Copyright 2008 Pearson Addison-Wesley. All rights reserved. Chapter 2 Money and the Payments...

Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Chapter 2

Money and the Payments System

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-2

Meeting the Needs of Exchange

• 3 methods to gain the efficiency benefits of specialization include barter, government allocation, and money

• Money can help people benefit from specialization without incurring the high trading costs of barter or the misallocations of government allocation


Figure 2.1 Methods of Exchange


Functions of Money

• Medium of exchange• Unit of account • Store of value• Standard of deferred payment


Criteria for Medium of Exchange

• Acceptable to most traders• Standardized quality• Durable• Valuable relative to its weight• Divisible


Payments Systems

• Commodity money– Physical goods (precious metals) by which trade was accomplished

• Fiat money– Money authorized by a central bank is the definitive money and

doesn’t have to be exchanged for gold or commodity money

• Checks– Promises to pay definitive money on demand, drawn on money

deposited in a financial institution

• Electronic funds– Computerized payment-clearing


Measuring the Money Supply

• To understand money’s role as an economic variable, we need to measure it.

• Definitions of the money supply are based o the assets included as money and depend on how substitutable different assets are for money.

• Liquidity refers to the cost at which an asset can be converted into definitive money.


Monetary Aggregates

• The Federal Reserve has developed 3 definitions of money that include assets broader than currency, called monetary aggregates:M1M2Broader monetary aggregates


Figure 2.2 Measuring Monetary Aggregates, February 2006


Selecting Monetary Aggregates

• M2 currently considered best.• Aggregates move broadly together over

long time periods.• Some significant differences in monetary

aggregate movements have occurred during certain periods

• The different monetary aggregates give a different picture of movements in the money supply over time.


Figure 2.3 Growth Rates of M1 and M2, 1960-2006

Copyright 2008 Pearson Addison-Wesley. All rights reserved. Chapter 2 Money and the Payments...

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