module 23-functions of money and the money supply j.a.sacco

Module 23-Functions of Money and the Money Supply

J.A.SACCO

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Module Outline

The Functions of Money

Monetary Standards, or What Backs Money

Defining the U.S. Money Supply

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Did You Know That...

The typical dollar bill changes hands 50 times a year?

Cash, of course, is not the only thing we use as money.

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Money

Money Anything that people generally accept in

exchange for goods and services

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Types of Money

Iron Boar tusk Playing cardsCopper Red woodpecker scalps LeatherBrass Feathers GoldWine Glass SilverCorn Polished beads (wampum) KnivesSalt Rum PotsHorses Molasses BoatsSheep Tobacco PitchGoats Agricultural implements RiceTortoise shells Round stones with centers removed CowsPorpoise teeth Crystal salt bars PaperWhale teeth Snail shells Cigarettes

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The Functions of Money

The functions of money are:1) Medium of exchange

2) Unit of accounting

3) Store of value (purchasing power)

4) Standard of deferred payment

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The Functions of Money

Medium of Exchange Any asset that sellers will accept as payment

Barter The direct exchange of goods and services for

other goods and services without the use of money

Advantages of Money over Bartering?

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The Functions of Money

Medium of Exchange- Advantages over Bartering Money reduces transactions costs

Means-of-payment uncertainty Eliminates problem of the double coincidence of

wants Makes specialization easier

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Functions of Money

Unit of AccountingA measure by which prices are expressedThe common denominator of the price systemA central property of moneyA unit of accounting is an agreed-upon measure for stating the prices of goods and services.Table shows how a unit of account simplifies price comparisons.

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The Functions of Money

Store of Value A store of value is any commodity or token

that can be held and exchanged later for goods and services.

The more stable the value of a commodity or token, the better it can act as a store of value and the more useful it is as money.

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The Functions of Money

Standard of Deferred Payment A property of an asset that makes it desirable

for use as a means of settling debts maturing in the future

An essential property of money

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Characteristics of Money

Portability

Uniformity

Acceptability

Durability

Divisibility

Stability

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The Functions of Money

Liquidity The degree to which an asset can be acquired or

disposed of without much danger of any intervening loss in nominal value and with small transaction costs

Money is the most liquid asset.

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The Functions of Money

Question: What is the cost of holding money?

Answer: The loss of interest you would receive in a bank

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Monetary Standards,or What Backs Money

Questions What backs money? Is it gold, silver, or the federal government?

Answer Confidence

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Monetary Standards,or What Backs Money

Fiduciary Monetary System (Fiat Money)

Objects that are money because the law decrees or orders them to be money. The currency is issued by the government and

its value is based uniquely on the public’s faith that the currency represents command over goods and services.

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How Do You Measure Money?

Two Methods

M1-Transaction Approach “money as a medium of exchange”

M2- Liquidity Approach“money as a temporary store of value”

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Defining the U.S. Money Supply

The Transaction Approach: M11) Currency

2) Checkable (transaction) deposits

3) Traveler’s checks

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Defining the U.S. Money Supply

M1 Currency

Minted coins and paper currency not deposited in financial institutions

Largest percentage of M1 2/3 held by foreigners a change since the 1990’s

WHY?

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Defining the U.S. Money Supply

M1 Checkable Deposits

Any deposits in a thrift institution or a commercial bank on which a check may be written

Thrift Institution Financial institutions that receive most of their

funds from the savings of the public

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Defining the U.S. Money Supply

M1 Travelers Checks

Financial instruments purchased from a bank or a nonbanking organization and signed during purchase that can be used as cash upon a second signature by the purchaser

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Defining the U.S. Money Supply

M1

Currency- 53.9%/ $759.6 B.

Checkable/Demand Deposits- 45.6%-$642.3B.

Travelers Checks- .5%- $6.3B.

Does this seem too little?

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Defining the U.S. Money Supply

Are Credit Cards Money? NO!- Defer rather than complete transactions

Are Debit Cards Money? NO!- Instruction to bank to transfer funds

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Defining the U.S. Money Supply

The Liquidity Approach: M2 M2 = M1 + (near money) savings deposits and

small denomination time deposits+ overnight repurchase

agreements+ overnight Eurodollars deposits+ retail money market mutual funds+ money market deposit accounts

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Defining the U.S. Money Supply

Near Monies Assets that are almost money Highly liquid

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Defining the U.S. Money Supply

M2 Savings Deposits

Interest-earning funds that can be withdrawn at any time without payment of a penalty

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Defining the U.S. Money Supply

M2 Time Deposit

A deposit in a financial institution that requires notice of intent to withdraw or must be left for an agreed period.

Early withdrawal may result in a penalty Certificates of Deposit

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Defining the U.S. Money Supply

M2 Money Market Deposit Accounts (MMDAs)

Accounts issued by banks yielding a market rate of interest with a minimum balance requirement and a limit on transactions

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Defining the U.S. Money Supply

M2 Repurchase Agreement (REPO, RPs)

An agreement made by a bank to sell Treasury or federal agency securities to its customers, coupled with an agreement to repurchase them at a price that includes accumulated interest

Allows businesses to dump excess cash instead of leaving in non-interest bearing accounts

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Defining the U.S. Money Supply

M2 Eurodollar Deposits

Deposits denominated in U.S. dollars but held in banks outside the United States

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Defining the U.S. Money Supply

M2 Money Market Mutual Funds

Funds of investment companies that obtain funds from the public that are held in common and used to acquire short-maturing credit instruments

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Review M1 and M2

Official Measures of Money: M1 and M2

M1 Currency and traveler’s checks plus checkable deposits

owned by individuals and businesses.

M2 M1 plus savings deposits and small time deposits,

money market funds, and other deposits.

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M1 and M2

Figure shows two measures of money.

M1

• Currency and traveler’s checks

• Checkable deposits

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M1 and M2

M2

• M1

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M1 and M2

• Savings deposits

M2

• M1

• Money market funds and other deposits

• Small time deposits

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M1 or M2?

You receive a cash gift of $500 from a rich uncle.

You open a checking account with a deposit of $400, the money you earned over the summer.

You receive $600 from the sale of a painting and deposit the money in a savings account.

You purchase a $50 U.S. savings bond.

You write a check to pay for your college tuition.

If you totaled the M1 and the M2, which would be greater? Is this always true?