Download What Is Money?

Chapter 3
What Is Money?
Meaning of Money
• Economists’ definition: Money (money supply)—
anything that is generally accepted in payment for
goods or services or in the repayment of debts; a
stock concept
• How does the above definition compare to “currency”?
• How about “wealth” or “income”

Wealth—the total collection of pieces of property that serve to
store value

Income—flow of earnings per unit
of time
3-2
Functions of Money
•
Medium of Exchange—promotes economic
efficiency by minimizing the time spent in exchanging
goods and services
•
By avoiding “double coincidence of wants” people can
specialize in what they do best.
For a commodity to function as a medium of exchange:





Must be easily standardized (no doubts about its value)
Must be widely accepted
Must be divisible (easy to make change)
Must be easy to carry
Must not deteriorate quickly
3-3
• Unit of Account—used to measure value in
the economy
• Store of Value—saves the purchasing power
from the time income is received until the time
income is spent (but loses value during
inflation)
•
•
•
What are some other assets which have store of
value?
What are the advantages of these other assets
over money?
Why do people hold money and not those other
assets?
• most liquid of all assets
3-4
Evolution of the Payments System
•
Commodity Money

Precious metals like gold and silver
What are the problems with commodity money?
•
Fiat Money

Initially paper currency was convertible into coins or a quantity of precious
metal. It was then decreed by the governments as the legal tenderfiat
money
What are the problems with fiat money?
•
Checks

What are the problems with checks? Why did it never pick up in Turkey?
•
Electronic Payment
•
E-Money

Debit cards, Stored-value cards, Smart cards
3-5
How do we measure the Money in the
economy?
• Given the rapid evolution of money, defining the
proper measure of money is not a straightforward task
(remember the definition of “money”).

Example:
• In a world with fiat money only, money would simply be equal to
currency in circulation
• With the introduction of checks, one needs to include checking
accounts into the definition of money
• With the introduction of alternative deposit accounts, more
assets become liquid forms of money
• There are several measures of money: M1, M2, M3
(dropped)
3-6
3-7
Monetary Aggregates
M1
M2
Currency
Traveler’s Checks
Demand Deposits
Other Check. Dep
Small Den. Dep.
Savings and MM
Money Market Mutual
Funds Shares
M3
• Why is it so crucial to come up with the
proper measure of money?
• Do different measures tell us different
stories about the money supply?
3-9
Figure 1 Growth Rates of the M1 and M2
Aggregates, 1960–2011
Sources: Federal Reserve Economic Database (FRED); Federal Reserve Bank of Saint Louis;
http://research.stlouisfed.org/fred2/categories/25
Assigned Questions
• Chapter 3: 2, 5, 6, 9, 11, 12, 13, 15, 16, 17
----------------------------------------------• Lecture notes are posted on KUAIS
courseware on the day before the lecture.
• Answer Key for End of Chapter problems are
posted on KUAIS
3-11
Selected end of chapter questions for
class discussion
5) For each of the following situations,
identify which function of money is
emphasized:
a) Brooke accepts money in exchange for
performing her daily tasks in the office,
since she knows she can use that
money to buy goods and services
3-12
b) Tim wants to calculate the relative value
of oranges and apples and therefore
checks the price per kg of each of these
goods quoted in currency units
c) Maria is currently pregnant. She expects
her expenditures to increase in the future
and decides to increase the balance in
her savings account.
3-13
• 11) If you use an online payment system
such as Paypal to purchase goods or
services on the internet, does this affect
the M1 money supply, M2 money supply,
both, or neither? Explain.
3-14
• 12) Rank the following assets from the most
liquid to least liquid:
• A) Checking account deposits
• B) Houses
• C) Currency
• D) Automobie
• E) Savings deposits
• F) Common stock
3-15
• 15) For each of the following assets,
indicate which of the monetary
aggregates (M1 and M2) includes them:
• A) Currency
• B) MMMF
• C) Small denomination time deposits
• D) Checkable deposits
3-16
• 16) Assume you are interested in
earning some return on idle balances
you usually keep in your checking
account and decide to buy some MMMF
shares by writing a check. Comment on
the effect of your action on M1 and M2.
3-17
• 17) In September 2008, the growth rate
of the M1 money supply was zero, while
the growth rate of the M2 money supply
was about 5 %. In July 2009, the growth
rate of M1 was about 17 %, an the
growth rate of M2 was about 8 %. How
should Federal Reserve policy makers
interpret these changes in the growth
rates of M1 and M2?
3-18