What Is What Is Money?Money?

Chapter 3Chapter 3

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Meaning of MoneyMeaning of Money Money (=money supply) any vehicle used as Money (=money supply) any vehicle used as

a means of exchange to pay for goods, a means of exchange to pay for goods, services or debts.services or debts.

In today’s society, any asset that can quickly In today’s society, any asset that can quickly be transferred into cash is considered money.be transferred into cash is considered money.

The more liquid an asset is, the closer it is to The more liquid an asset is, the closer it is to money.money.

In economics,money does not mean wealth In economics,money does not mean wealth nor does it mean income.nor does it mean income.

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Functions of MoneyFunctions of Money

Medium of exchangeMedium of exchangeUnit of AccountUnit of AccountStore of ValueStore of Value

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Medium of exchangeMedium of exchange By eliminating barter, this function of money By eliminating barter, this function of money

increases efficiency in a society. increases efficiency in a society. As human societies started to engage in As human societies started to engage in

exchange money had to be invented.exchange money had to be invented. Any technological change that reduces Any technological change that reduces

transaction costs increases the wealth of the transaction costs increases the wealth of the society.society.

Any technological change that allows people to Any technological change that allows people to specialize also increases wealth.specialize also increases wealth.

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Unit of AccountUnit of Account We use money to measure the value of goods We use money to measure the value of goods

and services.and services. Suppose we had 4 goods and no money. How do Suppose we had 4 goods and no money. How do

we measure the price of each good?we measure the price of each good? A in terms of BA in terms of B B in terms of CB in terms of C N!/2(N-2)! C in terms of DC in terms of D A in terms of CA in terms of C A in terms of DA in terms of D B in terms of DB in terms of D

Money allows to quote prices in terms of currency Money allows to quote prices in terms of currency only.only.

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A Proposed Unit of AccountA Proposed Unit of Account We could [have] labels providing a product or service’s We could [have] labels providing a product or service’s

“daily energy calories.” Along with physical labels, “daily energy calories.” Along with physical labels, imagine a smartphone app — we’ll call it “Decal” for imagine a smartphone app — we’ll call it “Decal” for short — that would scan a product’s bar code and report short — that would scan a product’s bar code and report how much energy it took to produce that item.how much energy it took to produce that item.

Like the nutritional data on the backs of food products, Like the nutritional data on the backs of food products, Decal would give consumers a user-friendly, universal Decal would give consumers a user-friendly, universal measure that they could use to compare products or measure that they could use to compare products or count their daily energy intake. count their daily energy intake. 

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http://www.nytimes.com/2011/03/09/opinion/09Little.html?partner=rss&emc=rss

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Store of ValueStore of ValueAll assets are stored value.All assets are stored value.Money, although without any return, is still Money, although without any return, is still

desirable to hold because it allows desirable to hold because it allows purchases immediately.purchases immediately.

Other assets take time (transaction costs) Other assets take time (transaction costs) to use as a payment for purchases.to use as a payment for purchases.

The more liquid an asset is, the less The more liquid an asset is, the less transaction cost it carries.transaction cost it carries.

Inflation erodes the value of money.Inflation erodes the value of money.

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Evolution of the Payments Evolution of the Payments SystemSystem

Commodity Money: valuable, easily Commodity Money: valuable, easily standardized and divisible commodities standardized and divisible commodities (e.g. precious metals, cigarettes).(e.g. precious metals, cigarettes).

Fiat Money: paper money decreed by Fiat Money: paper money decreed by governments as legal tender.governments as legal tender.

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Electronic MoneyElectronic Money Debit CardsDebit Cards

Instant transfer from your checking account to Instant transfer from your checking account to merchant’s checking account.merchant’s checking account.

Stored Value CardStored Value CardGift cards.Gift cards.

Electronic CashElectronic CashAccount set up on a person’s PC from her bank Account set up on a person’s PC from her bank

whereby she can buy products over the Internet.whereby she can buy products over the Internet. Electronic ChecksElectronic Checks

Checks written on PC and sent through the Checks written on PC and sent through the Internet.Internet.

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Benefits of Paper ChecksBenefits of Paper Checks

Cheaper than telecommunications network.Cheaper than telecommunications network.Provide receipts.Provide receipts.Allow float.Allow float.May be more secure; avoid hacker May be more secure; avoid hacker

problems.problems.Do not leave a wealth of information trail.Do not leave a wealth of information trail.

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Measuring MoneyMeasuring Money M1: Currency, demand deposits, travelers M1: Currency, demand deposits, travelers

checks.checks. M2: M1, saving deposits, small time deposits, M2: M1, saving deposits, small time deposits,

retail MMMF.retail MMMF. M3: M2, large time deposits, repos, Eurodollar M3: M2, large time deposits, repos, Eurodollar

deposits, institutional MMMF.deposits, institutional MMMF. MZM: M2, institutional MMMF minus small MZM: M2, institutional MMMF minus small

time deposits. time deposits. Growth rates of these aggregates do not Growth rates of these aggregates do not

always go hand in hand, making monetary always go hand in hand, making monetary policy difficult since signals are conflicting.policy difficult since signals are conflicting.

1212http://research.stlouisfed.org/publications/mt/page16.pdf

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Measuring MoneyMeasuring Money

http://research.stlouisfed.org/publications/mt/notes.pdf

M1: The sum of currency held outside the vaults of depository institutions, Federal Reserve Banks, and the U.S. Treasury; travelers checks; and demand and other checkable deposits issued by financial institutions (except demand deposits due to the Treasury and depository institutions), minus cash items in process of collection and Federal Reserve float.MZM (money, zero maturity): M2 minus small-denomination time deposits, plus institutional money market mutual funds (that is, those included in M3 but excluded from M2). The label MZM was coined by William Poole (1991); the aggregate itself was proposed earlier by Motley (1988).M2: M1 plus savings deposits (including money market deposit accounts) and small-denomination (under $100,000) time deposits issued by financial institutions; and shares in retail money market mutual funds (funds with initial investments under $50,000), net of retirement accounts.M3: M2 plus large-denomination ($100,000 or more) time deposits; repurchase agreements issued by depository institutions; Eurodollar deposits, specifically, dollar-denominated deposits due to nonbank U.S. addresses held at foreign offices of U.S. banks worldwide and all banking offices in Canada and the United Kingdom; and institutional money market mutual funds (funds withinitial investments of $50,000 or more).Bank Credit: All loans, leases, and securities held by commercial banks.Domestic Nonfinancial Debt: Total credit market liabilities of the U.S.Treasury, federally sponsored agencies, state and local governments, households, and nonfinancial firms. End-of-period basis.Adjusted Monetary Base: The sum of currency in circulation outside Federal Reserve Banks and the U.S. Treasury, deposits of depository financial institutions at Federal Reserve Banks, and an adjustment for the effects of changesin statutory reserve requirements on the quantity of base money held by depositories. This series is a spliced chain index; see Anderson and Rasche (1996a,b, 2001, 2003).Adjusted Reserves: The sum of vault cash and Federal Reserve Bank deposits held by depository institutions and an adjustment for the effects of changes in statutory reserve requirements on the quantity of base money held by depositories.This spliced chain index is numerically larger than the Board of Governors’ measure, which excludes vault cash not used to satisfy statutory reserve requirements and Federal Reserve Bank deposits used to satisfy required clearing balance contracts; see Anderson and Rasche (1996a, 2001, 2003).Monetary Services Index: An index that measures the flow of monetary services received by households and firms from their holdings of liquid assets; see Anderson, Jones, and Nesmith (1997). Indexes are shown for the assetsincluded in M2, with additional data at research.stlouisfed.org/msi/index.html.

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Measures of the Monetary Measures of the Monetary AggregatesAggregates

1515Source: http://research.stlouisfed.org/publications/mt/page4.pdf

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Reliability of the Money DataReliability of the Money Data Revisions are issued because:Revisions are issued because:

Small depository institutions report infrequentlySmall depository institutions report infrequentlyAdjustments must be made for seasonal variationAdjustments must be made for seasonal variation

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

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Growth Rate of M2: Initial and Growth Rate of M2: Initial and Revised Series, 2008 (%, annual rate)Revised Series, 2008 (%, annual rate)