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Chapter 3
WHAT IS MONEY
Meaning and Function of Money
Economist’s Meaning of Money
1. Anything that is generally accepted in payment for goods and services or in the
repayment of debts
2. Not the same as wealth or income
Wealth is the total collection of pieces of property that serve to store value. Wealth
includes money and other assets.
Income is a flow of earnings per unit of time. Money is a stock.
Functions of Money
1. Medium of exchange
The use of money promotes economic efficiency by eliminating the time spent in
exchanging goods and services
To function as a medium of exchange a commodity must:
 be standardized
 be widely accepted
 be divisible
 be easy to carry
 not deteriorate quickly
2. Unit of account
Money is used to measure value in the economy
The use of money reduces transaction costs by reducing the number of prices that need to
be considered
3. Store of value
Money is used to save purchasing power from the time income is received until the time
it is spent.
Money is preferred to other assets as a store of value because it is liquid. It does not have
to be converted into anything else in order to make purchases.
Evolution of the Payments System
1. Precious metals like gold and silver – commodity money
2. Paper currency – fiat money
3. Checks – IOUs payable on demand that allow transactions to take place without the
need to carry around a large amount of currency
4. Electronic means of payment: Fedwire, CHIPS, SWIFT, ACH
5. Electronic money: Debit cards, Stored-value cards, Electronic cash and checks
Federal Reserve’s Monetary Aggregates
1. M1 is the narrowest measure of money
M1 = currency + traveler’s checks + demand deposits + other checkable deposits
2. M2 includes assets with check-writing features and other liquid assets
M2 = M1 + small-denomination time deposits + savings deposits + money market
deposit accounts + money market mutual fund shares (noninstitutional)
3. M3 adds less liquid assets
M3 = M2 + large-denomination time deposits + money market mutual fund shares
(institutional) + term repurchase agreements + term Eurodollars
Growth Rates of Fed’s Monetary Aggregates
It makes a difference which monetary aggregate policymakers and economists choose
as the true measure of money.
We shouldn’t pay much attention to short-run movements in the money-supply
numbers but should be concerned with the longer-run movements.