6 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
7 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?
8 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
9 Functions of Money Unit of Accounting A measure by which prices are expressed The common denominator of the price system A central property of money A 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.
10 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.
11 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
13 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.
14 The Functions of Money Question: What is the cost of holding money? Answer: The loss of interest you would receive in a bank
15 Monetary Standards, or What Backs Money Questions What backs money? Is it gold, silver, or the federal government? Answer Confidence
16 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.
17 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”
18 Defining the U.S. Money Supply The Transaction Approach: M1 1) Currency 2) Checkable (transaction) deposits 3) Traveler’s checks
19 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?
20 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
21 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
22 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?
23 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
24 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
25 Defining the U.S. Money Supply Near Monies Assets that are almost money Highly liquid
26 Defining the U.S. Money Supply M2 Savings Deposits Interest-earning funds that can be withdrawn at any time without payment of a penalty
27 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
28 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
29 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
30 Defining the U.S. Money Supply M2 Eurodollar Deposits Deposits denominated in U.S. dollars but held in banks outside the United States
31 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
32 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.
33 M1 and M2 Figure shows two measures of money. M1 Currency and traveler’s checks Checkable deposits
35 M1 and M2 M2 M1
36 M1 and M2 Savings deposits M2 M1 Money market funds and other deposits Small time deposits
38 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?