Money & Banking Terms

money-banking Terms

Bank Run

Term applied to the panic that occurs when depositors lose confidence in their bank and withdraw their money en masse, often forcing the bank to close or suspend payments.

Certificates of Deposit

A type of investment instrument issued primarily by banks. Investors lend money to the financial institution at a set interest rate for a fixed period of time.

Checking Account

A type of demand deposit from which the funds can be withdrawn at any time by writing a check.

Clearinghouse Corporation

A financial corporation that facilitates the completion of money transfers for other banks and exchanges. A type of intermediary bank that, like Federal Reserve Banks, serves as a clearinghouse for checks.

Commodity Money

A type of money that has a value or use aside from its use as money. During the late eighteenth century, farmers in the Pennsylvania backcountry used whiskey for money. They bought and sold items by the jug. In ancient Rome soldiers were paid in salt.

Correspondent Banks

Commercial banks that provide services for other banks. A type of intermediary bank that, like Federal Reserve Banks, serves as a clearinghouse for checks.

Demand Deposits

A type of bank account from which the funds can be removed at any time, usually by writing a check.

Deposit Expansion Multiplier

This is formula that allows us to calculate the change in the money supply resulting from a total amount of money that banks can create from its deposits. By multiplying the amount of a deposit by the inverse of the reserve requirement, the result will be the total amount of money that the deposit will create. If a person deposited $100 and the reserve requirement was 10%, the formula would be $100 x 1/.10=$1000. If the reserve requirement was 15%, the equation would look like this: $100 x 1/.15= $666.67. ???

Federal Funds Rate

The interest rate charged by commercial banks when they issue short-term loans to another commercial bank, usually in order to meet its reserve requirement.

Federal Reserve System

America’s government controlled but privately owned central bank. Established by Congress in 1913 to ensure that the public retained confidence in its money and the financial institutions where it is held

The Federal Reserve System, also known as “the Fed,” is a network of twelve Federal Reserve Banks located in major cities across the country. Its seven-member board of governors is appointed by the president of the United States, but as the Fed is suppose to remain an independent economic institution, each member serves a fourteen-year term and is not eligible for re-appointment. 

The Federal Reserve System operates as the Federal government’s bank; it receives Treasury deposits and extends short-term loans to the government if necessary. It also serves as a clearinghouse for checks written against deposits in commercial banks, it sets reserve requirements to prevent commercial banks from over-lending depositors’ funds, and it serves as the “bankers bank,” extending short-term loans to local banks when they do not have enough cash on hand to handle daily transactions or meet their reserve requirement.

Fiat Money

A type of money that is backed only by the word of the government. Unlike representative money, fiat money is not backed by gold or any other substance of real value. And unlike commodity money, it has no real use or value other than its value as form of currency.

Fractional Reserve Banking

A banking system, like the American banking system, in which banks are required by law to keep a percentage of their deposits in reserve but are free to lend out the rest.

Gold Standard

A type of representative money in which currency is backed by a fixed quantity of gold. In 1879, the United States joined many other nations on an international gold standard. The price of gold was set at $20.67 per ounce and the federal government pledged to exchange dollars for gold at that rate. During the Great Depression, with Americans hoarding gold and commodity prices falling, President Franklin Roosevelt urged Congress to take the United States off of the gold standard. The value of the dollar was still linked to a certain amount of gold (now pegged at $35 per ounce), but private ownership of large quantities of gold was prohibited, and the government no longer exchanged dollars for gold. After World War II, the United States government pledged to redeem American dollars held by foreign central banks in gold (still at the rate of $35 per ounce) in order to unite and stabilize the world economy. But in 1971, with America’s trade deficit growing and gold reserves rapidly depleting, President Richard Nixon suspended the redemption of American dollars for gold, fully severing the United States from the gold standard.

Liquidity

Refers to easily a financial instrument or investment can be converted into cash. Currency has the highest liquidity. Real estate has much lower liquidity. That old Ricky Martin CD you have been hanging onto has virtually no liquidity.

M1

A measurement of the money supply that includes only fiat money (paper currency and coins) and demand deposits like checking accounts. M1 represents the portion of the money supply with the highest liquidity—that is, it is most easily spent. But it represents only about 18% of the larger money supply or M2. In 2008, M1 totaled $1.4 trillion; M2 totaled $7.7 trillion. (Source)

M2

a measurement of the money supply that includes M1 (fiat money and demand deposits like checking accounts) as well as near money. M1 represents the portion of the money supply with the highest liquidity—that is, it is most easily spent. But it represents only about 18% of the larger money supply or M2. In 2008, M1 totaled $1.4 trillion; M2 totaled $7.7 trillion. (Source) Breaking M2 down further, in 2008, the amount of currency in circulation equaled about $800 billion, checks totaled about $600 billion, savings accounts represented about $3.6 trillion, CDs added another trillion dollars to M2, and money market funds added about $1.7 trillion.

Medium Of Exchange

One of the functions of money. Money is a medium of exchange is the sense that we all agree to accept it in making transactions. Stores agree to accept money in exchange for their goods; employees agree to accept money in exchange for their labor.

Money Market Mutual Funds

A type of investment in which investors pool their money with others in a fund that is professionally managed and invested. The monies are usually invested in relatively conservative instruments such as government bonds and certificates of deposit.

Near Money

The largest part of the American money supply. Near Money includes savings accounts, certificates of deposits (CDs), and money market mutual funds. You cannot actually spend Near Money, but it is easily converted to cash or transferred to a checking account.

Representative money

A type of money that can be redeemed for something of real value. In the past, most representative money was backed by gold and silver. Countries pegged the value of their currency to a certain amount of the precious metal and promised to exchange their currency for the metal on demand.

Reserve Requirements

The portion of its deposits that a bank must keep in its vaults or place in the Federal Reserve Bank. Set by the Federal Reserve Board, these requirements ensure that banks do not lend out all of their depositors’ money and retain enough cash to handle day to day transactions. If a bank does meet its reserve requirement at the close of each day, it must borrow funds from another bank or the Federal Reserve Bank. Minimum reserve requirements are one of the tools of Monetary Policy.

Savings Account

An interest earning account at a bank from which the funds usually can be withdrawn on demand.

Store Of Value

One of the functions of money. Money serves as a store of value in that it allows us to store the rewards of our labor or business in a convenient tool. In other words, money lets us store the value of a long, hard week of work in a tidy little stack of cash. Without money, how would we set aside the compensation we receive for later use? We could be paid in cows, but that would not be a very convenient way to set aside our unspent compensation. We could be paid in pizzas, but the value of our labor would not be stored in the rotting little pies for very long.

Unit of Accounting

One of the functions of money. As a unit of accounting money provides a simple device for identifying and communicating value. Without this convenient, readily understood unit of accounting, setting and communicating value would be difficult. How much is that bicycle? Well, less than a piano but more than wheelbarrow—more precisely, about one third of a piano plus two backpacks and a small pizza.