CHAPTER 1
Introduction to Money and Banking
TEACHING OBJECTIVES
Goals of Chapter 1
A. Provide an introduction to the textbook.
B. Discuss two main themes in the book.
C. Describe the value of money and banking for everyday life.
D. Discuss why government policy is so crucial for money and banking.
E. Examine ten surprising facts about money and banking that will be
discussed in greater detail in the book.
TEACHING NOTES
A. Introduction
1. Money #ows around the world and is affected by government policy
2. People encounter money and the &nancial system frequently
3. If economic policy is poor, the economy does not work well
4. The Federal Reserve is a key policy institution; its decisions have
worldwide implications
B. What Is in This Text?
1. The Value of Money and Banking for Everyday Life
a) The amount you must repay on a car loan is a$ected by decisions
of the Federal Reserve
b) The interest rate on mortgage loans depends on many factors,
including the Federal Reserve’s decision
c) The returns from investing in the stock market depend on the
Chapter 1: Introduction to Money and Banking
(1)The Federal Reserve determines the money supply, sets rules
for check clearing, distributes currency, and supervises and
regulates banks
(2)A major decision by the Fed is to change the target for the
federal funds rate
Ten (Surprising) Facts Concerning Money and Banking
1. Most &nancial formulas—no matter how complicated they look—are
based on the compounding of interest
a) Complicated formulas related to &nancial transactions are based
on the simple idea of compounding
2. More U.S. currency is held in foreign countries than in the United
States
a) More U.S. dollars circulate outside the United States than within
b) Foreigners use U.S. dollars to avoid problems caused by inflation in
their own countries
c) U.S. taxes are lower because foreigners use U.S dollars, as the U.S.
government pro&ts from the sale of currency to foreigners
3. Interest rates on long-term loans generally are higher than interest
rates on short-term loans
a) There are many different interest rates
4. To understand how interest rates a$ect economic decisions, you must
account for expected inflation
a) People do not care about how many dollars they earn from lending;
they care about what they can buy
b) How much a lender can buy in the future depends on the expected
inflation rate
c) People form expectations of inflation in different ways, depending
on circumstances
Chapter 1: Introduction to Money and Banking
c) Stock investors should understand both, how the stock market
works within the &nancial system, and what a particular
investment will yield
6. Banks and other &nancial institutions made major errors that led to
the &nancial crisis of 2008
7. Recessions are diBcult to predict
a) A recession occurs when overall business activity declines
b) Recessions are diBcult to predict; indicators that seem to predict
recessions at one time lose their predictive ability at other times
c) But, analysis can reveal the economy’s susceptibility to a shock
that may lead to a recession
The Fed creates money by changing a number in its computer system
a) Money is created when the Federal Reserve buys government
securities, which it does by writing down a larger number in its
computer system
8. In the long run, the only economic variable the Federal Reserve can
a$ect is the rate of inflation—the Fed has no effect on economic
activity
a) The Fed can change economic activity, in the short run, by
changing the money supply and interest rates
b) In the long run, the Fed’s policy does not a$ect economic activity,
but only determines the inflation rate
9. You can predict how the Federal Reserve will change interest rates
using a simple equation
a) We can use our knowledge about the Fed’s actions, in the short run
and long run, to predict its behavior
b) The Fed’s decisions largely depend on the level of output relative
to potential and the inflation rate relative to its desired level
.