Money and Money and Banking—Banking—

Monetary PolicyMonetary PolicyChapter 13

Functions of MoneyFunctions of Money

1. Medium of exchange—used for buying 1. Medium of exchange—used for buying and selling g & sand selling g & s

2. Unit of account—prices are quoted in 2. Unit of account—prices are quoted in dollars & centsdollars & cents

3. Store of value: allows purchasing 3. Store of value: allows purchasing power to be stored until needed (liquid)power to be stored until needed (liquid)

Characteristics of MoneyCharacteristics of Money

1. portability—easily transferred1. portability—easily transferred 2. durability—should not deteriorate when 2. durability—should not deteriorate when

being used as a store of valuebeing used as a store of value 3. divisibility—easily broken down into 3. divisibility—easily broken down into

smaller unitssmaller units 4. limited availability--$ decreases in 4. limited availability--$ decreases in

value when there is too value when there is too muchmuch

How is money made?How is money made?

Supply of Money—M1Supply of Money—M1

Includes currency and checkable depositsIncludes currency and checkable deposits 1. currency (coins & paper) held by public1. currency (coins & paper) held by public

A. Is “token” money “fiat”A. Is “token” money “fiat” Ex: The metal in a dime is worth less then 10 cents.Ex: The metal in a dime is worth less then 10 cents.

B. B. All paper currency consists of All paper currency consists of Federal Reserve Federal Reserve Notes Notes issued by the FEDissued by the FED

Supply of Money—M1Supply of Money—M1

2. Checkable deposits are included since 2. Checkable deposits are included since they can be spent almost as readily as they can be spent almost as readily as currency & can be changed into currencycurrency & can be changed into currency A. Commercial banks A. Commercial banks are a main source of are a main source of

checkable deposits for households and businessescheckable deposits for households and businesses B. Thrift institutions B. Thrift institutions also have checkable deposits also have checkable deposits

(savings and loans, credit unions, etc.)(savings and loans, credit unions, etc.)

Supply of Money—M1Supply of Money—M1

3. Currency and checkable deposits held by 3. Currency and checkable deposits held by the federal gov’t or FED are not included in the federal gov’t or FED are not included in M1M1

M2M2

M2 = M1 + M2 = M1 + 1.1. Savings deposits & money market deposit Savings deposits & money market deposit

accountsaccounts

2.2. Certificates of deposit < $100,000Certificates of deposit < $100,000

3.3. Mutual FundsMutual Funds

M3M3

M3 = M2 + large CDs > $100,000M3 = M2 + large CDs > $100,000

ImportanceImportance

M2 is watched closely by the FED to M2 is watched closely by the FED to determine monetary policydetermine monetary policy

Credit CardsCredit Cards

Are they money?Are they money? No, they are short term loansNo, they are short term loans

Allow the owner to keep M1 levels low since Allow the owner to keep M1 levels low since they need less for daily purchasesthey need less for daily purchases

What “backs” the money supply?What “backs” the money supply?

1. 1. consumer confidenceconsumer confidence in the gov’t ability to in the gov’t ability to keep its value stablekeep its value stable

2. 2. the value of moneythe value of money is the exchange of g & s is the exchange of g & s Is a medium of exchangeIs a medium of exchange Legal tenderLegal tender Relatively scarce so maintains purchasing powerRelatively scarce so maintains purchasing power

3. Money’s 3. Money’s purchasing powerpurchasing power determines determines its value. Higher prices means less its value. Higher prices means less purchasing powerpurchasing power

4. Excessive 4. Excessive inflationinflation may make money may make money worthless.worthless.

5. 5. MaintainingMaintaining the valuethe value of money of money Congress through Congress through fiscal policy (G &T)fiscal policy (G &T) FED through FED through monetary policy (interest rates)monetary policy (interest rates)

Study QuestionsStudy Questions

Page 262Page 262 Numbers 1, 2, 3 (pick any 3 statements to Numbers 1, 2, 3 (pick any 3 statements to

explain) and 4 (first 3 questions only) explain) and 4 (first 3 questions only)

In Plain English VideoIn Plain English Video

Take notesTake notes Focus on theFocus on the

Board of Governors (BoG)Board of Governors (BoG) Federal Reserve BanksFederal Reserve Banks Federal Open Market Committee (FOMC)Federal Open Market Committee (FOMC)

The Money Market: Interaction of The Money Market: Interaction of Money Supply and DemandMoney Supply and Demand

Key Graph # 10 illustrates the money Key Graph # 10 illustrates the money market. If combines demand with supply market. If combines demand with supply of money.of money.

If the quantity demanded exceeds the If the quantity demanded exceeds the quantity supplied, people sell assets like quantity supplied, people sell assets like bonds to get money. This causes bond bonds to get money. This causes bond supply to rise, bond prices to fall and a supply to rise, bond prices to fall and a higher market rate of interest.higher market rate of interest.

If the quantity of supplied exceeds the If the quantity of supplied exceeds the quantity demanded, people reduce money quantity demanded, people reduce money holdings by buying other assets like holdings by buying other assets like bonds. Bond prices rise and lower market bonds. Bond prices rise and lower market rates of interest result.rates of interest result.

Monetary authorities can shift supply to Monetary authorities can shift supply to affect interest rate, which in turn affect Ig affect interest rate, which in turn affect Ig and C and AD and ultimately output, and C and AD and ultimately output, employment and prices.employment and prices.

Key Graphs 11 and 12Key Graphs 11 and 12