Economics: money, banking, and the Federal Reserve (grade 12) · lesson

What money does

💡 Money solves barter's matching problem by serving as a medium of exchange, a unit of account, and a store of value.

Before money, people bartered goods directly. Barter needs a double coincidence of wants: each side must want exactly what the other has. If you have fish and want shoes, the shoemaker has to want fish.

Money does three jobs. As a medium of exchange, it is used to buy and sell. As a unit of account, it gives a common measure of value, like a café listing all its prices in dollars. As a store of value, it lets you save now and spend later.

🧠 Let's work it out

Ask what the money is doing in the example.
Being spent? Medium of exchange.
Being used to compare or measure prices? Unit of account.
Being kept for later? Store of value.

What do you think comes next?

barter: trading goods directly without money
medium of exchange: something used to buy and sell
unit of account: a common measure of value
store of value: something that holds value over time

🔗 Khan Academy: The monetary system · Khan Academy (free) ↗

How banks create money

💡 Banks keep a small reserve and lend the rest, which creates new deposits, and deposit insurance keeps panics from emptying them.

Banks keep only part of their deposits as reserves and lend out the rest. If a bank must keep 10% and someone deposits $500, it keeps $50 and can lend $450.

The borrower spends the loan, and the money ends up deposited in another bank, which lends part of it again. Each round adds new deposits, so lending increases the money supply.

Because banks lend most deposits, they can't pay everyone at once. In the early 1930s, panicked depositors caused bank runs. The FDIC, created in 1933, insures deposits up to a limit. Insured depositors don't need to rush to pull out cash, so runs are much rarer.

🧠 Let's work it out

Follow one dollar.
It is deposited, most of it is lent, the borrower spends it, and it lands in another deposit.
Count how many accounts now show money.

What do you think comes next?

reserves: the share of deposits a bank keeps instead of lending
FDIC: the federal agency that insures bank deposits

The Federal Reserve and policy

💡 The Fed manages interest rates and the money supply, while Congress and the president handle taxes and spending.

The Federal Reserve is the US central bank. Congress gave it two goals: maximum employment and stable prices. It sets a target for short-term interest rates and buys or sells government bonds, called open market operations. This is monetary policy.

When inflation runs high, the Fed usually raises its target rate. Borrowing costs more, so people and businesses spend less, and price increases cool. To boost a weak economy, it lowers rates.

Fiscal policy is different. It is taxing and spending by Congress and the president, such as cutting income taxes or spending more on highways. The Fed doesn't set taxes or write the budget.

🧠 Let's work it out

Ask who is acting.
The Fed acting on rates or bonds is monetary policy.
Congress and the president acting on taxes or spending is fiscal policy.
Then ask the direction: to cool prices, make borrowing more expensive.

What do you think comes next?

monetary policy: the Fed's use of interest rates and the money supply
fiscal policy: government taxing and spending
interest rate: the price of borrowing money

Inflation and real value

💡 Inflation shrinks what money buys, so compare any raise or interest rate with inflation to find the real change.

Inflation is a general rise in prices. Purchasing power is how much your money can buy. If prices rise 5% and your pay rises 2%, your pay buys about 3% less.

The real return on savings is about the interest rate minus inflation. An account paying 3% when inflation is 4% has a real return of about −1%. You have more dollars, but they buy less.

🧠 Let's work it out

Always subtract inflation, never add it.
Raise minus inflation tells you whether your pay really grew.
Interest minus inflation tells you whether your savings really grew.

What do you think comes next?

inflation: a general rise in prices
purchasing power: how much money can buy
real return: the gain on savings after inflation