Money Its origin: –Barter didn’t work, so money became a store of value. We all agree on the...

Money• Its origin:

– Barter didn’t work, so money became a store of value.

• We all agree on the rules of the game (like monopoly), so we ‘buy in’ to the idea that a seemingly worthless piece of paper will have a certain value.

– The first type of money was specie money. It had actual value as a precious metal – probably gold.

– Then, government put their stamp on the money, being able to control how much of it was out there. This type of money is called fiat money

Inconvertible fiat money

• The U.S. dollar is inconvertible (can’t convert your money to a precious metal at a fed. reserve bank).

• So why does our currency have value?

What are some characteristics of an efficient money?

• It should be– Divisible– Portable– Durable

• How does our currency measure up?

How do banks make money?

• They use depositors’ money to loan to others (plus interest, of course)– Car loans, house, business, credit cards…

What if all of their money is loaned out?

• They borrow money from the Federal Reserve Bank – the ‘Central Bank’ of the United States.

The Federal Reserve must constantly choose between two evils:

• Inflation and Recession– By adding to the money supply, it attempts to

incentivize spending / borrowing • (expansion)

– By holding back the money supply, it attempts to de-incentivize spending / borrowing

• (contraction)

~How does it do this? Let’s see:

Interest Rates

• Discount Rate = the percentage rate the FED offers its member banks (currently 0.75%)– By lowering the %, the FED encourages

borrowing (loose money policy)• This sometimes leads to inflation

– By raising the %, the FED discourages borrowing (tight money policy)

• This stagnates spending/borrowing and can cause recession

• Prime Rate = the percentage rate banks offer their best customers (currently 3.25%)– Banks offer “Prime +” to most of their customers

• Mortgage loans = 5.5 – 7.5%• Car loans = 6 – 9%• Credit Cards = 12 – 29%

– If there is collateral involved, the % will be lower– Also involves your credit rating / FICO score,

earnings, and ‘character’.» Let’s look at your worksheet to see how you

measure up

Interest Rates (cont.)

Will the bank lend $ to me?• Do you have a job?

– If you can prove that you have consistent income which would allow you to make payments on a loan, then generally, yes…they will loan you money. But it’s a big risk for them, so it all depends on how much you need and for what!

• If you need the money for something that retains value (durable good), then they are more apt to say yes b/c they can take it from you and sell it if you stop paying.

• If you need it for a $200 pair of jeans, a weekend trip to Cabo, and a plane ticket, then…not so much.

Will the bank lend $ to me?

• Do you have collateral?– If you have “assets” (cash in the bank, stocks,

a car, house, a gold bar buried in the yard), then the bank is more confident that you’ll be able to pay back the loan, even if you lose your job.

• (or you could go and pawn your collateral goods on ‘Pawn Stars’)

Will the bank lend $ to me?

• Do you have a good credit history?– Your FICO score is like

your reputation…once it is tarnished, it’s hard to repair.

– If you make payments on-time, don’t “max out” your credit card, don’t open too many credit cards, your credit score will go up.

• Excellent Credit (750+)• Good Credit (700-749)• Fair Credit (650-699)• Poor Credit (600-649)

• Bad Credit (Below 599)• No Credit/Limited Credit

Other ways the Fed. tries to manipulate the financial system:

Reserve Requirement:• Banks use your money to make money, but…• Banks must keep a certain percentage of their

depositors’ money “in the vault”. (currently 10%)– By limiting the amount of money banks can use to

invest (raising the reserve req.) , the FED basically restricts the money supply, causing the econ. to slow.

– By lowering the reserve requirement, the FED is allowing the money supply to increase, causing the economy to expand.

Open Market Operations

• The Fed. Sells Treasury Bonds (and other federal securities) = pulling money out of circulation (fights inflation)

• The Fed. Buys Treasury Bonds = putting money into circulation (spurs inflation)

Moral Suasion

• Press releases, announcements, testimony by Fed. Chairperson that may influence banking policies.– Ex: Fed. Announces that inflation is on the

rise and it may raise interest rates. This would cause banks to restrict loans or be more cautious.

What else does the FED do?

• Enforce consumer legislation

• Clear checks

• Maintain currency and coins

Monetary Policy Review:

How does the Gov/Treasury Dept. and the Federal Reserve

incentivize and/or inhibit inflation?

In other words, how do they react to indicators in order to stabilize the

financial system?

~See Worksheet~