1. Collect materials needed:

A roll of 40 nickels
Activity 1, 5 copies, printed on white paper and cut apart
Activity 2, fill in date, make 5 copies on colored paper, and cut apart
Activity 3, 3 copies cut apart
Activity 4, one per student
Visual 1, one copy for each student
Visual 2, one copy for each student
Shoe box or other container to store deposits

2. Explain to the students that over the next few days they are going to learn more about the purposes and functions of the Federal Reserve System. Tell them that the Federal Reserve is our nation’s central bank.
Discuss the following:

  1. Why do people use banks?
(Banks provide financial services to individuals, businesses, and state and local governments. These services include checking accounts, savings accounts, certificates of deposit, loans, safe deposit boxes, ATMs, etc.)

b. Why do people keep their money in banks?

(It’s more secure in a bank than it is sitting in a box at home. If you keep money in a checking account at a bank, you can write checks and initiate electronic payments against the balances in the account. Banks also pay interest on many of the accounts they offer.)

c. How do banks make money?

(Banks make money by taking in deposits and making loans. They charge a higher interest rate on their loans than they pay on the deposits they take in. Banks also make money by charging fees for the services they provide to their customers.)

3. Tell students that you are going to open a classroom bank. This bank will be unique because it will accept only deposits and make loans in dollar bills. Tell students that you, the bank manager, will be paying 5 percent interest on all deposits. Have the students take out any dollar bills they have in their pocket. Choose or have the class elect a Recorder for the bank. Remind students that the classroom bank will accept only deposits of dollar bills—no other denomination of notes and no coins will be accepted.

4. Explain to the students that they will get all of their dollars back before the end of the class and that you will pay a nickel for each dollar deposited in the bank during the class period. Tell the students that when a bank offers 5 percent interest, it is usually referring to an annual rate of interest of 5 percent, but that you will assume this class period represents a full year. Anyone who deposits a dollar in the bank at the beginning of the class will withdraw the dollar at the end of the class period and get one nickel (5 percent) in interest paid by you, the bank manager.

5. Display Visual 1. Distribute a copy of Visual 1 to each student. Instruct the Recorder to record the names of the depositors and the amount they deposit in the bank on Visual 1 as each person gives you a deposit. Ask the students to follow along, recording the deposits on their copy of Visual 1.

6. Ask the students who wish to deposit dollar bills in the new bank to raise their hands.
Distribute one deposit slip from Activity 1 to the first 12 students who wish to deposit dollar bills in the new bank. If fewer than 12 students want to deposit dollar bills, that’s okay, but encourage at least a total of $10 in deposits. Limit the total number of dollar bills each student is allowed to deposit to no more than three dollar bills. Ask those students with deposit slips to complete them and line up in front of you in preparation to make their deposits.

7. Take the deposit from the first student. Paperclip the money to the deposit slip. Place the money and deposit slip in the shoe box or other container you are using to store deposits. Announce the name of the student and the amount she is depositing. Watch as the. Recorder enters the name of the depositor and the amount she deposited on Visual 1.
Instruct the students to also enter the name of the first depositor and the amount she has deposited on their copy of Visual 1. Complete and issue a deposit receipt from Activity 2 to the depositor. Once the deposit transaction is completed, ask the student to return to her seat. Continue accepting deposits and issuing deposit receipts until all students who wish to deposit dollar bills have made their transactions or 12 students have deposited their money, whichever comes first. Put the box containing the dollar bills away in a safe place.
8. Have the students add up the total deposits. Ask the Recorder to enter the total deposits on Visual 1.
9. Ask the students whether any of them would like to borrow money from the bank.
Distribute one loan application from Activity 3 to the first 12 students who wish to borrow dollar bills from the bank. Explain that each borrower may apply for one, two, or three dollars. Offer the loans at 0 percent interest. While fewer than 12 students may wish to borrow from the bank, encourage at least $10 total to be borrowed from the bank. After the students who wish to borrow money have completed their loan applications, ask them to line up in front of you.
10. Explain to the students that banks review the creditworthiness of borrowers before making loans, but that in this classroom example, you are going to assume that a credit check has been conducted and that all of the students who apply will be getting loans.
Explain that instead of giving cash to each approved borrower, you will open a bank account for each borrower and put the loaned money in the account. You will issue each borrower a receipt for money deposited in the new bank account.
11. Take the loan application from the first student. Approve the loan application of the first student. Announce the name of the student and the amount he is borrowing. Instruct the. Recorder to enter the name of the borrower and the amount he borrowed on Visual 1. Tell the students to also enter the name of the first borrower and the amount he has borrowed on their copy of Visual 1. Complete and issue a deposit receipt from Activity 2 in the amount of the loan to the borrower. Once the loan transaction is completed, ask the student to return to his seat. Continue accepting loan applications, making loans, and issuing deposit receipts until all students who wish to borrow dollar bills have made their transactions or 12 students have deposited their money or the value of the total loans equals the value of total deposits, whichever comes first.
12. Have the students add up the number of dollar bills loaned out by the bank. Ask the Recorder to enter the total loans on Visual 1.
13. Discuss the following:

  1. How many people have deposit receipts? (Answers will vary.)
b. What is the total value of those deposit receipts? (Amount will be the total of deposits and loans in the bank.)
c. Has the bank loaned out all of the money it accepted in deposits? (Answers will vary.)
d. Could all of the people who have deposit receipts withdraw the money in cash in their accounts? (No.)
e. What would happen if all of the people that have deposit receipts came to the bank on the same day to withdraw money in cash? (Not everyone would be able to get money out. The bank would have to make decisions about which depositors got their money out, or the bank would have to stop honoring withdrawal requests.)
14. Explain the following:
• The United States, and most of the world, has a fractional reserve banking system.
• Bank reserves are the amount of deposits not loaned out by banks. A bank’s reserves can be calculated by subtracting a bank’s total loans from its total deposits. Ask the students to calculate Classroom Bank’s current reserves. (Answers will vary.) Write this number on the board. If the total reserves are 0, ask the students why this would cause a problem. (If Classroom Bank’s reserves are 0, then if any of the depositors come in to make a withdrawal, there would be no cash on hand to honor the withdrawal request.)
• In a fractional reserve banking system, banks take in deposits and lend most of the money they take in. People who borrow money from banks use that money to buy houses or cars, start businesses, make home improvements, go to college, etc.
• Unlike in the Classroom Bank, the money loaned out by real banks does not sit in bank accounts—it gets spent almost immediately by the borrowers. Only a small fraction of the amount deposited in banks is kept on reserve, either in electronic accounts at the Federal Reserve or in vault cash. The result is that not everyone can get their money out of the bank in cash on the same day.
• The Federal Reserve requires most banks to hold a portion, up to 10 percent, of their deposits in reserve. These are called required reserves. Ask the students whether Classroom Bank is currently meeting a 10 percent reserve requirement. (Answers will vary.)
• Throughout history, there have been episodes where too many people tried to take their money out of their banks at the same time. During such episodes, banks usually ran out of cash and therefore couldn’t honor withdrawal requests, and many banks went bankrupt. When a bank goes bankrupt, it’s called a bank failure. When many depositors run into a bank at the same time to get their money out, we call that a bank run. When a bank run that begins at one bank spreads to other banks and causes people to generally distrust banks, we call that a bank panic.
15. Ask the students who deposited money in Classroom Bank the following:
Suppose you learned that the bank owner and manager was planning to leave the country and move permanently to Tahiti. What would you do? (Most students will say that they would want to withdraw their money immediately from the Classroom Bank, since they have no guarantee that you aren’t going to take their money with you when you move to Tahiti.)
16. Display Visual 5. Explain to students that:
• Monetary policy involves the Fed is changing the money supply in order to affect interest rates with the goal of price stability, full employment, and maximum sustainable economic growth.
• The Fed has at its disposal three tools of monetary policy:
  1. Reserve Requirements—The
Fed can increase the reserve requirement and thereby reduce the money supply as banks are forced to hold more reserves and lend less. Likewise, the Fed can decrease the reserve requirement and increase the money supply as banks are able to loan more. However, changes in the reserve requirement are made very infrequently and represent an extreme measure for affecting the money supply. Early in the Fed’s history, reserve requirements were fixed by law. The Thomas amendment to the Agricultural Adjustment Act of 1933 first gave the Fed power to change reserve requirements. That power was made permanent by the Banking Act of 1935.
b. Discount Rate—The discount rate, the rate at which banks can borrow from the
Federal Reserve can be increased in order to reduce the money supply and decreased in order to increase the money supply. Banks usually don’t borrow much from the Federal Reserve. Therefore, a change in the discount rate has a relatively small effect on the money supply. Early in the Fed’s history, changes in the discount rate were the primary monetary policy tool available to the Fed.
c. Open Market Operations—Open market operations, the Fed’s purchases and sales of U.S. Treasury securities, are the primary tool of monetary policy. Open market operations are carried out almost every business day by the Trading Desk at the Federal Reserve Bank of New York. The New York Reserve Bank carries out these operations on behalf of the entire Federal Reserve System. The Trading Desk is actually a staff of people who work at the Federal Reserve Bank of New York and who buy and sell government securities in order to change the money supply and get the federal funds rate, the interest rate that banks charge each other for short-term, usually overnight loans, as close as possible to the target for that interest rate set by the FOMC.
17. Using the information on the Federal Reserve System, the Board of Governors, the Federal Open Market Committee, and previous lessons fill in the blanks Activity 4 so as to accurately portray the structure of the Federal Reserve System.
18. Go over the results as a class.

Extension Activities
For extra credit the students can define the basic concepts of Bank Failure, Bank Panic, Bank Reserves, Bank Run, Discount Rate, Federal , Reserve System, and the Fractional Reserve Banking System.

National Standards

Standard 1 : Scarcity
Productive resources are limited. Therefore, people can not have all the goods and services they want; as a result, they must choose some things and give up others.

Related concepts: Capital Resources, Choice, Consumer Economics, Consumers, Goods, Human Resources, Natural Resources, Opportunity Cost, Producers, Production, Productive Resources, Scarcity, Services, Wants, Entrepreneurship, Inventors, Entrepreneur, Factors of Production

Standard 10 : Role of Economic Institutions
Institutions evolve in market economies to help individuals and groups accomplish their goals. Banks, labor unions, corporations, legal systems, and not-for-profit organizations are examples of important institutions. A different kind of institution, clearly defined and enforced property rights, is essential to a market economy.

Related concepts: Legal and Social Framework, Mortgage, Borrower, Interest, Labor Union, Legal Forms of Business, Legal Foundations of a Market Economy, Nonprofit Organization, Property Rights, Banking

Standard 11 : Role of Money
Money makes it easier to trade, borrow, save, invest, and compare the value of goods and services.

Related concepts: Exchange, Money Management, Money Supply, Currency, Definition of Money, Money, Characteristics of Money, Functions of Money

Standard 16 : Role of Government
There is an economic role for government in a market economy whenever the benefits of a government policy outweigh its costs. Governments often provide for national defense, address environmental concerns, define and protect property rights, and attempt to make markets more competitive. Most government policies also redistribute income.

Related concepts: Externalities, Income, Natural Monopoly, Redistribution of Income, Role of Government, Taxation, Transfer Payments, Bonds, Distribution of Income, Income Tax, Maintaining Competition, Monopolies, Negative Externality, Non-clearing Markets, Positive Externality, Property Rights, Public Goods, Maintaining Regulation, Taxes, Regulation, Government Expenditures, Government Revenues

Standard 20 : Monetary and Fiscal Policy
Federal government budgetary policy and the Federal Reserve System's monetary policy influence the overall levels of employment, output, and prices.

Related concepts: Inflation, National Debt, Tools of the Federal Reserve, Discount Rate, Federal Budget, Fiscal Policy, Monetary Policy, Open Market Operations, Reserve Requirements, Budget, Budget Deficit, Central Banking System, Budget Surplus, Causes of inflation

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