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Chapter 2Principles of Money

© 2000 South-Western College Publishing

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MoneyMoney is is

Anything that functions as a means of payment (medium of exchange), unit of account, and store of value

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Means of Payment(medium of exchange)

Something that is generally acceptable to make payments

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What is barter?

Trading goods for goods

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Double Coincidence of WantsDouble Coincidence of Wants

In barter, when each person involved in a potential exchange has what the other person wants

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Store of ValueStore of Value

Something that retains its value over time

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Unit of AccountUnit of Account

A standardized accounting unit such as the dollar that is the consistent measure of value

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Transactions costs associated with

barter

Development of money

Specialization and division of labor

Economic development

Exchange (trading)

encourage

facilitates

facilitates

facilitates

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Money Market Deposit Accounts (MMDAs)

Money Market Deposit Accounts (MMDAs)

Financial claims — with some check-writing privileges —that earn higher interest than checkable deposits and have a higher minimum balance

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Unit of AccountThe accounting unit or

standardized measure of value in which prices are quoted

Exhibit 2.1

Medium of ExchangeA means of payment; something used

in transactions to make payments

Store of ValueSomething that retains

its value if held

$

Functions of Money

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Monetary Aggregates are

The measures of money — including M1, M2, M3, and L — that are monitored and tracked by the Fed

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What is M1?

Currency in the hands of the public plus checkable deposit

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What is M2?

Everything in M1 plus other highly liquid assets

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What is M3?

Everything in M2 plus some less liquid assets

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What is L?

Everything in M3 plus some additional less liquid assets

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Checkable Deposits

Deposits that are subject to withdrawal by writing a check

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Demand Deposits

Non-interest earning checking accounts issued by banks

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Negotiable Orders of Withdrawal (NOW)

Interest-earning checking accounts

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Near Monies

Highly liquid financial assets that can easily be converted to transactions money (M1) without loss of value

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Domestic Nonfinancial Debt (DNFD)

An aggregate that is a measure of total credit market debt owed by the domestic nonfinancial government and private sectors

21Exhibit 2.3

$1,080.8

M1 M2 M3 L DNFD

April 1998 (Billions)

$4,164.9$5,574.3

$6,825.6

$15,477.3

22Exhibit 2.4

20001995199019851980197519701965

$3,000

$6,000

$9,000

$12,000

$15,000

M1

M2M3

L

DNFD

Monetary Aggregates and DNFD, 1960-1999

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Payments MechanismPayments Mechanism

The means by which transactions are consummatedhow money is transferred in an exchange

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Electronic Funds Transfer System

The transfer of funds to third parties in response to electronic instructions rather than instructions written on a paper check

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Point-of-Sale Terminals

Computer terminals that use a credit card to electronically transfer funds from a deposit account to the account of a third party

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Automated Teller Machines (ATMs)

Machines that permit a depositor to make deposits and withdrawals to an account even if the financial institution is closed