Chapter 13 Money, Banking and the Creation of Money   1/16/17

I. Functions of Money  1 video
II. The Supply and Demand for Money
III. United States Private Banking System
IV. Organization of The Federal Reserve System

V. Functions and History of the FED  1 video
VI Fractional Reserve System
VII. The Monetary Multiplier
VIII. Recent Developments 1 video

IX. Additional Money Creation and History Reading
X. Twentieth Century Banking History by decade
XI. Visual Learning Stuff

XII. Quick Notes Economic Reviews for those pressed for time.

I. Functions of Money
   A. Medium of exchange: facilitate exchange eliminating barter which
        requires people with mutually needs.
   B. Standard of value: allows for the pricing of heterogeneous goods.
   C. Store of value: maintains value and provides liquidity so extra spending
        power is available as needed. Maintaining money's value requires
        1. A sound fiscal policy (a reasonable federal debt)
        2. A sound monetary policy (not using inflation to pay the federal debt)
        3. A brief history of U S dollar debasement?
   D. Standard of deferred payment: makes credit contracts possible so credit 
         transactions are possible.
   E. Trade necessitated the development of modern money replaces barter Video 7 min.
F. Unit 1 Review Functions of Monet are Medium of Exchange, Standard of Value,
    Store of Value

Image result for Creating Money Cartoons

II. The Supply and Demand for Money
      A. Three categories of the supply of money
     1. M1 = Currency, coins, and demand deposits (checking accounts). 
           2. M2 = M1 plus near monies such as small time deposits (savings 
               accounts) and short-term government securities. 
           3. M3 = M2 plus large time deposits (over $100,000)
      B. What backs the dollar?
           1. In 1971 President Nixon took the U.S. off a partial gold standard. See
The Gold Reserve Act 
           2. It is a debt of the federal government.
           3. Backed by faith in the government's ability to control inflation.
           4. Value is determined by acceptability (it is legal tender and scarce).
5. Commodity money, such as tobacco used as money in the Virginia colony, has intrinsic
               value of its own.
           6. It's fiat (by decree of the government) money.
               a. Fiat money's first appearance in the U.S. when Congress issued Continental currency
                   with no gold backing
Gresham's Law (bad money chases good) caused it to disappear after the war.
                    2.  State issued their own money.
                    3. Ben Franklin on Paper Money Economy
               b. Greenbacks (demand notes on the Treasury) that were green in color were issued as legal
                   tender during the Civil War.
               c. An intermittent return to
Gold Standard (only gold is money) followed although the U.S.
                   left gold for good in 1971as high inflation caused a run on gold that the U.S. Treasury
                   could not satisfy.             
           7. Today, coins are called token money because they have little intrinsic value.
           9. Types of money has more information

Continental Currency

Image result for Ben Franklin quotes on Paper money cartoon

1923 Germany Hyperinflation in the Weimar Republic  A 50,000,000 (50 million) mark banknote

     C. The Demand for Money 
          1. Transaction D, Dt, results because people hold money, often in
               a money market account, to use as a medium of exchange.
          2. Asset Demand, Da, results because people accumulate money,
              often held in an investment account, to buy assets.
          3. The demand for money Dm= D t + Da
          4. Interest rates are set in the money market. more interesting history.
          5. For more information visit
Demand for money

Unit II. Review Types of money are M1 cash, DD are only backed by faith, M2 are Near moneys like savings accounts and treasury bonds, B3 M2 plus time deposits > $100,000

D. History

1. Brief History of Money Or, how we learned to
stop worrying and embrace the abstraction          
2. 300 Years-of-financial-crises-1620-1920

3. Gold Timeline
4. The continental currency crisis of 1779 and today's
European debt crisis  4/11/14
5. Central bank crisis management during wall street's
first crash in 1792  5//14
The Slump that Shaped Modern Finance 4/14
7. Infographic History of U.S. Money
8. History of the Gold Standard
9. History of Money
A Brief History of U S Banking Problems and
11. The Essence of Money, a Medieval Tale (7:36)



Source The Economist   4/5/14

Editor's Note: How much of recent price stability  is the FED and How much is world-wide competition.?

III. United States Private Banking System
A. Two kinds of banks
          1. Commercial banks offer demand deposits (checking accounts)
          2. Savings and loan associations used to specialize in time deposits (saving
              accounts) and home mortgages. Now, because of deregulation during
              the early 1980's, they are similar to commercial banks. 
     B. Federal deregulation contributed to banking difficulties in the 1980's.

     C. Visit  brief history provided by the Federal Reserve Bank for
          a time line of the U.S. banking System. Be sure to point at each date
          to see what happens during that period.
Private Banking System has Commercial Banks have savings accounts and demand deposits, Savings Banks just savings accounts and The Federal Reserve System


IV. Organization of the FED

    A . Board of Governors oversee the Federal Reserve System
         1. Seven governors
         2. Governors are appointed by the President and confirmed by the Senate.
         3. The chair is appointed by the President for a four-year term.
             a) To foster independence, the term does not coincide with the
                  President's term. 
             b) Other board members are appointed to 14-year terms on a staggered
                  basis to insure an experienced board.
             c) Understand Political Economy using the FED and financial markets

                     1) The Man Who Knew: The Life and Times of Alan Greenspan 45
                     2) More Money Than God: Hedge Funds and the Making of a New Elite 58
                     3) Niall Ferguson on Financial Crises, Populist Backlashes and the Lessons of History 82
    B. Federal Open Market Committee
        1. Membership consists of the Board of Governors and 5 of the 12 Federal
            Reserve bank presidents with the N.Y. president always a member 
            because N.Y. City is the financial center for U.S. international trade.
        2. The Committee tries to affect interest rates by affecting the supply of
            money by buying and selling U.S. government bonds (See Chapter 15).
    C. Federal Advisory Council 12 prominent commercial bankers, one from
         each district, who advise the Board of Governors
    D. Twelve Federal Reserve Banks
         1. The United States is divided into 12 homogenous districts and each 
             has its own bank
         2. Bank for the federal government
         3. Bank for member banks
         4. Graphic is complements of the Board of Governors of the Federal
             Reserve System.
    E. Member commercial banks
    F. Nonmember commercial banks and thrifts are regulated by other
         government agencies.

Unit IV. Summary  FED is a somewhat private-sector entities established
by the authority of the United States Congress.

Federal Open Market Committee meeting at the Federal Reserve in Washington, DC

The Federal Reserve System 
Organization Chart

       Operations Chart






    V. Functions and History of the FED
        A.  Functions
             1. Regulate the money supply
             2. Check collection and clearing
             3. Fiscal agent for the government
             4. Supervise  and audit member banks 
             5. Hold reserves (deposits) for member banks
             6. Compile economic statistics such as the
Latest Beige Book
                 quarterly summary of each districts' recent economic activity.

             7. Readings
                 a. Full Employment Mandate of the Federal Reserve

         b. Federal Reserve System Purposes and Functions
                 c. Lender of last resort
              8 Sundry
                  a. Should FED manage Asset Price
                  b. Why Are Banks Regulated?      
                  c. Did The Dodd-Frank Act Make The Financial System Safer?
                  d. Blind Spots in Shadow Banking 3/24/17


Unit V. Review Functions include regulate money supply, check processing, federal fiscal agent, supervise and audit financial system, hold reserves, compile the Beige Book 1




Stay Current With
Global Economic Intersection Newsletter
Latest Beige Book
Economy Continues to Grow Modestly
Yellen Says the Economy is Growing Moderately

Profit isn't usually listed as a function of the FED but $325 from 20010 -13 isn't chicken feed. 1/11/14 Source

   B. History
          1. The Bank that Hamilton Built
          2. ANDREW JACKSON took on the eastern bankers, vetoed 
              the charter extension of the Second Bank of the United States
             because he felt it had excessive power over farmers.
          3. THEODORE ROOSEVELT took on the corporate monopoly
              Trusts that control railroad rates and routes and thus destroyed
              small towns and farms. 
              a. Panic of 1907
              b. T.R. vs. J.P
          4. Nixon Shock inflationary pressure and French President De Gaulle
              force the US to stops the convertibility of dollars to gold and
              a new mandate adds low unemployment to the job.
          5. Cooperation, conflict and the emergence of the FED
          6. Greenspan's Latest Bio
              a. The Man Who New Video
b. Book review from Brookings is a good summary
          7. Other Histories
              a. President at War With Hh=is FED Over 5 Decades
              a. A Century of U.S. Banking: Fall 2013 Ben Bernanke
              b. How the Federal-reserve-was-created-100-years-ago
              c. Philadelphia Reflections: Whither, Federal Reserve?
                  is a well done, concise history of banking in the United States.
  VI. Fractional Reserve System/Creation of Money
         A. Commercial banks are required to keep a reserve (cash) of about 12%
              of their demand deposits (checking accounts) at their bank or on deposit
              with the Federal Reserve (required reserves). The remainder, (Excess
may be loaned out even though they support deposits.
         B. Money is created by these loans as long as the demand deposits (DD) created
              by them stay within the banking system, that is, the money loaned is redeposit
              as a DD into a bank within the system. The banks owe the demand deposits
              created by the loans to each other. These inter-brain debts  are canceled with
              a bookkeeping entry. It should be pointed out that the demand deposits 
              created by such loans are spent, and goods transferred, just as if the 
              transaction involved  currency.
         C. Example: Bank A has $50,000 in demand deposits. A reserve requirement of 
             10% would yield required reserves of .10 x $50,000 = $5,000. If Bank A 
              had $7,000 in reserve, it could loan up to $2,000 in the form of demand 
              deposits. Suppose Bank B does exactly the same with both banks' customers
              depositing their DD in the other bank. Banks would owe cashed checks to 
              each other, would cancel interbank debts, and money  has been created.
         D. The system works in reverse with money destroyed if reserves leave the system.
         E. Required reserves, reserves not loaned, and loans of cash (reserves) represent
              a leakage which eventually stops money supply growth.
         F. Readings and Video
             1. The Truth is Out: Money is Just an IOU and the Banks are Rolling In It
             2. Money Creation in the Modern Economy
             3. Money Creation Video 13.03 minutes is well done
Unit VI. Review Banks allowed to hold less in reserves than demand deposits
creating money for borrowers.


Source and prediction of coming inflation A. Laffer, 6/11/14


VII. The Monetary Multiplier
       A. An infusion of reserves into the system by the Treasury as directed by the 
           Federal Reserve can be loaned a number of times by the commercial 
           banking system. For example, the Federal Reserve may buy a $100 
           Treasury bond from Ms. A who deposits the Federal Reserve check
           (reserves) into Bank A. 
       B. Bank A's new DD of $100 requires them to keep $10 (10%) in reserve
            leaving $90 excess to loan to Mr. B who deposits it in Bank B.
       C. Bank B needs to keep only $9 ($90 x .1) in reserve and may loan out $81. 
       D. This process continues and as long as the demand deposits being created
            by the loans stay within the commercial 
            banking system, interbank debts are canceled and money has been created
       E. Monetary multiplier (M) sets the upper limit of the expansion
           1. R = reserve requirement = 10% = .1
           2. M = 1/R = 1/.1 = 10
       F. In the above example the total amount of DD created beginning with Bank
           A's $90 in excess reserves would equal 
           Excess Reserves x M = $90 x 10 = $900. If the $100 infusion by the 
           Federal Reserve is included, the increase is 10 x 100 = $1,000.
Video 2.43 minute Practice Problems Video 3.02
      H. Visit
The Banking System and the Money Multiplier
from Jay Kaplan
            of the University of Colorado at Boulder for more information.

Unit VII. Review Monetary multiplayer measures the amount actual increase in loan created demand deposits in relation to the FED created excess reserve.



VIII. Recent Developments
A. 1990's Liberalization
Financial Institutions Reform, Recovery and Enforcement Act of 1989
                liberalized banking laws, caused a declined in their importance although 
                reforms resulting from the Great Recession of 2008 cold change this.
            2. Consolidation has caused their numbers to decline and their size to increase.
            3. Many bank/thrift services are now performed by insurance companies, 
                pension, and securities companies.
Rise of the Shadow-Banking System
            5. Long Term Capital Management collapsed in the late 1990s
B.  Politicizing the FED
            1. Some politicians think the Federal Reserve system is too independent.   
            2. Congress Is Politicizing the Fed
Jan 25, 2010
            3. Central bank independence versus inflation
                 This often cited
  [49] research published by Alesina and Summers (1993)[50]
                 is used to show why it is important for a nation's central bank (i.e.-monetary
                 authority) to have a high level of independence. This chart shows a clear
                 trend towards a lower inflation rate as the independence of the central bank
                 increases. The generally agreed upon reason independence leads to lower
                 inflation is that politicians have a tendency to create too much money if given
                 the opportunity to do it. The Federal Reserve System in the United States
                 is generally regarded as one of the more independent central banks.
             4. Presidential Elections of 1828 and 1832 were about the need for a  strong
                 central bank
             5. Former FED Chairman Ben Bernanke defined the FED economic roll as follows
                 a. Inflation targeting i.e. macro stabilization
                 b. Financial Oversight
                 c. Unlimited crisis intervention See
Lombard Street for historical creation
                     1. Macro prudential regulation used by FED to regulates and controls the
                         financial system (investment banks) as FED does  banking system
                     2. Lombard Street: A Description of the Money Market, Project Gutenberg
                     3. Text at Library of Economics and Liberty   
             6. Money, Banking and the Federal Reserve 43 min conservative video
Central Bank Independence: Growing Threats 1/2/17
 C. The Money Project has many informative visuals

Unit VIII. Review Fewer controls and anti-activities of late 20th century.





Helicopter Money

Image result for hELICOPTER mONEY

IX. Additional reading
      A. Money Creation
          1. Money creation

Recollections of Pine Gulch
reviews money.
          3. Banks Create Money
          4. The (2nd) Deleveraging: What Economists Need to Know of Money Creation

        B. Keynes' Liquidity Preference Trumps Debt Deflation in 1931 an/b>
      C. More History 
     1. A Brief History of U S Banking Problems 
Dirk-bezemer-the-post-bubble-economy is a four part video explaining
              credit evolution. 7/6/13
. A 9-page summer read  for historical context in understanding the history
               of monetary policy: the famous 
Wizard of Oz,
an economic allegory/satire
               on who will create US money: federal government as "money" or a central
as "debt." This issue was the foundation for the "Greenback Party,"
             "Populist Party," "free silver," and William Jennings Bryan's three
               presidential campaigns (and "Cross of Gold" speech): or a film version
               of this allegory
The Secret of Oz
 can be viewed online (winner of
               two 2010 international Best Documentary awards).
The Nixon Shock from Business Week 8/14/11 How Nixon stopped backing
               the dollar with gold and changed global finance,

  a 40-year-old decision that still echoes in Greece, Ireland, and the U.S.
           4. Buttonwood, Forty years on from 8/11 of Economist Magazine
        5. Mississippi-bubble of 1720 and the-European Debt Crisis

Other Macro Chapters

8) Measuring Total Economic Activity 

9) The Business Cycle

10) Macro Equilibrium 
11) Competing Macro Theories and Issues

2 Keynesian Economics: Expanded View
14) Fiscal Policy
15) Monetary Policy  
16) Stagflation & Rise of Supply-Side Economics
17) Budget Deficits
18) Economic Growth

X. Twentieth Century U.S. Political Economy is About Money
Source Concise U.S. Economic History

The 19th Century ended with Monarchs in control and liberal economic thought expanding.
1900-09 A sever recession brings the need government take-over of central banking.
1910-19 FED becomes the Lender of Last Resort, few labor gains and war.
1920-29 Recession then economy and Wall Street dominates with loans to war-torn to nations.
1930-39 Great Depression dominates, Keynes Wins, communism affects Western economies.
1940-49 U.S. dominates world after WWII and Marshal Plan hopes to defeated communism.
1950-59 U.S. vs. with communists, labor power, and segregationists don't slow economy.
1960-69 OPEC oil slows manufacturing and Vietnam enrages many.
1970-79 Nixon starts inflation, closes gold door, opens China, and lies.
1980-89 FED recession solve inflation, RR cuts taxes and regulation.
1990-99 Tax increase hurts Bush, free trade and capital markets expands.
2000-09 Two tax cuts, three wars and one health care acts expand government
2010-04 Government expands to end Great Recession and expand health care.

               Editor's Note:
One has to wonder why Warren Buffet Predicted the 2007-8 Financial Crisis
               in 2002 three
years before Greenspan's 2005 retirement.

Can We Afford Entitlements

Can We Afford Large Deficits

Last Chapter  Chapter 13 Class Discussion Questions   Chapter 13 Homework Questions   Next Chapter  Table of Contents Economics Internet Library

 XI. Visual Learning Stuff.



Some Central Banks Are Easing to Create Growth,

Some Are Not  






Source 2014/09/28/


Facts On The Early History Of The US Dollar