13 C H A P T E R Examples of Money Cattle, cigarettes, shells, stones, gold, pepper, wampum, and...

13C H A P T E R

Examples of Money Cattle, cigarettes, shells,

stones, gold, pepper, wampum, and even beer as money

So what is Money?Money is anything that does

what money does

•Durability•Portability•Divisibility•Uniformity•Limited Supply•Acceptability

Six Characteristics of Money

FUNCTIONS OF MONEY• Medium of Exchange

•Money can be used for buying and selling goods and services •without money we have the problems of barter and the coincidence of wants•money allows for greater specialization and trade and productive efficiency

• Unit of Account•Prices are quoted in dollars and cents.

• Store of Value•money allows us to transfer purchasing power from present to future.•it is the most liquid (spendable) of all assets •a convenient way to store wealth.

Circular Flow Model of Capitalism Which of the arrows in the figure below represent money flow? Flow (1) is costs and income money flows and flow (4) represents consumer expenditures and business receipts money flows.

Why Monetary Side is Important

Barter is the direct exchange of goods and services for other goods and services.

Without money there would be barter.

BARTERa. Definition: the exchange of one good or service for another good or serviceb. Problems with barter:•coincidence of wants:

•a situation in which the good or services that one trader desires to obtain is the same as that which another desires to give up and an item that the second trader wishes to acquire is the same as that which the first trader desires to surrender •you have to find somebody who wants to trade the item that you want to get AND who also wants the item that you have that you want to trade

•With barter there will be less specialization because of the difficulty of overcoming the coincidence of wants.

•If you can't find someone to trade with, you will have to produce it yourself •Less specialization means less output and MORE SCARCITY

Barter requires the "double coincidence of wants." If someone wants something, he or she will have to find someone who wishes to part with that good and at the same time wishes to exchange the good for something that the first party wishes to part with.

REVIEW

What problems does barter entail?

With money as a medium of exchange, one knows the purchase price of the item to be purchased and its price relative to other items. Money is a very convenient common denominator, a common measure of value that is also used as a medium of exchange. Money also encourages specialization. Without money, workers and other resources could not be paid except in the output produced. All those who participated in the production of the good would have to collectively exchange it for all the goods and service desired by the resource owners.

Indicate the economic significance of money as a medium of exchange.

WHAT WHAT ABOUT ABOUT CREDIT CREDIT CARDS?CARDS?Credit cards are not money, but their use involves short-term loans; their convenience allows you to keep M1 balances low because you need less for daily purchases.

•Commodity money = objects that have value in themselves and that are also used as money (salt, cattle, gems, etc)•Representative Money = objects that have value because the holder can exchange them for something else of value•Fiat Money = valuable because the government says its valuable “legal tender”

Money’s Value

WHAT BACKS THE MONEY SUPPLY?

Money as DebtThe government's ability to keep its value stable provides the backing. People cannot convert paper money into a fixed amount of gold or any other precious commodityValue of Money

• Acceptability• Legal Tender - fiat money• Relative Scarcity

Money and Prices• Value of the Dollar• D = 1/Price Level

Inflation and Acceptability

MONEY SUPPLY

Currency•Token Money•Federal Reserve Notes•Intrinsic Value

Checkable Deposits•Commercial Banks•Thrift Institutions

Definition…

Review: If I take $10 from my wallet and put it into my checking account, what happens to M1?

http://www.mhhe.com/cgi-bin/mcbrue15.pl?url=analogies13-1

MONEY SUPPLY

= Plus...Near-monies

Savings Deposits• Money Market Deposit Accounts

(MMDAs)Smaller Time DepositsMoney Market Mutual Funds (MMMFs)

Review: If I take $10 out of my wallet and put it into my savings account what happens to M1? what happens to M2?

The following are NOT part of M1:•currency in banks •currency and checkable deposits owned

by the government •currency and checkable deposits owned

by the Federal Reserve Banks

REMEMBER

MONEY SUPPLY

= Plus...Large Time Deposits

$100,000.00 or more

Illustrated…

Currency (coins & paper money)

plus Checkable deposits

equals M1

M1 M2 M3

$1101

2000 Data(billions of dollars)

MONEY SUPPLY

M1 M2 M3

$1101


$4827

MONEY SUPPLYCurrency (coins & paper money)


equals M1

plus Savings deposits,

including MMDA’s plus Small time deposits plus Money market mutual fund (MMMF) balances

equals M2

M1 M2 M3

$1101


$4827

$6853

MONEY SUPPLYCurrency (coins & paper money)


equals M1



equals M2 plus Large time deposits

equals M3

Currency (coins & paper money)


equals M1



equals M2

A. currency and checkable deposits of the government, Federal Reserve, and banks

B. income is not money income is a FLOW concept: you earn income over time (e.g.. $500 a week)

money is a STOCK concept: you have a given amount at a point in time ( e.g. $500 in your wallet and checking account right now)

when we talk about "money demand" we will mean a demand for more liquidity (more in my wallet) NOT an increase in my income

Can you get an increase in your income and have less money?

YES, if you put more of your income in the stock market and less in your checking account

WHAT BACKS THE MONEY SUPPLY?

So, What Backs the Money Supply?

Stable Value!through...

• Appropriate Fiscal Policy• Intelligent Management

of the Money Supply

THE DEMAND FOR MONEY

Transactions Demand, Dt

varies directly with nominal GDP

Asset Demand, Da

varies inversely with the interest rate

illustrated...

+TransactionsDemand, Dt

Ra

te o

f in

tere

st,

i (

pe

rce

nt)

Amount of moneydemanded (billions

of dollars)

Dt

10

7.5

5

2.5

00 50 100 150 200 250 300


+ =TransactionsDemand, Dt

AssetDemand, Da

Ra

te o

f in

tere

st,

i (

pe

rce

nt)


of dollars)

Dt

10

7.5

5

2.5

00 50 100 150 200 250 300


Ra

te o

f in

tere

st,

i (

pe

rce

nt)


of dollars)

10

7.5

5

2.5

0

Da

0 50 100 150 200 250 300


AssetDemand, Da

Total demandfor money, Dm

0 50 100 150 200 250 300

Ra

te o

f in

tere

st,

i (

pe

rce

nt)


of dollars)

Dt

10

7.5

5

2.5

00 50 100 150 200 250 300


Ra

te o

f in

tere

st,

i (

pe

rce

nt)


of dollars)

10

7.5

5

2.5

0

Da

Ra

te o

f in

tere

st,

i (

pe

rce

nt)


of dollars)

0 50 100 150 200 250 300

10

7.5

5

2.5

0

Dm


AssetDemand, Da

Total demandfor money, Dm

0 50 100 150 200 250 300

Ra

te o

f in

tere

st,

i (

pe

rce

nt)


of dollars)

Dt

10

7.5

5

2.5

00 50 100 150 200 250 300


Ra

te o

f in

tere

st,

i (

pe

rce

nt)


of dollars)

10

7.5

5

2.5

0

Da

Ra

te o

f in

tere

st,

i (

pe

rce

nt)


of dollars)

0 50 100 150 200 250 300

10

7.5

5

2.5

0

Sm

EquilibriumInterest Rate

ie

Ra

te o

f in

tere

st,

i (

pe

rce

nt)


of dollars)

0 50 100 150 200 250 300

10

7.5

5

2.5

0

Dm

ADD THEMONEY SUPPLY

TO FIND THEEQUILIBRIUM RATE

OF INTEREST

Ra

te o

f in

tere

st,

i (p

erce

nt)

Amount of money demanded(billions of dollars)

0 50 100 150 200 250 300

10

7.5

5

2.5

0

Dm

ie

Sm

THE MONEY MARKET

Suppose the moneysupply is decreasedfrom $200 billion, Sm,

to $150 billion Sm1.

Ra

te o

f in

tere

st,

i (p

erce

nt)


0 50 100 150 200 250 300

10

7.5

5

2.5

0

Dm

ie

Sm

A temporary shortageof money will requirethe sale of some assetsto meet the need.

Sm1

THE MONEY MARKET

Ra

te o

f in

tere

st,

i (p

erce

nt)


0 50 100 150 200 250 300

10

7.5

5

2.5

0

Dm

ie

Sm

THE MONEY MARKET

Suppose the moneysupply is increasedfrom $200 billion, Sm,

to $250 billion Sm2.

Ra

te o

f in

tere

st,

i (p

erce

nt)


0 50 100 150 200 250 300

10

7.5

5

2.5

0

Dm

ie

Sm Sm2

THE MONEY MARKET

A temporary surplusof money will requirethe purchase of someassets to meet the de-sired level of liquidity.

Ra

te o

f in

tere

st,

i (p

erce

nt)


0 50 100 150 200 250 300

10

7.5

5

2.5

0

Dm

ie

Sm Sm2

THE MONEY MARKET

A temporary surplusof money will requirethe purchase of someassets to meet the de-sired level of liquidity.

Bonds are assumedas a typical asset with

lower prices associatedwith higher

interest rates

Centralization and Public Control• Board of Governors• Assistance & Advice

• Federal Open Market Committee• Three Advisory Councils

• The 12 Federal Reserve Banks• Central Bank Role• Quasi-Public Banks• Banker’s Banks

• Commercial Banks & Thrifts

THE FEDERAL RESERVE AND THE BANKING SYSTEM

THE FEDERAL RESERVE AND THE BANKING SYSTEM

Open MarketCommittee

AdvisoryCouncils

Board ofGovernors

12 FederalReserve Banks

CommercialBanks

Thrift Institutions(Savings & loan associations,

mutual savings banks, credit unions)

The Public(Households and

businesses)

FED Functions & the Money Supply

• Issuing Currency• Setting Reserve Requirements

& Holding Reserves• Lending Money to Banks &

Thrifts• Providing for Check Collection• Acting as Fiscal Agent• Supervising Banks• Controlling the Money Supply

FED Functions & the Money Supply Federal Reserve IndependenceRecent Developments

•Relative Decline of Banks and Thrifts

•Financial Services Industry•Consolidation Among Banks and Thrifts

•Globalization of Financial Markets

•Electronic Transactions

FED Functions & the Money Supply Federal Reserve IndependenceRecent Developments

•Relative Decline of Banks and Thrifts

•Financial Services Industry•Consolidation Among Banks and Thrifts

•Globalization of Financial Markets

•Electronic Transactions

ChapterConclusions

ENDBACK

medium of exchangeunit of accountstore of valueM1, M2, M3token moneyFederal Reserve Notescheckable depositscommercial banksthrift institutionsnear-moniessavings accountmoney market deposit

account (MMDA)time deposits

money market mutual fund (MMMF)

legal tendertransactions demandasset demandtotal demand for

moneymoney marketFederal Reserve

SystemBoard of GovernorsFederal Open Market

Committee (FOMC)Federal Reserve Banksfinancial services

industryelectronic transactions

Copyright McGraw-Hill/Irwin 2002

How Banks and Thrifts Create Money

Chapter 14

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