits are savings
deposits and small time deposits, which are part of
M2.
 Financial Institutions

• Functions include:
– (1) Accepting Deposits. (Primary source of
money for loans)
– (2) Extending Loans
(3) Provision of Miscellaneous Services

(Carper 140, 141)

 Creating A Bank

1. Obtain a Charter
- Apply to the “Comptroller of the Currency”
(federal charter) or state treasurer’s office (state
charter)
2. Raise Financial Capital
- selling shares
3. Buying Equipment
4. Accepting Deposits

(Blade et al. 524)

5. Establishing A Reserve Account
- “The bank’s required reserves equal the required
reserve ratio multiplied by the amount of deposits.”
- “Excess reserves equal actual reserves minus
required reserves. The bank can loan only its excess
reserve.”
6. Clearing Checks
7. Buying Government Securities
- “Government securities provide a bank with an income
and are a safe asset that is easily converted back into
reserves when necessary.”
8. Making Loans
- Generates the primary income for the institution
(I.e., interest).
(Blade et al. 524)
 THE BANKING SYSTEM
• Thrift Institutions
–Three types of thrift institutions are savings and
loan associations, savings banks, and credit unions.
–A savings and loan association (S&L) is a financial
institution that accepts checkable deposits and
savings deposits and that makes personal,
commercial, and home-purchase loans.
–A savings bank is a financial institution that accepts
savings deposits and makes mostly consumer and
home-purchase loans.
 THE BANKING SYSTEM

–A credit union is a financial institution owned by a

social or economic group, such as a firm’s
employees, that accepts savings deposits and makes
mostly consumer loans.
–Like commercial banks, thrift institutions hold
reserves and must need minimum reserve ratios set
by the Fed.
 Contractual Savings Institutions

• Institutions who operate under contract to

receive regular payments or premiums, invest
the funds, and return stipulated amounts
prescribed by the contract – insurance
companies and pension funds.

(Carper 138, 139)

 Finance Companies

• Make consumer loans (tend to offer higher

rates than commercial banks)

(Carper 138, 139)

 Investment Companies

• Mutual funds and other investment

companies pool shareholders money to
purchase stock & return profit to the
shareholders.

(Carper 138, 139)

 THE BANKING SYSTEM

• Money Market Funds

– A money market fund is a financial institution that
obtains funds by selling shares and uses these
funds to buy assets such as U.S. Treasury bills.
– Money market fund shares act like bank deposits.
Shareholders can write checks on their money
market fund accounts.
– There are restrictions on most of these accounts.
 THE FEDERAL RESERVE
SYSTEM
• The Federal Reserve System
–The Federal Reserve System is the central bank of
the United States.
–A central bank is a public authority that provides
banking services to banks and regulates financial
institutions and markets.
–The Fed’s main task is to regulate the interest rate
and quantity of money to achieve low and
predictable inflation and sustained economic growth.
 Activity 35: “What’s All This About the Ms?”
1. What are the three basic functions of money?
Medium of exchange, a standard of value (unit of
account), and a store of value.
2. Why is it important for the Fed to know the size and rate of
growth of the money supply?
The size of the money supply and the rate at which it is
growing can have a significant impact on the economic
well being of the country.
(A) What are the effects if the money supply grows too slowly?
If the money supply is growing too slowly, the likelihood of recession
increases because the demand for money will increase, driving interest rates
up. As interest rates rise, investment declines, slowing the growth rate of
real output.

(B) What are the effects if the money supply grows too rapidly?
If the money supply is growing too quickly, it could lead to inflation.
3. Name a type of money that serves primarily as a medium of
exchange.
Currency, coin, debit cards or checkable deposits
4. Name a type of money that serves primarily as a store of value.
Savings account or money market mutual fund account.

5. With the use of credit cards becoming more prominent and

the availability of credit broader than ever, why are credit cards
not included in the Ms?
Credit cards are short-term loans. Credit-card bills are not
directly subtracted from checking accounts. Instead the
credit-card holder pays the bill from a checking or NOW
(negotiable order of withdrawal ) account. Not only should
loans NOT be counted as money, but if they were and the
payment were also counted, one economic transaction would
be double-counted in the money supply.
6. Why is it difficult for the Fed to get an accurate measure of the
money supply?
Because of the volume of transactions in the United states, which can
range into the trillions on a daily basis, getting an accurate measure of
each transaction can be an arduous task. The inputs are constantly
changing as banks make new loans and people repay loans ahead of
schedule.
7. Why must the fed continue to develop new ways to track the
money supply?
Because of technological innovation in the financial
services industry and profit maximizing behavior on the
part of commercial banks, the Fed must find new
measures for tracking the money supply to assist with
monetary policy.
8. Use the data in Figure 35.1 to calculate M1, M2, and M3.
Assume that all items not mentioned are zero. Show all
components for your answers.
• Figure 35.1: Calculating the Ms
Checkable deposits $850
(demand deposits, NOW, ATM
and credit union share draft
accounts)
Currency $200
Large time deposits $800
Non-checkable savings dep. $302
Small time deposits $1,745
Institutional money
market mutual funds $1,210

M1 = ____________________________
850 + 200 = 1,050
1,050 + 1,745 + 302 = 3, 097
M2 = ____________________________
3,097 + 800 + 1,210 = 5,107
M3 = ____________________________
 Works Cited

Blade, Robin, and Michael Parkin. Foundations of Economics:

Instructor’s Manual. 2nd ed. Boston: Pearson Education, Inc.,
2007.
Carper, Alan. Economics for Christian Schools. Greenville: Bob
Jones University Press, 1998.
“Discontinuance of M3.” Federal Reserve. 9 Mar 2006. 21
Mar 2008.
http://www.federalreserve.gov/Releases/H6/20060309/h6.txt
“Money Stock Measure.” Federal Reserve Statistical Release. 20
Mar 2008. 21 Mar 2008.
http://www.federalreserve.gov/releases/h6Current/
"The New King James Version." Logos Bible Software.
CD_ROM. ed. 2004.