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Money and Banking

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Banks as financial intermediaries

  • Bring borrowers and lenders together

Bank profits & interest rates

  • Banks lend at higher interest rates than they pay for money deposited
  • The more a bank lends, the more profit it can make

Bank reserves

  • Banks keep a portion of deposited funds on hand to meet day to day needs

Fractional reserve banking & consumer confidence

  • The banking system depends on consumers believing they can get their money when they ask

Bank runs

  • If everyone wants their money at once, they won't be able to get it
  • Bank runs occurred frequently during the great depression

Beginnings of Central Banking

  • Need for Government Involvement in banking--a sound economy requires a sound banking system
  • 1st Bank of U.S. (1791)
  • 20 year charter
    • Responsibilities--print money and lend to government
    • Controversy over whether bank was constitutional
      • McCulloch vs. Maryland (1819)
        • Supreme Court decision supported bank
        • Said "Constitutional end justifies any means"
  • 2nd Bank of U.S. (1816-1836)

Federal Reserve System

  • Organization
    • 12 geographic districts
    • Led by a 7 member Board of Governors
      • Chair: Alan Greenspan--may be 2nd most influential person in the U.S.

Independence of FED

  • Funding from banks, not from Congress
  • 14 year terms for Board of Governors, removal difficult


  • Provide currency to banks
  • Act as a clearing house for checks
  • Specify reserve requirements--minimum % that banks cannot loan out
  • Supervise banks--assure that good practices are followed
  • Make loans to banks--to meet short term needs
  • Regulate money supply--increase or decrease the amount of money in the economy as a means of keeping the economy healthy

The Fed and Interest Rates

The interest rate is the price of money

Supply and demand interact to determine the market interest rate (when D = S)

If the FED decreases the supply of money, there will be excess demand for money (D>S)

Excess demand increases prices. Since the interest rate is a price, interest rates will go up.

Interest Rates and the Economy

  • Money earned by savers
    • Bonds
  • Money market accounts
  • Certificates of deposit
  • Business investment
    • New facilities
  • Modernization of existing facilities
  • "Large Ticket" consumer purchases
    • Homes
  • Automobiles
Copyright 2008, by the Contributing Authors. Cite/attribute Resource . factadmin. (2007, October 25). Money and Banking. Retrieved January 08, 2011, from Free Online Course Materials — USU OpenCourseWare Web site: This work is licensed under a Creative Commons License Creative Commons License