1. Chapter 24
Money and the Federal
Reserve System
• Key Concepts
• Summary
• Practice Quiz
• Internet Exercises
©2000 South-Western College Publishing
1

2. In this chapter, you will
learn to solve these
economic puzzles:
WhyIs “plasticthe Federal
What nations use money?
do does money”
Reservemoney?
really bank do?
2

3. What is Barter?
The direct exchange of one
good for another good,
rather than for money
3

4. What is the problem
with Barter?
It requires a
coincidence of wants
4

5. What is Money?
Anything that serves as
a medium of exchange,
unit of account, and
store of value
5

6. What is the
Advantage of Money?
The use of money simplifies
and therefore increases
market transactions
6

7. What are the
Functions of Money?
• Medium of exchange
• Unit of account
• Store of value
7

8. What is a
Medium of Exchange?
The primary function of
money to be widely
accepted in exchange for
goods and services
8

9. What is a
Unit of Account?
The function of money to
provide a common
measurement of the relative
value of goods and services
9

10. What does it mean that
Money is Liquid?
It is available to spend in
exchange for goods and
services without any
additional expense
10

11. Are Credit Cards Money?
No, credit cards fail to
meet the store-of-value
criterion and are
therefore not money
11

12. 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
12

13. What are other
Properties of Money?
Money must be …
• portable
• divisible
• uniform
• acceptable
13

14. What is
Commodity Money?
Anything that serves as
money while having
market value in other uses
14

15. 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 15

16. What is Fiat Money?
Money accepted by
law and not because
of redeemability or
intrinsic value
16

17. What makes our Dollar
Bills Fiat Money?
All our bills claim that “This
note is legal tender for all
debts public and private”
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18. What does
Legal Tender mean?
Legally dollar bills
cannot be refused as
payment for a debt
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19. What is Currency?
Money, including coins
and paper money
19

20. 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
20

21. What is M1?
The narrowest definition of
the money supply. It
includes currency,
traveler’s checks, and
checkable deposits
21

22. 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
22

23. What is M3?
The definition of the money
supply that equals M2 plus
large time deposits of
$100,000 or more
23

24. What distinguishes M1
from M2 and M3?
M1 is more liquid
than M2 or M3
24

25. The Money Supply
Currency
42%
Traveler's checks -
checkable deposits
58%
25

26. The Money Supply
22% 25%
M1
Savings deposits
Small time
deposits
53% 26

27. The Money Supply
26%
M2
Large time
deposits
74%
27

28. What is the Federal
Reserve System?
The 12 central banks that
service banks and other
financial institutions
within each of the Federal
Reserve districts
28

29. What is the Board of
Governors of the Fed?
The seven members
appointed by the
President and confirmed
by the U.S. Senate
29

30. How long does a Board
Member serve?
They serve for a
non-renewable
fourteen-year term
30

31. What is the responsibility
of the Board?
To supervise and control the
money supply and the
banking system of the U.S.
31

32. 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
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33. Who is Alan Greenspan?
Chairman of the Board of
Governors of the Fed
33

34. What is the Federal Open
Market Committee?
The FOMC is the Fed’s
committee that directs the
buying and selling of U.S.
government securities
34

35. What is the purpose of
the FOMC?
To increase the
money supply if we
have unemployment
and decrease it if we
have inflation
35

36. What is the Federal
Advisory Council?
12 prominent commercial
bankers who council
board members but who
do not have voting rights
36

37. How many
Commercial Banks are
members of the Fed?
About 6,000 of the 15,000
37

38. What percent of all
deposits reside in
Member Banks?
About 70%
38

39. The Fed’s
Board of Governors Organization
Regional Fed Bank
U.S. Banking System
39

40. 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
40

41. 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
41

42. 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
42

43. Key Concepts
43

44. 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?
44

45. 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?
45

46. Key Concepts cont.
• What is the Chairman of the Board of Govern
• 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 Corpo
46

47. Summary
47

48. 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.
48

49. Medium of exchange is the
most important function of
money. This means that money
is widely accepted in payment
for goods and services.
49

50. 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.
50

51. 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.
51

52. Credit cards are not money.
Credit cards represent a short-
term loan and therefore fail as a
store of value.
52

53. Commodity money is money
that has a marketable value, such
as gold and silver. Today, the
U.S. uses fiat money, which must
be accepted by law, but is not
convertible into gold, silver, or
any commodity.
53

54. 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.
54

55. The Money Supply
Currency
42%
Traveler's checks -
checkable deposits
58%
55

56. The Money Supply
22% 25%
M1
Savings deposits
Small time
deposits
53% 56

57. The Money Supply
26%
M2
Large time
deposits
74%
57

58. Chapter 24 Quiz
©2000 South-Western College Publishing
58

59. 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.
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60. 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 U.S. paper
money was removed in 1934.
60

61. 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.
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62. 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.
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63. 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.
63

64. 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.
64

65. 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.
65

66. 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.
66

67. 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.
67

68. 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.
68

69. 11. Which of these institutions has the
responsibility for controlling the money
supply?
a. Commercial banks.
b. Congress.
c. The U.S. Treasury Department.
d. The Federal Reserve System.
D. The Federal Reserve System is our
central bank.
69

70. 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 U.S. Treasury prints our currency.
70

71. 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 U.S. securities (Treasury bills, notes,
and bonds) is one of the major tools for
controlling the money supply.
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72. 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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73. Internet Exercises
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73

74. END
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