3. What is Money?

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Meaning of Money • Money (money supply)—anything that is

generally accepted in payment for goods or services or in the repayment of debts

• Wealth—the total collection of pieces of property that serve to store value

• Wealth includes not only money but also other assets such as bonds, common stock, art, land, furniture,cars, and houses.

• Income—flow of earnings per unit of time

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Functions of Money • Medium of Exchange—it is used to pay for goods and services. • promotes economic efficiency by minimizing the time spent in

exchanging goods and services

• For a commodity to function effectively as money, it has to meet the following criteria: Must be easily standardized - making it simple to ascertain its

value Must be widely accepted Must be divisible Must be easy to carry Must not deteriorate quickly

• Unit of Account—used to measure value in the economy.

• Store of Value—used to save purchasing power; most liquid of all assets but loses value during inflation

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Evolution of the Payments System • Payment system: the method of

conducting transactions in the economy • The payment system has evolved from

commodity money to E-money • Commodity Money • Fiat Money • Checks • Electronic Payment • E-Money

Commodity Money

• Money made up precious metal or another valuable commodity

• Commodity money functioned as the medium of exchange in all but the most primitive societies

• Problem: Very heavy and very hard to transport from one to another

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Fiat Money

• Paper currency decreed by governments as legal tender

• Much lighter than coins or precious metals

• But can easily be stollen

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Checks

• Instrument from a holder to a bank to transfer money from the holders account to somebody else’s account

• No need to curry around large amounts of currency

• Takes time to make use of the funds • Paper required to process checks is

costly Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 3-7

Electronic payment

• Computers and internet now make it cheap to make payments electronically

• Saves time and effort

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E-Money • Money that exists in electronic form • Debit card allows a holder to purchase

goods and services by electronically transferring funds directly from their bank account to a merchant’s account

• Store-value card another form of e-money and works like a prepaid phone card

• Smart card contains a computer chip, which allows it to be loaded with cash from the owners bank account whenever needed Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 3-9

Measuring Money

• The method by which central banks define money differs from one economy to another

• Money supply (monetary aggregates) differs depending on the norms of money holders, the innovation of financial instruments and the variety of issuers of money

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Table 1 Measures of the Monetary Aggregates M1 = Currency + Traveler’s checks + Demand deposits + Other checkable deposits M2 = M1 + Small-denomination time deposits and repurchase agreements + Savings deposits and money market deposit accounts + Money market mutual fund shares (noninstitutional) M3 = M2 + Large-denomination time deposits and repurchase agreements + Money market mutual fund shares (institutional) + Repurchase agreements + Eurodollars Total M 3 Source: www.federalreserve.gov/releases/h6/hist.

Monetary Aggregates in Namibia

• Narrow Money Supply (M1) is defined to include currency in circulation and transferable deposits of resident sectors, excluding Central Government and depository corporations.

• Broad Money Supply (M2) include currency outside depository corporations, transferable and other deposits in national currency of the resident sectors, excluding deposits of the Central Government and those of the depository corporation

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How Reliable are the Money Data?

• Revisions are issued because: Small depository institutions report infrequently Adjustments must be made for seasonal variation

• We probably should not pay much attention to short-run movements in the money supply numbers, but should be concerned only with longer-run movements

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Review Questions

• If gold is used in the conduct of transactions, this is called: fiat money barter money cheque commodity money

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Near money assets are: A. are physical assets not easily convertible to cash B. are wealth assets not easily convertible to cash C. are assets not easily convertible to cash D. are assets easily convertible to cash

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Rank the following from most liquid to least liquid

• Cheque account deposits • House • Currency • Washing Machine • Savings deposit • Common stock

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