Lecture 2 chapter 3 what is money

dollar and coins • A rather broad definition: – such as savings deposits can in effect function as money if they can be quickly and easily converted into currency or checking account dep

UNIVERSITY OF FINANCE-MARKETING

The Economics of MBFM

Lecture-2

Chapter 3: What is Money?

Lecturer: Sumit, Ph.D.(in progress), MPA, MFC, NCFM, PGDPM

Today’s Lecture

• Meaning of money

• Function of money

– Medium of Exchange

– Unit of account

– Store of value

• Evolution of the payment system

– Commodity, money

– Flat money

– checks

– E-payment

– E-money

• Measuring money

– The Federal Reserve’s Monetary Aggregates

Meaning of Money

• What is it?

– Money (or the “money supply”): anything that is generally accepted in payment for goods or

services or in the repayment of debts E.g dollar and coins

• A rather broad definition:

– such as savings deposits can in effect function as money if they can be quickly and easily converted into currency or checking account deposits

Meaning of Money (cont’d)

• There is difference between money and currency

• Money (a stock concept) is different from:

– Wealth: the total collection of pieces of property,

stock, bonds cars etc that serve to store value

– Income: flow of earnings per unit of time

(a flow concept)

• Money discussed in subject refers to anything that is generally accepted in payment for goods and services or in the repayment of debts and is distinct from income and wealth

Functions of Money

• Medium of Exchange:

– Eliminates the trouble of finding a double

coincidence of needs(barter system: e.g economic

lecturer) (reduces transaction costs: time spent to exchange G/S)

– Promotes specialization(what they do best)

– A medium of exchange must

• be easily standardized(its value)

• be widely accepted

• be divisible(make change)

• be easy to carry

• not deteriorate quickly

Functions of Money (cont’d)

• Unit of Account:

– Used to measure value in the economy(parking ticket 5k Dong

and food 50k Dong)

– Reduces transaction costs(by reducing no of price e.g barter

system= 1 chicken≈2kg pork so need more chick if more pork )

• Store of Value:

– Used to save purchasing power over time.

it, but rather prefer to wait until we have the time or the desire to shop

– Other assets also serve this function not only money:

• Stocks, bonds, land, houses, art, or jewelry—can be used to store wealth Many such assets have advantages over money as a store of value: lender receives interest

– Money is the most liquid of all assets but loses value during

inflation(next ppt.)

Function of money(contd.)

• Hyperinflation occurred in

Germany after World War I

By the end of the

hyperinflation in 1923, the

price level had risen to more

than 30 billion times what it

had been just two years

before The quantity of

money needed to purchase

even the most basic items

became excessive Money

was losing its value so

rapidly that workers were

paid and given time off

several times during the day

to spend their wages before

worthless

Evolution of the Payments System

• Objective to function as money must be

universally accepted

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

– Problem: very heavy.

• Next development- Fiat Money:

– paper money decreed by governments as legal tender

– Problem: easy to be stolen

Evolution of the Payments System

(cont’d)

• Development of modern banking: Checks:

– an instruction to your bank to transfer money

from your account

– Problem: time taking process and check processing

costly

• Electronic Payment (e.g online bill pay).

– Debit card, credit card, smart card, e-cash(web)

Measuring Money

• What makes an asset money is that people believe it will be accepted by others when making payment

• How do we measure money? Which particular assets can be called “money”?

– The Federal Reserve System (the Fed), the central banking authority responsible for monetary policy in the United States, has conducted many studies on how to measure money & has settled

on the following measures of the money supply, which are also

referred to as monetary aggregates(ppt.12)

• Construct monetary aggregates using the concept of liquidity:

– M1 (most liquid assets) = currency + traveler’s checks + demand deposits + other checkable deposits

• These are clearly money as can be used directly medium of exg.

Measuring Money (cont’d)

• M2 (adds to M1 other assets that have check-writing features) = M1 + money market deposit accounts and money market mutual fund shares + savings deposits, small-denomination time deposits and repurchase agreements (extremely liquid, because they can be turned into cash quickly at very little cost)

• M3 monetary aggregate adds to M2 +large-

denomination time deposits +repurchase agreements +Eurodollars +institutional money market mutual fund shares.

– somewhat less liquid assets

Table 1 Measures of the Monetary

Aggregates

M1,M2 and M3

• Figure 1 plots the growth rates M1, M2, and M3 from 1960 to 2002 The growth rates of these three monetary aggregates do tend to move together; the timing of their rise and fall

is roughly similar until the 1990s, and they all show a higher growth rate on average in the 1970s than in the 1960s

• Conclusion: the choice of monetary aggregate

is important for policymakers

Figure 1 Growth Rates of the M1, M2

and M3 Aggregates, 1960–2005

Sources: Federal Reserve Economic Database (FRED); Federal Reserve Bank of Saint Louis;

http://research.stlouisfed.org/fred2/categories/25

If you have any question, please

feel free to ask