What is Money?
“Money is what money does.”
“Money is a belief that has to be shared with other people….Otherwise money’s useless: you can’t eat or wear it, buy love with it (though you may broaden your chances), and you don’t take it with you when you die. Money can be anything you like-gold or silver, peas or paper, tiny shells or massive stones or nothing at all but surf on the electronic highway. But everyone must agree on what it is: we accept money because we believe others in turn will accept it too . It works because it works.”
Jason Goodwin, Greenback, page 5
What is money?Functions and Characteristics of MoneyDefinitionsCommodity Money, Fiat Money, Legal TenderMoney and PricesThe Demand for MoneyThe Money Market
Why Did Money Develop?Barter, swapping goods
and services for other goods and services, is likely to be difficultBarter requires a
coincidence of wantsTrade is unlikely if there
is no coincidence of wants
Many societies have used many things as money, including :stones shellselephant tail bristlesgold and silver coins furssalt whales’ teeth pieces of paper
Functions of MoneyMedium of exchange
Money can be used for buying and selling goods and services
Money allows society to avoid the difficulties associated with barter
Unit of accountMoney can be used to judge the relative value of
different goods and servicesMoney assists consumers and producers in making
rational decisionsStore of value
Money can be used to transfer purchasing power from the present into the future
Characteristics of “Good” MoneyDivisible
It can be broken into smaller unitsRelatively scarce
There is not as much of it as everyone wantsDurable
It lasts a long timePortable
It is easy to carryDesirable
It is something that people wantDistinguishable
It is easy to recognize and difficult to fake
Money Definitions
M1M2
Money Definitions – M1M1 is the “narrowest” definition of money in the
United StatesM1 includes:
Currency (coins and paper money) in the hands of the public
All checkable deposits (all deposits in commercial banks and savings institutions on which checks of any size can be drawn).
Traveler’s checks
M1= $1.386 trillion (as of June 2008)
More on the Components of M1
Coins and Paper MoneyCoins represent 2-3% of M1Paper currency represents a little less that
50% of M1U.S. coins in circulation are token money
because the value of the metal in the coin is worth less that the value of the coin
All paper money is in the form of Federal Reverse Notes
There is more than $750 billion in currency in circulation
More on Components of M1
Checkable depositsCheckable deposits represent slightly
less than 50% of M1Checks represent a convenient, safe
way of transporting money and making payments
People can generally convert checkable deposits quickly into paper money and coin, therefore checks drawn on these deposits are viewed as equivalent to currency
Money Definition – M2
M2 is a “broader” definition of money and includes M1, plus a number of “near-monies”Savings deposits, including money market
accounts (MMA)Small (less than $100,000) time deposits (CD’s)Money market mutual funds (MMMF’s)
These “near-monies” can be easily converted into currency
M2= $7.666 Trillion (as of 2008)
Commodity MoneyAnything that serves as money
and has an alternative use Corn, tobacco, and salt are some
examples of commodities that have been used as money at different times and places
Precious metal have also been used as commodity
Fiat MoneyAny item without intrinsic value, which has
been declared to be money by the governmentFederal Reserve Notes are fiat money; they
have no intrinsic value
"Fiat money is similar to representative money except it can't be redeemed for a commodity, such as gold or silver. The Federal Reserve notes we use today are an example of fiat money." [
Legal TenderFederal Reserve notes are legal tender
Legal tender means that paper currency must be accepted in payment of a debt, or else the creditor forfeits the privilege of charging
Coins and checks are not legal tender, yet they are widely excepted.
Money and PricesInflation is a rise in the general level of
pricesDisinflation is a reduction in the level of
inflationDeflation is a decline in the general level
of pricesWe CAN MEASURE THE GENERAL LEVEL OF PRICES WITH THE CONSUMER PRICE INDEX (CPI)
Money and PricesVery high levels of
inflation can result in a breakdown in
money’s function as a medium of exchange
A breakdown in money’s function as a store of value
A breakdown in money’s function as a unit of account
The Demand for MoneyTransactions Demand for Money
People hold money because it is convenient for purchasing goods and services
Transactions demand for money varies directly with nominal GDP
Asset Demand for Money People hold their financial assets in many forms including
corporate stock, bonds, and money Asset demand varies inversely with interest rates