sg26 - Chapter 10 MONEY, BANKS, AND THE FEDERAL RESERVE*...

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15110MONEY, BANKS,AND THE FEDERALRESERVE** This is Chapter 26 inEconomics.K e y C o n c e p t sWhat is Money?Moneyis anything generally acceptable as ameans ofpayment,that is, a method of settling a debt. Moneyhas three functions:Medium of exchange — money is accepted in ex-change for goods and services. Without money,barter(exchanging one good directly for another)would be necessary.Unit of account — prices are measured in units ofmoney.Store of value — money is exchangeable at a laterdate. A low inflation rate makes money as useful aspossible as a store of value.Currencyis the bills and coins we use. Money consistsof currency plus deposits at banks and other depositoryinstitutions. The two major measures of money in theUnited States are:M1— currency outside of banks plus travelerschecks plus checking deposits.M2— M1 plus saving and time deposits andmoney market mutual funds.Liquiditymeans that an asset can be instantly con-verted into a means of payment with little loss of value.The assets in M2 that are not directly a means of pay-ment are very liquid.The deposits at depository institutions are money, butthe checks transferring these deposits from one personto another are not money. Credit cards are not money;they are a way to get an instant loan.Depository InstitutionsAdepository institutionis a firm that takes depositsand then uses the deposits to make loans. Depositoryinstitutions includecommercial banks,thrift institu-tions(savings and loan associations, savings banks, andcredit unions) and money market mutual funds.A balance sheet shows that a bank’s liabilities plus itsnet worth equal its assets. Banks divide their assets intotwo broad components:Reserves— cash in the bank’s vault plus its depos-its at Federal Reserve banks.Loans — liquid assets, investment securities, andloans. These assets pay the bank a return.Depository institutions provide four economic services:Create liquidity — bank deposits are highly liquid,that is, easily convertible into money.Minimize cost of obtaining funds — borrowingfrom one bank is cheaper than borrowing from avariety of lenders.Minimize cost of monitoring borrowers — deposi-tory institutions specialize in monitoringborrowers.Pool risk — depository institutions reduce risk bymaking loans to many borrowers.Depository institutions face two types of regulation:Deposit insurance — deposits at most intermediar-ies are insured by a federal agency.Balance sheet rules — intermediaries often faceequity capital requirements, reserve requirements,deposit rules, and lending rules.In the 1980s and 1990s, depository institutions werelargely deregulated.

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Jakes
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Economics
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Economics
Arnold
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