Chapter 3

List all currencies in the M1 Money Supply:

1. Coins and Currency in Circulation 2. Checkable Deposits 3. Traveler's Checks

List all currencies in the M2 Money Supply:

1. Coins and Currency in Circulation 2. Checkable Deposits 3. Traveler's Checks 4. Saving Deposits 5. Money Market Funds 6. Certificates of Deposit (CDs) 7. Other Time Deposits

In today's increasingly global business environment, commerce has gone electronic. It is important to understand types of electronic payments:

1. Electronic funder transfer (EFT) 2. Digital cash 3. Ecash 4. Credit Card 5. Smart Phones 6. Personal e-currencies 7. Electronic Chip Implants

Money solves the problems created by the barter system:

1. First, money serves as a medium of exchange, which means that money acts as an intermediary between the buyer and the seller 2. Second, money must serve as a store of value. Consider the barter between the hairstylist and shoemaker again. The shoemaker risks having his shoes go out of style, especially if he keeps them in a warehouse for future use—their value will decrease with each season. Shoes are not a good store of value. Holding money is a much easier way of storing value 3. Third, money serves as a unit of account, which means that it's the ruler by which other values are measured 4. Another function of money is that money must serve as a standard of deferred payment. This means that if money is usable today to make purchases, it must also be acceptable to make purchases today that will be paid in the future

Money serves all of these functions:

1. It is a medium of exchange 2. Store of value 3. Unit of account 4. Standard of deferred payment

There are two definitions of money:

1. M1 money supply 2. M2 money supply

A central bank has the following three traditional tools to implement monetary policy in the economy:

1. Open market operations 2. Changing reserve requirements 3. Changing the discount rate

Two variants of digital cash are presently available:

1. Prepaid cards 2. Smart cards

The Federal Reserve, like most central banks, is designed to perform the following three important functions:

1. To conduct monetary policy 2. To promote stability of the financial system 3. To provide banking services to commercial banks and other depository institutions, and to provide banking services to the federal government

A smart card, containing memory and a microprocessor, can store as much as...

100 times more data than a magnetic-stripe card. The microprocessor can be programmed

Where does "plastic money" like debit cards, credit cards, and smart money fit into this picture?

A debit card, like a check, is an instruction to the user's bank to transfer money directly and immediately from your bank account to the seller. It is important to note that in our definition of money, it's checkable deposits that are money, not the paper check or the debit card. Although you can make a purchase with a credit card, it is not considered money but rather a short term loan from the credit card company to you. When you make a purchase with a credit card, the credit card company immediately transfers money from its checking account to the seller, and at the end of the month, the credit card company sends you a bill for what you have charged that month. Until you pay the credit card bill, you have effectively borrowed money from the credit card company. With a smart card, you can store a certain value of money on the card and then use the card to make purchases. Some "smart cards" used for specific purposes, like long-distance phone calls or making purchases at a campus bookstore and cafeteria, are not really all that smart, because they can only be used for certain purchases or in certain places

____, literally trading one good or service for another, is highly inefficient for trying to coordinate the trades in a modern advanced economy

Barter

The cashless solutions that seem to get the most attention these days are really just making it easier for more people to access the existing electronic payment networks owned and operated by Visa and MasterCard, both of which are using existing state-issued currencies. But BitCoin and other electronic currencies are quite different:

BitCoins are not issued by a state or a central bank. BitCoin is an alternative currency, one that is parallel to the dollar, pound, euro, yen, etc., and can be exchanged for these central-bank currencies according to market-based, variable exchange rates. The BitCoin system is certainly "cashless"—all their accounts and transactions are processed electronically

____ consists of objects that have value in themselves as well as value in their use as money. Gold, for example, has been used throughout the ages as money, although today it is not used as money but rather is valued for its other attributes

Commodity money

____ are dollar bills or other currencies with values backed up by gold or another commodity held at a bank

Commodity-backed currencies

Now that you have a good understanding of money, what qualifies as money, and how money facilitates exchanges between buyers and sellers, we need to look at how money evolves from a medium of exchange to a system. There was a time in the United States when there was no monetary system, and buyers and sellers who traveled from state to state had to carry multiple currencies. The ____ was issued by the newly formed confederacy just before the outbreak of the American Civil War. It wasn't backed by hard assets (i.e., commodities) but simply by a promise to pay the bearer after the war, on the prospect of Southern victory and independence

Confederate States of America dollar

____ is an electronic parallel of notes and coins

Digital cash

To understand the usefulness of money, we must consider what the world would be like without money. How would people exchange goods and services?

Economies without money typically engage in the barter system

What is the advantage of Electronic Funds Transfer (EFT)?

Electronic checking is fast; transactions are instantaneous. Paper handling costs are substantially reduced. Bad checks are no longer a problem because the seller's account balance is verified at the moment of the transaction. EFT is flexible; it can handle high volumes of consumer and commercial transactions, both locally and internationally. The international payment clearing system, consisting of more than 100 financial institutions, handles more than one trillion dollars per day

____, introduced in the late 1960s, uses the existing banking structure to support a wide variety of payments. For example, consumers can establish monthly checking account deductions for utility bills, and banks can transfer millions of dollars

Electronic funds transfer (EFT)

Most nations have central banks or currency boards. Some prominent central banks around the world include the...

European Central Bank, the Bank of Japan, and the Bank of England

PayPal has made person-to-person payments possible, internationally as well as nationally, but it has downsides:

Every time money is withdrawn from a PayPal account into a normal bank account, PayPal takes a cut. And unlike cash payments, PayPal is not anonymous

The United States' paper money, such as the dollar bill, is not fiat money (T/F)

False

On a more mundane level, the Federal Reserve ensures that enough currency and coins are circulating through the financial system to meet public demands. For example, each year the...

Fed increases the amount of currency available in banks around the Christmas shopping season and reduces it again in January

The ____ makes the decisions regarding these open market operations. It is made up of the seven members of the Federal Reserve's board of governors. It also includes five voting members who are drawn, on a rotating basis, from the regional Federal Reserve Banks

Federal Open Market Committee (FOMC)

In the United States, the central bank is called the ____—often abbreviated as "the Fed"

Federal Reserve

The ____, which is the central bank of the United States, is a bank regulator. It's responsible for monetary policy, and it defines money according to its liquidity

Federal Reserve Bank

The ____ is responsible for tracking the amounts of M1 and M2 and prepares a weekly release of information about the money supply

Federal Reserve System

The Federal Reserve is more than the board of governors. The Fed also includes twelve regional ____, each of which is responsible for supporting the commercial banks and economy generally in its district

Federal Reserve banks

Theoretically, a ____-enabled chip could one day make it possible for individuals to be physically located by latitude, longitude, altitude, speed, and direction of movement. This chip would be able to work with the microchip implants. Though, such implantable devices are not commercially available at this time

Geographical Positioning System (GPS)

During much of its history, the money supply in the United States was backed by gold and silver. Interestingly, antique dollars dated as late as 1957 have "Silver Certificate" printed above the portrait of...

George Washington. This meant that the holder could take the bill to the appropriate bank and exchange it for a dollar's worth of silver

What individual can make the financial market crash or soar just by making a public statement?

It's not Bill Gates or Warren Buffett. It's not even the president of the United States. The answer is the chair of the Federal Reserve Board of Governors. In early 2014, Janet L. Yellen became the first woman to hold this post. Yellen has been described in the media as "perhaps the most qualified Fed chair in history." With a PhD in economics from Yale University, Yellen has taught macroeconomics at Harvard, the London School of Economics, and most recently at the University of California at Berkeley. From 2004-2010, Yellen was president of the Federal Reserve Bank of San Francisco. Not an ivory-tower economist, Yellen became one of the few economists who warned about a possible bubble in the housing market, more than two years before the financial crisis occurred. Yellen served on the board of governors of the Federal Reserve twice, most recently as vice chair. She also spent two years as chair of the President's Council of Economic Advisors. If experience and credentials mean anything, Yellen is likely to be an effective Fed chair

____ refers to how quickly a financial asset can be used to buy a good or service

Liquidity

____ includes those monies that are very liquid such as cash, checkable (demand) deposits, and traveler's checks

M1 money supply

What does the M1 money supply include?

M1 money supply includes coins and currency in circulation—the coins and bills that circulate in an economy that are not held by the U.S. Treasury, at the Federal Reserve Bank, or in bank vaults. Closely related to currency are checkable deposits, also known as demand deposits. These are the amounts held in checking accounts. They are called demand deposits or checkable deposits because the banking institution must give the deposit holder his money "on demand" when a check is written or a debit card is used. These items together—currency, and checking accounts in banks—comprise the money defined as M1, which is measured daily by the Federal Reserve System. Traveler's checks are also included in M1 but have recently decreased in use.

What does the M2 money supply include?

M2 is a broader category of money. It includes everything in M1 but also adds other types of deposits. For example, M2 includes savings deposits in banks, which are bank accounts on which you cannot write a check directly, but from which you can easily withdraw the money at an automatic teller machine or bank. Many banks and other financial institutions also offer a chance to invest in money market funds, where the deposits of many individual investors are pooled together and invested in a safe way, such as in short-term government bonds. Another portion of M2 are the relatively small (that is, less than about $100,000) certificates of deposit (CDs) or time deposits, which are accounts that the depositor has committed to leaving in the bank for a certain period of time, ranging from a few months to a few years, in exchange for a higher interest rate. In short, all these types of M2 are money that you can withdraw and spend, but which require a greater effort to do so than the items in M1

____ is less liquid in nature and includes M1 monies plus savings and time deposits, certificates of deposits, and money market funds

M2 money supply

____ is really anything that people use to pay for goods and services and to pay people for their work

Money

Alabama, Arkansas, Florida, Georgia, Louisiana, Mississippi, South Carolina, Tennessee, Texas, and Virginia each printed and circulated currency that had value only within the state. It was not until 1863 when President Lincoln signed the ____ that the federal dollar was established as the sole currency in the United States

National Banking Act

Anyone who has used eBay (the world-wide online market place) will know about ____. It's a system that allows individuals selling goods to receive payments from the buyer's credit card, a facility normally reserved for established businesses

PayPal

Nagy and Koltay are not the only ones aiming at the micro payments niche. In spite of the rocky beginning of digital cash in the 1990s, several alternative micro payment systems have sprung up, including...

Peppercoin, PayCash and Open Money

A human microchip implant is an integrated circuit device or ____ transponder encased in silicate glass and implanted in the body of a human being. A sub-dermal implant typically contains a unique ID number that can be linked to information contained in an external database, such as personal identification, medical history, medications, allergies, and contact information

Radio Frequency Identification (RFID)

What about other kinds of currency? Cash in your wallet certainly serves as money, but how about checks or credit cards? Are they money, too?

Rather than trying to determine a single way of measuring money, economists offer broader definitions of money based on liquidity

What is the disadvantage of Electronic Funds Transfer (EFT)?

The major shortfall of EFT is that all transactions must pass through the banking system, which is legally required to record every transaction. This lack of privacy can have serious consequences whereas cash gives anonymity

As commodity money, gold has historically served its purpose as a medium of exchange, a store of value, and as a unit of account (T/F)

True

The late bank robber named ____ was once asked why he robbed banks. He answered: "That's where the money is." While this may have been true at one time, from the perspective of modern economists, Sutton is both right and wrong. He is wrong because the overwhelming majority of money in the economy is not in the form of currency sitting in vaults or drawers at banks, waiting for a robber to appear. Most money is in the form of bank accounts, which exist only as electronic records on computers. From a broader perspective, however, the bank robber was more right than he may have known. Banking is intimately interconnected with money and, consequently, with the broader economy

Willie Sutton

United States' paper money—like the dollar bill, for instance—carries this statement: "This note is legal tender for all debts, public and private." In other words, by government decree, if you owe...

a debt, then legally speaking, you can pay that debt with the U.S. currency, even though it's not backed by a commodity

To use ePoints, a person requests an ePoint "note" - in reality an encrypted code that represents some amount of ePoints - from an ePoints issuer. The issuer is the person or body that administers the system and ensures that ePoints aren't duplicated. The issuer cryptographically signs each ePoint note in exchange for some money of equivalent value in...

another currency, say pounds or dollars, or for some work done, or as payment for some other service. When someone spends ePoints, the person receiving them in payment contacts the issuer to verify they are not counterfeit. The cryptographic algorithms ensure the issuer cannot tell where the ePoint originated, nor the chain of hands it has passed through; only that he has been asked to confirm an ePoint is authentic

One key message here is that counting and tracking the money in a modern economy doesn't just involve paper bills and coins; instead, money is closely linked to ____. Indeed, the macroeconomic policies concerning money are largely conducted through the banking system

bank accounts

For example, cash is very liquid. Your $10 bill can easily be used to buy a hamburger at lunchtime. However, $10 that you have in your savings account is not so easy to use. You must go to the...

bank or ATM machine and withdraw that cash to buy your lunch. Thus, $10 in your savings account is less liquid

Regardless of the form it takes, money needs to...

be widely accepted by both buyers and sellers in order to be useful

In short, all these types of M2 are money that you...

can withdraw and spend, but which require a greater effort to do so than the items in M1

The organization responsible for conducting monetary policy and ensuring that a nation's financial system operates smoothly is called the ____

central bank

Another portion of M2 are the relatively small (that is, less than about $100,000) ____ or ____, which are accounts that the depositor has committed to leaving in the bank for a certain period of time, ranging from a few months to a few years, in exchange for a higher interest rate

certificates of deposit (CDs), time deposits

One member of the board of governors (Federal Reserve) is designated as the ____

chair

M1 money supply includes ____—the coins and bills that circulate in an economy that are not held by the U.S. Treasury, at the Federal Reserve Bank, or in bank vaults

coins and currency in circulation

The ____ in each district elect a board of directors for each regional Federal Reserve bank, and that board chooses a president for each regional Federal Reserve district. Thus, the Federal Reserve System includes both federally and private-sector appointed leaders

commercial banks

Closely related to currency are checkable deposits, also known as ____. These are the amounts held in checking accounts. They are called demand deposits or checkable deposits because the banking institution must give the deposit holder his money "on demand" when a check is written or a debit card is used. These items together—currency, and checking accounts in bank

demand deposits

The lines separating M1 and M2 can become a little blurry. Sometimes elements of M1 are not treated alike; for example, some businesses will not accept personal checks for large amounts but will accept traveler's checks or cash. Changes in banking practices and technology have made the savings accounts in M2 more similar to the checking accounts in M1. For example, some savings accounts will allow...

depositors to write checks, use automatic teller machines, and pay bills over the Internet, which has made it easier to access savings accounts. As with many other economic terms and statistics, the important point is to know the strengths and limitations of the various definitions of money, not to believe that such definitions are as clear-cut to economists as, say, the definition of nitrogen is to chemists

Finally, the Fed is responsible for assuring that banks are in compliance with a wide variety of consumer protection laws. For example, banks are forbidden from discriminating on the basis of age, race, sex, or marital status. Banks are also required to publicly...

disclose information about the loans they make for buying houses and how those loans are distributed geographically, as well as by sex and race of the loan applicants

Another problem with the barter system is that it...

doesn't allow people to easily enter into future contracts for the purchase of many goods and services. For example, if the goods are perishable, it may be difficult to exchange them for other goods in the future. Imagine a farmer wanting to buy a tractor in six months using a fresh crop of strawberries

In an economy without money, an exchange between two people would involve a ____, a situation in which two people each want some good or service that the other person can provide. For example, if a hairstylist wants a pair of shoes, she must find a shoemaker who has a pair of shoes in the correct size and who is willing to exchange the shoes for a certain number of hairdos. Such a trade is likely to be difficult to arrange

double coincidence of wants

The ____ system set up by Agnes Koltay and Daniel Nagy is different. It allows anonymous person-to-person transactions (just like cash exchange) over the web, and though the software itself costs money, Nagy says every subsequent transaction will be free

ePoints

Electronic funds transfer (EFT) is essentially electronic checking. Instead of writing a check and mailing it, the buyer initiates an electronic checking transaction (e.g., using a debit card at a point-of-sale terminal). The transaction is then...

electronically transmitted to an intermediary (usually the banking system), which transfers the funds from the buyer's account to the seller's account. A banking system has one or more common clearinghouses that facilitate the flow of funds between accounts in different banks

The name, open market operations, is a bit of a misnomer since the ____ is the interest rate charged by commercial banks making overnight loans to other banks. As such, it is a very short-term interest rate, but one that reflects credit conditions in financial markets very well

federal funds rate

As economies grew and became more global in nature, the use of commodity monies became more cumbersome. Countries moved toward the use of ____, which is legal tender whose value is backed by the government that issued it

fiat money

Banks are a ____—that is, an institution that operates between a saver who deposits money in a bank and a borrower who receives a loan from that bank. All the funds deposited are mingled in one big pool, which is then loaned out

financial intermediary

The Federal Reserve provides many of the same services to banks as banks provide to their customers. For example, all commercial banks have an account at the Fed where they deposit reserves, and they can obtain loans from the Fed through the "discount window." The Fed is also responsible for check processing. When you write a check to buy groceries, for example, the grocery store deposits the check in its bank account. Then, the physical check (or an image of that actual check) is returned to your bank, after which...

funds are transferred from your bank account to the account of the grocery store. The Fed is responsible for how these transactions are handled once the check leaves the cash register and is deposited into the store's bank account. Does that mean that your check to the grocery store goes all the way to Washington, D.C.? No. Instead the regulations that govern how banks handle checks, deposits, withdrawals are regulated by The Federal Reserve Act. This act is the reason that a bank must start paying you interest on a savings deposit the day it is received. It's also the reason that if you deposit a large check, your bank may tell you that the funds will not be available for three to five business days

Money, loans, and banks are all tied together. Money is deposited in bank accounts, which is then loaned to businesses, individuals, and other banks. When the interlocking system of money, loans, and banks works well, economic transactions in...

goods and labor markets happen smoothly, and savers are connected with borrowers. If the money and banking system does not operate smoothly, the economy can either fall into recession or suffer prolonged inflation

While the barter system might work alright in small economies, it will keep those economies from ____. The time that individuals might otherwise spend producing goods and services and enjoying leisure time is spent bartering

growing

At the national level, the Federal Reserve, it is run by a board of governors, consisting of seven members appointed by the president of the United States and confirmed by the Senate. Appointments are for fourteen-year terms and they are arranged so that one term expires January 31 of every even-numbered year. The purpose of the long and staggered terms is to...

insulate the board of governors as much as possible from political pressure so that policy decisions can be made based only on their economic merits. In addition, except when filling an unfinished term, each member only serves one term, further insulating decision-making from politics

An ____ is one who stands between two other parties

intermediary

Monetary policy involves...

managing interest rates and credit conditions, which influence the level of economic activity

Money serves as a ____, which means that money acts as an intermediary between the buyer and the seller. Instead of exchanging hairdos for shoes, the hairstylist now exchanges hairdos for money. This money is then used to buy shoes

medium of exchange

Possibly the most frightening aspect of the movement toward a cashless society is the emergence of technology that would allow a ____ to be placed in the human hand that would identify every human being on the planet and allow them to buy and sell without coins, paper or a card

microchip

The most important function of the Federal Reserve is to conduct the nation's ____. Article I, Section 8 of the U.S. Constitution gives Congress the power "to coin money" and "to regulate the value thereof." As part of the 1913 legislation that created the Federal Reserve, Congress delegated these powers to the Fed

monetary policy

Many banks and other financial institutions also offer a chance to invest in ____, where the deposits of many individual investors are pooled together and invested in a safe way, such as in short-term government bonds. This is also considered M2

money market funds

In short, credit cards, debit cards, and smart cards are different ways to move money when a purchase is made. But having more credit cards or debit cards does...

not change the quantity of money in the economy, any more than having more checks printed increases the amount of money in your checking account

The most commonly used tool of monetary policy in the U.S. is ____, which take place when the central bank sells or buys U.S. Treasury bonds in order to influence the quantity of bank reserves and the level of interest rates. The specific interest rate targeted in open market operations is the federal funds rate

open market operations

You know that you don't need to spend money immediately, because it will still hold its value the next day or the next year. This function of money doesn't require that money is a ____ store of value. In an economy with inflation, money loses some buying power each year, but it remains money

perfect

Peppercoin, PayCash, Open Money, and Epoints are all ____

personal e-currencies

The phonecard, the most common form of ____, was first issued in 1976 by the forerunner of Telecom Italia. The problem with special-purpose cards, such as phone and photocopy cards, is that people end up with a purse or wallet full of cards

prepaid card

In making decisions about the money supply—that is, the total amount of monetary assets available in an economy at a specific time—a central bank decides whether to raise or lower interest rates and, in this way, to influence macroeconomic policy, whose goal is low unemployment and low inflation. The central bank is also responsible for...

regulating all or part of the nation's banking system to protect bank depositors and insure the health of the bank's finances

Policy decisions of the Fed (Federal Reserve) do not...

require congressional approval, and the president cannot ask for the resignation of a Federal Reserve governor as the president can with cabinet positions

Historically, money has taken different forms in different cultures—everything from...

salt, stones, and beads to gold, silver, and copper coins and, more recently, virtual currency has been used

M2 includes ____ in banks, which are bank accounts on which you cannot write a check directly, but from which you can easily withdraw the money at an automatic teller machine or bank

savings deposits

Unlike most central banks, the Federal Reserve is...

semi-decentralized, mixing government appointees with representation from private-sector banks

A ____ combines many functions into one card: it can serve as personal identification, credit card, ATM card, telephone credit card, critical medical information record and as cash for small transactions

smart card

Another function of money is that money must serve as a ____. This means that if money is usable today to make purchases, it must also be acceptable to make purchases today that will be paid in the future

standard of deferred payment

Banks make it far easier for a complex economy to carry out the extraordinary range of transactions that occur in goods, labor, and financial capital markets. Imagine for a moment what the economy would be like if all payments had to be made in cash. When shopping for a large purchase or going on vacation, you might need to carry hundreds of dollars in a pocket or purse. Even small businesses would need...

stockpiles of cash to pay workers and to purchase supplies. A bank allows people and businesses to store this money in either a checking account or savings account, for example, and then withdraw this money as needed through the use of a direct withdrawal, writing a check, or using a debit card

Money must serve as a ____. Consider the barter between the hairstylist and shoemaker again. The shoemaker risks having his shoes go out of style, especially if he keeps them in a warehouse for future use—their value will decrease with each season. Shoes are not a good store of value. Holding money is a much easier way of storing value

store of value

Gold is a good conductor of electricity and is used in the electronics and aerospace industry. Gold is also used in...

the manufacturing of energy efficient reflective glass for skyscrapers and is used in the medical industry as well. Of course, gold also has value because of its beauty and malleability in the creation of jewelry

The Fed chair (federal reserve) is first among equals on the board of governors. While he or she has only one vote, the chair controls the agenda, and is...

the public voice of the Fed, so he or she has more power and influence than one might expect

The government of every country has public policies that support the system of money, loans, and banking. But...

these policies do not always work perfectly

Money serves as a ____, which means that it's the ruler by which other values are measured. For example, a hairstylist may charge $30 to style someone's hair. That $30 can buy two shirts (but probably not a pair of shoes). Money acts as a common denominator, an accounting method that simplifies thinking about trade-offs

unit of account

To serve as a medium of exchange, money must be...

very widely accepted as a method of payment in the markets for goods, labor, and financial capital

But anonymity alone is not going to make people use it. If ePoints is going to catch on, it will have to find a niche that makes it attractive to a large pool of users. That is where ePoints' cheap and borderless nature comes in. ePoints can be seen as an international electronic currency and this, Nagy and Koltay believe, along with security and anonymity, will provide the niche it needs. ePoints may also be attractive to companies that...

want an electronic method for handling payments of a few pennies. Credit card companies charge a minimum fee for each transaction they process, and for transactions of less than a few dollars this can represent a large slice of the total. In return, credit card companies provide a high level of security. But as Nagy points out, this is overkill when only small sums are changing hands. A penny transaction should not need a lot of security, Nagy says. A thief will gladly invest five pennies of effort to steal a credit card, but no smart thief will spend five pennies to steal a one-penny ePoint

Loans and future agreements are stated in monetary terms and the standard of deferred payment is...

what allows us to buy goods and services today and pay in the future

The only backing of our money is...

widespread faith and trust that the currency has value—and nothing more

Banks are a critical intermediary in what is called the payment system, which helps an economy exchange goods and services for money or other financial assets. Also, people with extra money that they'd like to save can store their money in a bank rather than look for an individual who is...

willing to borrow it from them and then repay them at a later date. Those who want to borrow money can go directly to a bank rather than trying to find someone to lend them cash. Thus, banks act as financial intermediaries—they bring savers and borrowers together