. 20
( 33)


1980 1998
continues until the cumulative val-
Quintiles Quintiles Cumulative
ues of all quintiles are plotted.
Lowest Fifth 5.3% 3.6% 3.6%
If all families received exactly the
Second Fifth 11.6% 9.0% 12.6%
same income”so that 40 percent of
Third Fifth 17.6% 15.0% 27.6%
the families would earn 40 percent of
Fourth Fifth 24.4% 23.2% 50.8%
the total income and so on”the Highest Fifth 41.1% 49.2% 100%
Lorenz curve would appear as a diag- Top 5 Percent 14.6% 21.4%
onal line running from one corner of
the graph to the other. Because all
B The Lorenz Curve
families do not receive the same
Percent of Total Income
income, however, the Lorenz curve is
not a diagonal. As you can see in the Equality of Income
figure, the distribution of income 58.9%
recently has become more unequal 1980
than it was in 1980. 40
20 3.6% b = 27.6%
Reasons for Income a = 12.6%
Inequality 20 40 60 80 100
Percent of Total Families
A number of reasons explain Source: U.S. Bureau of the Census
why the incomes of various
Categorizing Information
groups may be different. They
Economists use the Lorenz curve
include education, wealth, discrimi-
to contrast the distribution of
nation, ability, and monopoly
income at different points in
time. What percentage of Visit epp.glencoe.com and click on
Textbook Updates”Chapter 14 for
income is received by the
an update of the data.
Education richest quintile in 1980? In
Some people have higher incomes
than others because they have more
education. Although exceptions
highest to lowest, the top fifth has 75 percent of all
exist, there is generally a strong relationship between
the wealth in the country. The bottom two-fifths,
median income and level of education. Education
which is 40 percent of the people in the country,
puts people in a better position to get the higher-
have less than 2 percent of the total wealth.
paying jobs that require a higher level of skills.
This inequality has an impact on people™s ability
to earn income. Wealthy families can send their
Wealth children to expensive colleges and universities. The
Income also varies because some people hold wealthy can also afford to set their children up in
more wealth than others”and the distribution of businesses where they can earn a better income.
wealth is even more unequal than the distribution Even if the wealthy choose not to work, they can
of income. When wealth holders are ranked from make investments that will bring them income.

Discrimination living in poverty if their incomes fall below certain
levels. Poverty guidelines are annual dollar
Discrimination is another factor influencing
amounts used to evaluate the money income that
income. Women may not be promoted to execu-
families and unrelated individuals receive. In
tive positions in some companies because male
1999, poverty was defined as having an income of
executives simply are not accustomed to women in
less than $16,700 for a family of four.
roles of power. Some unions may deny immigrants
or ethnic minorities membership on the grounds
People in Poverty
that they “don™t belong” in the professions.
Although discrimination is illegal, it still takes Poverty in the United States is more extensive
place. When it does occur, discrimination causes than most people realize. According to recent fig-
women and minority groups to be crowded into ures, there are 34.5 million Americans in poverty”
other labor markets where oversupply drives or approximately 12.7 percent of the total
down wages. population.
As Figure 14.8 shows, even the record economic
expansions of the 1980s and 1990s failed to make a
significant dent in the percent of Americans living
Some people earn more income because they
in poverty. In fact, the proportion of the popula-
have certain natural abilities, such as professional
tion living in poverty was smaller in the late 1960s
athletes who sometimes earn millions of dollars
and 1970s than it is today.
every year. Such athletes as Shaquille O™Neal and
Of those in poverty, slightly more than two-
Anna Kournikova earn high incomes because they
thirds are white and approximately one-quarter are
have unique abilities or talents. The same is true of
African American. Finally, children of all races
popular performers such as Oprah Winfrey, Jim
make up approximately 40 percent of the people in
Carrey, and Harrison Ford.
poverty even though they account for only 26 per-
cent of the total population.
Monopoly Power
Another factor is the degree of monopoly power The Growing Income Gap
that some groups hold. Recall from Chapter 8 that
One reason for the continued high poverty num-
unions have been able to obtain higher wages for
bers is the growing gap in the distribution of income.
their members. Some white-collar workers”clerical,
According to the Census Bureau, the growing spread
business, or professional workers who generally are
that has taken place since 1980 has several causes.
salaried”also hold a degree of monopoly power.
The first involves a structural change in the
The American Medical Association, for example,
economy as industry changes from goods produc-
has been successful in limiting the number of peo-
tion to service production. Because wages are typi-
ple in its profession by limiting enrollments in
cally lower in the service industries such as
medical schools. More recently, the AMA voted to
fast-food chains, movie theaters, and entertainment
unionize in order to be in a better position to deal
parks, weekly paychecks tend to be lower.
with the health maintenance organizations that
The second reason for the spread in income dis-
employ them.
tribution is the growing gap between well-educated
and poorly educated workers. During the 1990s,
wages for the highly skilled soared, while wages for
Poverty the less skilled tended to remain about the same.
Poverty is a relative measure that depends A third reason”declining unionism (especially
on prices, the standard of living, and the among low-skilled workers)”is adding to the grow-
incomes that others earn. Poverty is a major prob- ing differential. The decline of unions means that
lem in America”and one that is extremely difficult many low-skilled workers have to work elsewhere
to resolve. Families and individuals are defined as for less pay.

Figure 14.8
The fourth reason for the income gap concerns AT A GLANCE
the changing structure of the American family.
Poverty in the United States:
The shift from two-parent families to single-parent
families and other nonfamily household living
Total Number and Rate
arrangements tends to lower average family
income. All of these factors contribute to the trend 50
of the rich getting richer and the poor getting

Number in Poverty

Antipoverty Programs 30
Over the years, the federal government has
instituted a number of programs to help the

needy. Most come under the general heading of 20
welfare”economic and social programs that pro-
vide regular assistance from the government or pri-
vate agencies because of need. Poverty Rate

Income Assistance 0







Programs that provide direct cash assistance to







those in need fall into the category of income Year
assistance. One such program is the Temporary Source: U.S. Bureau of the Census
Aid to Needy Families (TANF), which replaced
the Aid to Families with Dependent Children Using Graphs The dividing line between
(AFDC) in 1996. Although provisions and bene- those officially considered poor and those
fits vary from state to state, many families are able not officially considered poor is the poverty
to receive cash payments because of the death, line. Was the percentage of the pop-
continuous absence, or permanent disability of a ulation below
parent. the poverty
Another income assistance program is the line greater in
Supplemental Security Income (SSI), which makes the 1990s than Visit epp.glencoe.com and click on
cash payments to blind or disabled persons age 65 in the 1980s? Textbook Updates”Chapter 14 for
and older. Originally, the states administered the an update of the data.
program because benefits varied so much from
state to state. The federal government took it over
in 1979 to assure more uniform coverage.

General Assistance $1 food stamp, that person is getting a dollar™s
Programs that assist poor people but do not worth of food for a fraction of its cost. The pro-
provide direct cash assistance fall into the cate- gram, which began in 1961 and became law in
gory of general assistance. One example is the 1964, is different from other programs because eli-
food stamp program that serves millions of gibility is based solely on income.
Americans. Food stamps are government-issued Another general assistance program is medicaid”
coupons that can be redeemed for food. They a joint federal-state medical insurance program
may be given or sold to eligible low-income per- for low-income people. Under the program, the
sons. If, for example, a person pays 40 cents for a federal government pays a majority of health-care

costs, and the state governments pay the rest of the Tax Credits
cost. Medicaid serves millions of Americans, Many working low-income Americans qualify
including children, the visually impaired, and the for special tax credits. The most popular is the
disabled. Earned Income Tax Credit (EITC) which pro-
vides federal tax credits and sometimes cash to
Social Service Programs low-income workers. The credit was created in
1975 to partially offset the payroll tax burden on
Over the years, the individual states have devel-
working families. The credit is applied first to fed-
oped a variety of social service programs to help
eral income taxes, but low-income workers can
the needy. These include such areas as child abuse
take the remainder of the credit in cash if the
prevention, foster care, family planning, job train-
credit is larger than the taxes owed. The credit has
ing, child welfare, and day care.
proved to be popular, with approximately 20 mil-
Although the states control the kinds of serv-
lion working families receiving nearly $30 billion
ices the programs provide, the federal government
matches part of the cost. To be eligible for match-
ing funds, a state must file an annual service plan.
If the plan is approved, the state is free to select Enterprise Zones
social issues it wishes to address, set the eligibility
Special enterprise zones are areas where compa-
requirements for the programs, and decide how
nies can locate free of some local, state, and federal
the programs are to be carried out.
tax laws and other operating restrictions. Many
enterprise zones are established in run-down or
depressed areas. This benefits area residents
because they can find work without worrying about
transportation, thereby helping depressed areas to
grow again.
Nearly everyone agrees that a healthy and grow-
Urban Planners ing economy helps alleviate poverty. The enter-
prise zone concept is an attempt to focus some of
Most urban and regional
that growth directly in the areas that need it most,
planners work for com-
making more employment opportunities available.
munity, county, and city
Workfare Programs
The Work
Because of rising welfare costs, many state and
Planners develop compre-
local governments require those individuals who
hensive plans for the devel-
opment and rebuilding of receive welfare to provide labor in exchange for ben-
communities. Planners rec- efits. Workfare is a program that requires welfare
ommend strategies on how recipients to exchange some of their labor for bene-
to effectively utilize land fits. People on workfare often assist law enforcement
and resources to meet the needs of the community. officials or sanitation and highway crews, or perform
They also take part in decisions about transportation other types of community service work.
systems, resource development, and protection of the
Most states that have workfare programs
environment. Planners often specialize in a single
require almost everyone except for the disabled,
area such as transportation, demography, housing, or
the elderly, and those with very young children to
urban design.
work. If the workfare assignments are well
Qualifications designed, then recipients have a valuable oppor-
tunity to learn new skills that will eventually help
Most jobs in government agencies require a master™s
them get other jobs.
degree in urban or regional planning or urban design.

Figure 14.9

Per Capita Personal Income by State
A. CT B. Per Capita Personal Income, 1998
AK $18,998“$21,551 $25,979“$33,953
$21,500“$25,028 $29,932“$32,902
$24,302“$27,667 $33,953“$37,700
OR C. Average Annual Percentage Growth of Real
Per Capita Personal Income, 1994“98
MT 3.4%“ 5.5%
Per Capita
Personal Income
WV 0.0%“ 2.4% 3.9%“ 5.4%
(in $1,000s)
2.1%“ 4.7% 3.8%“ 5.8%
0 5 10 15 20 25 30 35 40
U.S. Average Annual Per Capita Personal Income 4.3%“ 4.6% 4.6%“ 5.5%
Source: Survey of Current Business, various issues

Using Graphs and Maps Average per capita personal income varies considerably from state to
state, ranging from a low of $18,998 to a high of $37,700. The average rate of growth, after
adjusting for inflation, amounted to 1.48 percent. One state”Alaska”had a negative annual rate of
growth from 1990 to 1998. In what range was the per capita personal income in your state?

Many welfare-to-work programs, like the UPS pro- another way of saying that the person will receive
gram discussed in the cover story, have had promis- $8,000 from the government. Or, if the person
ing results. In many cases, companies can even earn earned exactly $12,000, then the person would
federal tax credits when they hire workers directly receive an additional $5,000 under the formula for
from the welfare rolls, making the employment a a total of $17,000. Under this formula, a person
win-win situation for both employer and employee. would have to make $32,000 before any taxes were
actually paid.
The negative income tax is different from other
Negative Income Tax antipoverty programs in two respects. First, it is a
The negative income tax is a proposed type of market-based program designed to encourage peo-
tax that would make cash payments to certain ple to work. The object of the negative income tax
groups below the poverty line. These cash pay- is to make the minimum payment large enough to
ments would take the place of existing welfare pro- be of some assistance, yet small enough to
grams rather than supplement them. Also, encourage people to work. Then, when people do
everyone would qualify for the program, not just go to work, the taxes they actually pay need to be
working people as with the EITC. small enough so as not to discourage them from
Under the negative income tax, the federal gov- working.
ernment would set an income level below which Second, the negative income tax would be cost-
people would not have to pay taxes. Then, the gov- effective because it would take the place of other
ernment would pay a certain amount of money to costly welfare programs. In the end, individuals
anyone who earned less than that amount. would have money to spend as they saw fit.
For example, suppose that an individual™s tax lia- Government would also save because it would
bility was computed using the following formula: have fewer welfare programs and administrative
costs than it does currently. Although the negative
taxes (25% of income) $8,000
income tax is currently not used, many economists
Under this formula a person with no income believe it would be a reasonable alternative to the
would have a tax of minus $8,000”which is existing welfare structure.

Checking for Understanding Applying Economic Concepts
1. Main Idea Using your notes from the graphic 6. Distribution of Income What would happen
organizer activity on page 394, list the rea- to the Lorenz curve if nonfinancial aid such as
sons for the growing income gap. food stamps and medicaid were treated as
income? Explain why this would occur.
2. Key Terms Define Lorenz curve, poverty
guidelines, welfare, food stamps, Earned
Income Tax Credit (EITC), enterprise zone,
workfare, negative income tax.
3. Describe how the distribution of income is 7. Analyzing Information Some people have
measured. said that “the rich got richer” in the 1990s.
What factors can you cite to explain that
4. List the five main reasons for inequality of
what actually happened was more complex
than this simple statement?
5. Identify the major programs and proposals
designed to alleviate the problem of poverty. Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

Section 1 Section 3

Business Cycles and Fluctuations Inflation (pages 389“392)

(pages 375“380) Inflation is the rate of change in the price level as
measured by the CPI.
• Business cycles are systematic
• Terms used to describe the severity of inflation
increases and decreases in real
are creeping inflation, galloping inflation, and
GDP; unsystematic changes
are business fluctuations.
• Generous credit conditions and excessive growth of
• The two phases of the cycle are
the money supply allow demand-pull, deficit spend-
recession and expansion; a
ing, cost-push, and wage-price spiral inflation to take
peak is when the expansion
ends, while a trough is when the recession ends.
• Inflation erodes the value of the dollar, makes life
• The Great Depression of the 1930s was the worst
difficult for people on fixed incomes, changes the
economic decline in U.S. history; income distribu-
spending habits of consumers and businesses, and
tion inequalities, risky credit practices, weak interna-
alters the distribution of income in favor of debtors.
tional economic conditions, and tariff wars all
contributed to the Depression.
• Several short, mild recessions have occurred since
Section 4
• Business cycles are caused by changes in capital and
Poverty and the Distribution of
inventory spending by businesses, stimuli supplied
Income (pages 394“400)
by innovations and imitations, monetary factors, and
external shocks.
• The distribution of income is measured by ranking
• Econometric models and the index of leading family incomes from lowest to highest and then
indicators are used to predict changes in future dividing the ranking into quintiles. The income
economic activity. earned by each quintile is then compared to other
• The Lorenz curve shows that incomes are not evenly
Section 2 distributed, and that they are becoming less equal.
• Factors accounting for the unequal distribution of
Unemployment (pages 382“387) income include educational levels, wealth, discrimi-
• Unemployed persons are identified monthly by the nation, ability, and monopoly power.
Census Bureau. The number of unemployed is
• Poverty is determined by comparing the amount of
divided by the civilian labor force to arrive at the income earned by families to measures called the
unemployment rate. poverty guidelines.
• The unemployment rate does not count dropouts,
• The growing income gap is due to the increased
nor does it distinguish between full- and part-time importance of the service industry, the widening
employment. workers™ skills gap, the decline of union influence,
• Frictional, structural, cyclical, seasonal, and and the changing composition of the American
technological are different forms of unemployment. family.

7. caused by workers who are “between jobs” for
short periods
8. describes the requirement that welfare recipients
exchange labor for benefits
Self-Check Quiz Visit the Economics: Principles
9. happens when workers face the threat of
and Practices Web site at epp.glencoe.com and
click on Chapter 14”Self-Check Quizzes to pre-
pare for the chapter test.
10. growth path in absence of recession or expansion
11. measured by changes in the CPI
Identifying Key Terms 12. lowest point of the business cycle
13. measured by the CPI
Write the letter of the key term that best matches each
14. shows how much the actual distribution of income
definition below.
differs from an equal distribution
a. trend line
15. real GDP declines two consecutive quarters
b. cyclical unemployment
c. unemployed 16. works less than one hour per week for pay or profit
d. food stamps
e. frictional unemployment
Reviewing the Facts
f. peak
g. trough
Section 1 (pages 375“380)
h. inflation
1. Describe the Great Depression.
i. Lorenz curve
j. poverty guidelines 2. Distinguish between depressions and recessions.
k. price level
3. Identify two methods economists use to predict
l. seasonal unemployment
business cycles.
m. structural unemployment
n. technological unemployment
Section 2 (pages 382“387)
o. recession
p. workfare 4. Describe how the unemployment rate is
1. marks the end of a recession
5. Identify the major types of unemployment.
2. an example of a welfare program
6. Explain what is meant by full employment.
3. annual benchmark used to evaluate the money
income that families receive
Section 3 (pages 389“392)
4. caused by a shift in demand or a change in the way
7. Compare the difference between the price level
the economy operates
and inflation.
5. caused by annual changes in weather and holiday
8. Identify the five causes of inflation.
9. List four destabilizing effects of inflation.
6. caused by periodic swings in business activity

Section 4 (pages 394“400) Math Practice
10. Explain what is meant by the distribution of Use the following information to determine real
income. GDP per capita for each of the following years.
11. Identify five major reasons for inequality in the
distribution of income. Population
Year Real GDP in $billion
1960 179,323,000 $2,263
12. Explain how the Lorenz curve is used to show
1970 203,302,000 $3,398
the inequality of income distribution. 1980 226,542,000 $4,615
1990 248,710,000 $6,136
13. Name seven antipoverty programs.

Thinking Critically
Thinking Like an Economist
1. Drawing Conclusions Why is it important to
Why is an economist likely to prefer a program like
understand the causes of business cycles?
negative income tax over other welfare programs?
2. Analyzing Information Why might a govern-
ment statistic about the number of employed
Technology Skill
people be misleading?
3. Understanding Cause and Effect Explain the
Sending E-Mail Write a topic sentence about
effect that inflation has on the financial positions
income to research. Examples include: “Is income
of borrowers and lenders. Use a chart similar to
rising above or below the rate of inflation?” “Is
the one below to help you organize your answer.
there an income gap between men™s and women™s
If you managed a bank, what interest rate would
wages? And if so, “Is the income gap widening?”
you charge to overcome the disadvantage of long-
Then browse the Internet or call the government to
term inflation?
obtain the E-mail address of a federal agency con-
cerned with this issue. E-mail the federal agency,
sharing your topic and requesting information.

Applying Economic Concepts
1. Unemployment rate If we were to enter a period
Using the Internet Search for information on
of recession, what would likely happen to the unem-
trends in inflation and unemployment rates
ployment rate? The inflation rate? The poverty rate? from the following sites on the Internet: the
Census Bureau, the Bureau of Labor Statistics,
2. Inflation Explain why inflation cannot take place
and the Economic Statistics Briefing Room.
without an expansion of the money supply.
Search for recent articles discussing unem-
3. Lorenz curve Suppose that a new government ployment, inflation, or poverty. Download at
program reduced the level of poverty in the coun- least two recent press releases from each of
the above sites. Summarize the articles and
try. How would this affect the Lorenz curve?
share your findings with other members of
the class.
Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

Issues in Free

Issues in Free
Not everyone in the United States makes the same amount of money. Some people make a
great deal, some make very little, and most make something in between. Economists call this
situation, quite simply, income or wage inequality. Others call it the income gap.
An income gap is inevitable in a free market economy. First, the market gives different values
to different activities, and second, some people work more than others. So the existence of
some income inequality, in and of itself, doesn™t generally cause concern.
But some analysts express concern that, if the gap widens, it will be more and more difficult
to close. In other words, the rich will get richer and the poor will get poorer.

As you read the selections, ask yourself: Is the income gap a
serious economic problem, or are fears about it overblown?

The Gap is unimportant, since, with effort and a bit of luck,
P R O Widening those at the bottom can still move toward the top?
Not exactly. First of all, we know that historically
high rates of mobility in the United States resulted
from fast economic growth that was shared across
the board. Today, growth benefits the wealthy far
Income inequality has been worsening in the
more than the middle class, let alone the poor.
United States since the early 1970s. Before 1973,
all groups enjoyed healthy income gains, particu-
larly the middle class. However, since 1979, the
rich have gained far more than the middle class,
while the income of the poor has fallen in
absolute terms. A recent study found that the
richest one percent of families (average annual
income: $800,000 for a family of four)
captured 70 percent of the total rise in
family income in the United States
between 1977 and 1989.
America has always been considered
a land of opportunity, where parents
believe in the possibility of a “better
life” for their children. Does upward
mobility mean growing inequality is

Second, although many families do move from now is a problem of individual behavior, social
one income category to another over time, indi- organization and policy, not of society™s material
viduals have suffered larger downward, and smaller scarcities.
upward, income changes since the 1970s”with the Two centuries ago land was the essential
exception of the rich, whose earnings have jumped source of wealth. One century ago, physical cap-
dramatically. ital was. Today, human capital”knowledge, cog-
Third, though education has always been seen nitive skill”is, and such capital is widely
as the great leveler, it now reinforces initial advan- distributed by nature and is augmented by uni-
tages instead of compensating for initial handi- versal education. Furthermore, sexual equality
caps. [Schools] no longer effectively make up for has advanced so far that young men and women
deep inequalities among children. . . . of comparable education and training now earn
So, if America is to remain the land of oppor- essentially equal incomes.
tunity, elementary and secondary education must As societies become more wealthy, DeMuth
work for the poor. Otherwise, inequality of argues, money income becomes a less informa-
income will come to reflect not just differences in tive measure of individual welfare, as is demon-
motivation, work effort, and sheer luck among strated by this fact: Western democracies have
players in a fair game, but different rules for rich become so wealthy that, for the first time in his-
and poor. tory, “voluntary reduction in time spent at paid
employment has become a major social and eco-
”Nancy Birdsall, Executive Vice-President,
nomic phenomenon.” This reduction appears in
Inter-American Development Bank
expanded education of the young and, even
more, in longer retirement of the elderly. . . .
The modern age™s expansion of individual
autonomy . . . frees individuals for admirable and
The Problem is improving pursuits”and for unworthy and self-
C O N Exaggerated destructive behavior. With the growth of wealth,
freedom and equality has come an equally
astounding explosion of social pathologies, from
family disintegration and illegitimacy to drug
abuse and vulgar popular entertainment. . . .
That we are rapidly becoming richer is clear. Citizens are turning their attention, as indi-
People who deny that equality is increasing are viduals and as members of civic and religious
fixated on the recent small increase in income groups, to the question: What is freedom for?
inequality. That increase, the subject of an The question is itself among the luxuries of a
unceasing journalistic drumbeat, is, [Chris wealthy, free and equal society.
DeMuth, president of American Enterprise
”George F. Will, Washington Post Writers Group
Institute] argues, a small incongruity in the long-
term “leveling of material circumstances” that
has been underway for three centuries and is
Analyzing the Issue
Since 1700, the average life span in Western
societies has doubled. Today material necessities” 1. Summarize Birdsall™s argument.
food, shelter”are so universally available that the 2. What does Will mean by calling income inequality
problem of poverty, understood as material (quoting DeMuth) “a small incongruity”?
scarcity, has been solved. Poverty, DeMuth notes,
3. Will calls America “a wealthy, free and equal
society.” Considering Birdsall™s argument, do you
agree? Explain.

One important re-
quirement of money is
that it be worth about the same
amount from one year to the
next. In Chapter 15, you will
learn that money must have
stability in value to function as
it should. To learn more about
how the Federal Reserve System
controls the money supply, view
the Chapter 22 video lesson:
The Federal Reserve System
and Monetary Policy

Chapter Overview Visit the Economics: Principles
and Practices Web site at epp.glencoe.com and
click on Chapter 15”Chapter Overviews to pre-
view chapter information.

The Federal Reserve
System controls the supply
of money in the economy.
The Federal Reserve System
Main Idea Key Terms
The Federal Reserve works to strengthen and stabilize member bank, bank holding company, Regulation Z,
the nation™s monetary system. currency, coins
Reading Strategy Objectives
Graphic Organizer As you read this section, complete After studying this section, you will be able to:
a graphic organizer similar to the one below by list- 1. Describe the structure of the Federal Reserve System.
ing the components that make up the Federal 2. Explain the major regulatory responsibilities of the
Reserve System. Fed.

Applying Economic Concepts
The Federal
Truth-in-Lending Laws Have you or your parents ever
Reserve System
bought anything on credit? Read to find out how the
Fed influences the type of information you receive
from the lender.

n December 23, 1913, Congress created the
Cover Stor y Federal Reserve System, or “Fed,” as the
central bank of the United States. Today,
Design by Sculptor of Vietn the Fed provides financial services to the govern-
ment, regulates financial institutions, maintains the
Women™s Memorial Selecte payments system, enforces consumer protection
for Coin laws, and conducts monetary policy. Even the new
Sacagawea dollar coin featured in the cover story is
a by
A rendering of Sacagawe warehoused and distributed by the Fed. Because
the New Mexico sculptor everyone uses money, and because interest rates
created the Vietnam Wom affect the overall level of economic activity, the
Memorial will appear in
Fed™s activities affect us all.
lions of Americans™ po
starting in 2000.
After sorting through
Structure of the Fed
than 90,000 comments Rendering of
Internet, U.S. Mint offi- Sacagawea used
via the Figure 15.1 outlines the main organiza-
by] Glenna
cials [selected a design for the coin
tional structure of the Federal Reserve
. . . . It will
Goodacre of Santa Fe
er who accompanied
the Shoshone teenag System. The Fed™s main components have
d William Clark to the
s Meriwether Lewis an remained practically unchanged since the Great
16 when she accompa-
Ocean in 1805. . . . Just Depression of the 1930s.
acted as an interpreter
e explorers, Sacagawea
nied th
bes along the way. . . .
and go-between with tri
icans would accept the Private Ownership
cials weren™t sure Amer
ternet responses over-
ditional look, . . . but In One of the unique features of the Fed is that
nontra e
and child theme and th
ingly favor the mother
whelm it is privately owned by its member banks”
realistic portrayal. commercial banks that are members of, and hold
tive, December 17, 1998

Figure 15.1

Structure of the Federal Reserve System
Board of Governors
7 members appointed by the
President to 14-year terms
Federal Open Market Advisory Councils
Committee (FOMC) supervises and
Federal Advisory Council
Composition: regulates the Fed
Consumer Advisory Council
7 members of the
Thrift Institution Advisory
Board of Governors,
5 presidents of
district banks
decides monetary policy

12 District Banks

Contribute funds Receive stock

Member Banks
Approximately 2,650 national and 1,000 state banks

Using Charts The Board of Governors supervises the Federal Reserve System. The FOMC,
The Board of Governors supervises the Federal Reserve System. The FOMC
has primary responsibility for monetary policy. The member banks contribute a small amount
of funds and receive stock ownership shares in return. Three advisory councils also provide
direct advice to the Board on a regular basis. What functions does the Board of
Governors perform?

stock in, the Fed. When the Fed was established in Private individuals can only own shares indirectly
1913, it was organized as a corporation that issued by owning shares of stock in a Fed-member bank.
shares of stock, just like any other corporation. Today, Fed membership consists of all national
Individual banks may or may not belong to the Fed. banks and some state banks.
National banks”those chartered by the national gov-
ernment”must belong. Those chartered by state gov-
Board of Governors
ernments have the choice to belong or not.
In 1935 Congress established a seven-member
When privately owned banks joined the Fed,
Board of Governors for the Federal Reserve System.
they were required to purchase some of its shares.
Each member is appointed by the president and
This made them part owners of the Fed, just as
approved by the Senate to serve a 14-year term of
someone might own shares in IBM, Ford Motor, or
office. These appointments are staggered, so that one
Microsoft. Only member banks can own shares.

appointment becomes vacant every two years. As a members from the Board of Governors, the presi-
result, there are always experienced people on the dent of the New York district Fed, and four dis-
board. trict Federal Reserve bank presidents who serve
The Board is primarily a regulatory and supervi- one-year rotating terms.
sory agency. It sets general policies for Federal The committee meets eight times a year in
Reserve and member banks to follow, regulates Washington, D.C., to review the country™s econ-
certain operations of state-chartered member omy and to make decisions about the cost and
banks, and conducts some aspects of monetary availability of credit. Most decisions are made in
policy. It also makes a report each year to Congress private but are announced almost immediately.
and puts out a monthly bulletin that reports on The FOMC is the Fed™s primary monetary policy-
national and international monetary matters. making body.

Federal Reserve District Banks Advisory Committees
When the Fed was established in 1913, it was The Fed has three advisory committees that
intended to operate as a system of 12 independent advise the Board of Governors directly. The first is
and equally powerful banks. Each reserve bank was the Federal Advisory Council, which consists of
responsible for a district, and Federal Reserve notes representatives from each of the 12 district banks.
even carried the name of the district bank on the It provides advice to the Federal Reserve on mat-
seal to the left of the portrait. Restructuring mini- ters concerning the overall health of the economy.
mized, and later eliminated, the Fed™s regional The second committee is the Consumer Advisory
nature. The new Fed seal does not incorporate any Council. The council™s 30 members meet with the
mention of the district banks. Board three times a year on consumer credit laws.
Today, the 12 Federal Reserve dis-
trict banks and 25 additional branch
Board of Governors
banks are strategically located so that
they can be near the commercial
banks they serve. While each of the
12 banks has its own president and
board of directors, the Reserve banks
are supervised by the Federal Reserve
Board in Washington, D.C. The
Federal Reserve banks carry out the
same functions for banks and thrift
institutions as those institutions carry
out for people. The district banks
accept the deposits of and make
loans to banks and thrift institutions,
just as banks perform these functions
for the public.

Federal Open Market
The Federal Open Market
Committee (FOMC) makes deci-
Responsibilities The Board of Governors supervises the entire
sions about the growth of the
Federal Reserve System. What role does the Fed play in merg-
money supply and the level of inter- ers of member banks?
est rates. It has 12 members: seven

Members include educators, consumer legal special- today. First, the banks use reserves to clear checks.
ists, and representatives from consumer and finan- Second, the Fed uses reserves to control the size of
cial industry groups. the money supply.
The third advisory group is the Thrift Institutions
Advisory Council. On the council are representa-
Bank Holding Companies
tives from savings and loan associations, savings
The Fed also has broad legislative authority over
banks, and credit unions. It meets with the Board
bank holding companies”corporations that own
annually to advise on matters pertaining to the thrift
one or more banks. Holding companies, unlike
banks, do not accept deposits or make loans. When
individuals buy stock in a bank today, they gener-
ally purchase the stock of the holding company,
Regulatory Responsibilities which in turn owns one or more individual banks.
The Federal Reserve System has a broad This arrangement may seem unusual, but it can
range of responsibilities ranging from mem- be traced to the many restrictions placed on banks
ber bank supervision to enforcing consumer after many of them failed during the Great
legislation. Depression. At the time, bankers tried to sidestep
the restrictions by setting up holding companies
that would not be subject to banking laws because
State Member Banks they were not banks in the traditional sense. Later,
Congress gave the Fed the power to regulate the
All depository institutions”including commer-
activities of the holding companies so that they
cial banks, savings banks, savings institutions, and
could not evade restrictions.
credit unions”must maintain reserves against their
Today about 6,000 holding companies control
customers™ deposits. The Fed is responsible for
approximately 7,000 commercial banks. In many
monitoring the reserves of its state-chartered mem-
cases, the holding company structure has resulted in
ber banks, while other federal agencies monitor the
even more regulation and supervision. For example,
reserves of nonmember banks and other depository
the FDIC may inspect and regulate three nonmem-
ber state banks that a single holding company owns,
While reserves were originally a matter of pru-
while the Fed regulates the holding company itself.
dent banking practice, they fulfill two key roles

Financial Services

Managed Money Because nations no longer back their money with gold, they rely on central banks, like
the Fed, to manage the amount of money in circulation. What financial services does the Fed provide to
the government?

International Operations Bank Mergers
Foreign banks have a large presence in the econ-
omy. Banks from 60 different countries operate
about 500 branches and agencies in the United
States. In addition, foreign banks own shares of
many large United States banks. In all, foreign
banks control about 20 percent of all banking
assets in the United States.
The Fed has broad authority to supervise and
regulate these foreign banks. Branches and agencies
of these banks are examined annually, and the Fed
even has the power to terminate the domestic oper-
ations of foreign banks.
In addition, the Fed authorizes and supervises
the international operations of United States
member banks and holding companies. Currently,
Fed member banks operate about 800 branches in
foreign countries.

Member Bank Mergers
A merger of two or more banks requires the
approval of the appropriate federal banking author-
ity. If the surviving bank is a state member bank,
The Fed™s Role Mergers are a fact of economic
the Fed must approve the merger.
life. What is the Federal Reserve™s role in bank
Other banking authorities approve other merg-
ers. If two national banks merge, the Comptroller
of the Currency, a Treasury Department official,
must approve the merger. If two nonmember state
funds are moved from one member bank™s account
banks merge, the FDIC must approve the merger.
to another until the check returns to the issuer. The
money is then removed from the issuer™s checking
Other Federal Reserve Services The Fed clears millions of checks at any given
time by using the latest high-speed check-sorting
The Federal Reserve has other responsibili-
equipment available. In some cases banks gather
ties as well. These include clearing checks,
information from a check when it is deposited, and
enforcing consumer legislation, maintaining cur-
then transfer the information to computer files.
rency and coins, and providing financial services to
These files are sent to the Fed, which uses the infor-
the government.
mation to adjust member banks™ accounts. In this
One major service the Fed performs is that of
way, the member bank™s balance can be adjusted
clearing checks, a process that makes extensive use
without the check having to go through the entire
of the reserves in the banking system. In general, the
deposits that member banks keep with the Fed are
The Fed is also responsible for some consumer
shifted from one bank to another, depending on the
legislation, primarily the federal Truth in Lending
way checks are written on the member banks.
Act that requires sellers to make complete and
Figure 15.2 illustrates the check-clearing process.
accurate disclosures to people who buy on credit.
The person in the example writes a $5 check. As the
Under Regulation Z, the Fed has the authority to
check is processed through the banking system,

Figure 15.2

Clearing a Check

Date 19

Anna Nathan
Pay to the
order of


DDA $100 DDA $100

95 105
The process begins with
The check is returned Nathan deposits
Anna, who has a $100
to Anna. the check.
demand deposit account
(DDA) with Bank X. Anna
Bank X Bank Y
writes a check for $5, which
she gives to Nathan. At the
same time, she records the
amount in her checkbook to
show a new balance of $95.
(Note that only the accounts
affected by the $5 check are
Bank X then returns Anna™s check Nathan, who banks at Bank Y,
shown in this figure.)
to her at the end of the month, now has the check. If he decides
along with any others she wrote to cash it, he will have $5 in
during the same period. When currency in addition to his DDA
Anna gets the canceled checks, of $100. If he decides to make a
she balances her checkbook to deposit, his DDA will rise to
make sure her records agree $105. Either way, Bank Y ends up
with the bank™s. with the check written by Anna.

Bank X learns of Anna™s check Because the check is drawn on
only when it arrives from the Fed. Bank X, Bank Y gets payment for
The bank then makes up for the it by sending the check to the
loss of the $5 in its MBR account district Federal Reserve Bank.
by reducing Anna™s DDA by $5. The Fed then processes the check
by transferring $5 from Bank X™s
Bank X MBR account to Bank Y™s MBR
account. The Fed then sends
MBR $10 Anna™s DDA $100
Anna™s check to Bank X.
5 95
Bank Y
Bank X has its MBR reduced,
and receives Anna™s check. MBR $10 Nathan™s DDA $100
15 105

Bank Y sends the check to the Fed
District Federal
district bank for payment.
Reserve System Bank
MBR Bank X $10
MBR Bank Y $10

extend truth-in-lending disclosures to millions of
individuals who purchase or borrow from corpora-
tions, retail stores, automobile dealers, banks, and Commercial Banks Commercial banks are the largest
lending institutions. financial institutions in the country and are the main
If you buy furniture or a car on credit, for sources for exchanging money. The first commercial
example, you will discover that the seller must bank in the United States was founded in 1782 in
explain several items before you make the pur- Philadelphia. Today, commercial banks hold about
two-thirds of the nation™s money deposits.
chase. These items include the size of the down
payment, the number and size of the monthly
payments, and the total amount of interest over
the life of the loan. One of the Fed™s important functions involves
Today™s currency, the paper component of the the financial services it provides to the federal gov-
money supply, is made up of Federal Reserve ernment and its agencies. For example, the Fed
notes”fiat paper money issued by Federal Reserve conducts nationwide auctions of Treasury bills,
banks and printed at the Bureau of Engraving and bonds, and notes. It also issues, services, and
Printing. This currency, issued in amounts of $1, redeems these securities on behalf of the Treasury.
$2, $5, $10, $20, $50, and $100, is distributed to In the process, it maintains the equivalent of
the Fed district banks for storage. numerous demand deposit accounts for the
The Bureau of the Mint produces coins”metallic Treasury and clears all checks drawn on those
forms of money”such as pennies, nickels, dimes, accounts. Other accounts are used to process the
quarters, and the new Sacagawea dollar coin. After tens of millions of dollars of U.S. savings bonds
the coins are minted, they are shipped to the Fed that are sold and redeemed annually.
district banks for storage. When member banks The Fed also maintains accounts for the IRS,
need additional coins or currency, they contact the which holds federal taxes paid by individuals and
Fed to fulfill their needs. businesses. In fact, any check written to the
When banks come across coins or currency that United States Treasury is deposited in the Fed.
are mutilated or cannot be used for other reasons, Any federal agency check, such as a monthly
they return it to the Fed for replacement. The Fed Social Security payment, comes from accounts
then destroys the old money so that it cannot be held at the Fed. In essence, the Fed serves as the
put back into circulation. federal government™s bank.

Checking for Understanding manager about the type of information that
the store is required to disclose when the sale
1. Main Idea What is the purpose of the Federal
is made. Obtain copies of the disclosure forms
and share them with your classmates.
2. Key Terms Define member bank, bank hold-
ing company, Regulation Z, currency, coins.
3. Describe the structure of the Fed.
6. Synthesizing Information One of the
4. List eight areas in which the Fed has responsibilities of the Fed is to approve or
responsibility. disapprove mergers between state member
banks. Explain how the mergers of two such
Applying Economic Concepts
banks would be classified according to the
5. Truth-in-Lending Laws Visit any local store
discussion of mergers in Chapter 3.
that sells goods on credit”appliances, cars,
or furniture, for example. Ask the owner or Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

Enormous Power:
Alan Greenspan

In some ways, Alan Greenspan
is like many other people in gov-
ernment today”a longtime public
servant, a respected administrator,
and a fiscally conservative theorist
with a Ph.D. in economics. What
sets him apart, however, is that he
is widely regarded as being the
second most powerful person in
America, after the president.
Greenspan is chairman of the Dow-Jones Industrial Average fell to the reform of the nation™s
Federal Reserve System™s Board of 145 points. Such is the power of Social Security system.
Governors. As such, his views on Greenspan. Greenspan joined the Fed in
the economy are closely moni- 1987 and was appointed chair of
tored by almost everyone in the F I S C A L C O N S E RVAT I S M the Fed™s Board of Governors by
business community. Presidents Reagan, Bush, and
Greenspan is a longtime conser-
Clinton. Greenspan continues to be
vative. Early in his career, he was
MOVING MARKETS a strong supporter of the free mar-
even a staunch advocate of the
ket and an opponent of government
In late 1996, when stocks were gold standard, which he saw as a
intervention in the economy. As the
setting record highs during a bull way to assure monetary stability
second most powerful person in
market, Greenspan asked publicly and fiscal responsibility by govern-
America, people will continue to
if prices weren™t being propelled ment. In his career he has worked
scrutinize his every statement.
by the “irrational exuberance” of as an economic consultant to pri-
investors. The reaction to his vate industry and served on a
remarks was almost instantaneous: number of corporate and industry
Examining the Profile
investors, fearing that the Fed boards. Greenspan served from
chairman was about to implement 1974 to 1977 as chair of the presi- 1. Synthesizing Information Explain
restrictive monetary policies that dent™s Council on Economic how Greenspan™s position as chairman
would drive stock prices down, Advisors during the Ford adminis- of the Federal Reserve System™s Board
began to sell. Within hours, stock tration. From 1981 to 1983, he of Governors makes him extremely
exchanges around the world lost chaired the National Commission influential.
2 percent of their value, and the on Social Security Reform, leading 2. Evaluating Information Do you
think Greenspan has too much
power? Explain your answer.

Monetary Policy
Main Idea account, time deposit, member bank reserve, easy
Federal Reserve actions intended to stabilize the money policy, tight money policy, open market opera-
economy make up what is called monetary policy. tions, discount rate, margin requirement, moral sua-
sion, selective credit controls
Reading Strategy
Graphic Organizer As you read the section, complete
After studying this section, you will be able to:
a graphic organizer similar to the one below.
1. Describe the use of fractional reserves.
2. Understand the tools used to conduct monetary
Cause: The Fed
raises the reserve Effect:
Applying Economic Concepts
Key Terms Fractional Bank Reserves Did you know that most of
our money supply exists in the form of intangible
monetary policy, fractional reserve system, legal
computer entries? Read to find out how the fractional
reserves, reserve requirement, excess reserves, liabili-
reserve system works.
ties, assets, balance sheet, net worth, liquidity, savings

ne of the Federal Reserve System™s most
Cover Stor y important responsibilities is that of mone-


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