What is Money?
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1 “ “ Money is whatever is generally Money is whatever is generally accepted in exchange for goods accepted in exchange for goods and services and services — — a temporary a temporary abode of purchasing power to abode of purchasing power to be used for buying still other be used for buying still other goods and services.” goods and services.” -- Milton Friedman -- Milton Friedman
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“Money is whatever is generally accepted in exchange for goods and services — a temporary abode of purchasing power to be used for buying still other goods and services.” -- Milton Friedman. What is Money?. Money is … - PowerPoint PPT Presentation
Transcript of What is Money?
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““Money is whatever is generally Money is whatever is generally accepted in exchange for goods and accepted in exchange for goods and services services — — a temporary abode of a temporary abode of purchasing power to be used for purchasing power to be used for buying still other goods and buying still other goods and services.”services.”
-- Milton Friedman-- Milton Friedman
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What is Money?
Money is …– anything generally acceptable to
sellers in exchange for goods and services.
– a liquid asset is that can easily (i.e., quickly, cheaply, conveniently) be exchanged for goods and services.
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Functions of Money Medium of exchange Unit of account
–Standard of Deferred Payment Store of value
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Money: A Medium of ExchangeMoney: A Medium of ExchangeMoney as a medium of exchange lowers
transactions costs.Trade without money, directly exchanging
goods for goods, is barter.– Barter requires a double coincidence of
wants – Barter is time-consuming and costly.
A medium of exchange must be:– Widely accepted for payment– Portable– Divisible
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Money: A Unit of Account
Money is a common unit of measurement.–Allows us to compare the values of
dissimilar things.–Makes accounting possible.– Lowers information costs.
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Money: A Standard of Deferred Payment
Debt is denominated in money terms.– The standard for repayment is
money.There is a difference between money
and credit:–Money is what you use to pay for
goods and services.–Credit is debt, something you owe.
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Money: A Store of Value = WealthMoney: one possible way to carry
buying power forward into the future.– For money to be a store of value, it
must be durable retain value over time.
– Inflation reduces the effectiveness of money as a store of value.
– High inflation can lead to currency substitution• the use of foreign money as a substitute
for domestic money dollarization
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M1 Money Supply: Means of Payment
– Currency … the bills and coins we use.– Demand Deposits / Other Checkable
Deposits … can be converted into currency and are
used to settle debts.– Travelers Checks … accepted in
payment for things
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In 2003, currency was 52% of M1.U.S. currency is not backed by gold It is backed by the confidence and trustconfidence and trust
of the public. • It is a fiduciary monetary system.
(“Fiducia” means “trust”“trust” in Latin.)– Money backed by gold or silver (or
something else) is commodity money.• Gresham’s Law: if two coins have the same face
value but different intrinsic (commodity) values, the cheaper coin will be used and the other coin will be hoarded.
• “Bad money drives out good.”
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M2: A Broader Definition of Money
M2 includes everything in M1Adds:– Savings deposits– Small denomination time deposits
(CDs)–Retail money market mutual funds
M2 adds to M1 less liquid assets that can easily be converted to M1 (means of payment)
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Financial Intermediaries That Hold Our Money
1) Commercial banks2) Savings and loan associations3) Savings banks and credit unions4) Money market mutual funds
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U.S. Depository InstitutionsU.S. Depository Institutions
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Deposit InsuranceBank panicBank panic: depositors fearfear a bank
will fail rushrush to withdraw their $$ bank failsbank fails
Federal Deposit Insurance Corporation (FDIC – 1933) –A federal agency that insures bank
deposits so that depositors do not lose their deposits if a bank fails.
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Bank FailuresBank Failures
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International Banking
Eurocurrency market or “offshore banking– A German firm may deposit Euros in a Tokyo
bank– A U.S. firm may borrow dollars from a bank in
London. International Banking Facilities (IBFs)
– a division of a U.S. bank that receives deposits from and make loans to nonresidents of the U.S. without the restrictions that apply to domestic U.S. banks.
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Fractional Reserve Banking
Banks keep less than 100 percent of deposits available for withdrawal.– They lend out the rest–An outgrowth of goldsmith
practices.
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How Banks Create Money
Reserves: Actual and Required– Reserve ratio: the fraction of a bank’s
total deposits that are held in reserves.– Required reserve ratio: • must be kept on hand or on deposit
with the Federal Reserve (the U.S. Central Bank)
– Excess reserves are the cash reserves beyond those required
– Excess reserves can be loaned.
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Multiple Creation of Bank Deposits M1
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How Banks Create Money
Deposit Expansion Multiplier =1
Reserve Requirement (ratio)
