Introduction This lecture examines the definition of money. What is meant by money? Why is it important that we define it correctly? What are the problems associated with measuring money
Financial Innovation & Deregulation Global markets have seen financial innovation and deregulation. This has led to the breakdown in the traditional relationships between the measures of money and economic activity. This has raised the issue as to what is meant by money.
Definition - a procedure One of two procedures. Attach labels to real world objects - Nominalist. Attach labels to concepts and then search for the corresponding real world entity - Empiricist.
Characteristics of Money Medium of Exchange - (concrete) Unit of Account - (abstract) Store of Value. Nothing is more ultimate than money. Instead of going out of existence, unwanted money gets passed around until it ceases to be unwanted Yeager
Artificial historical framework Commodity money - problem of jointness Localised issue - reputation Government issue - legal tender
Forms of money No generalised market for titles - (Paul Davidson) Legal restrictions - (Neil Wallace) Means of Final Payment - (Charles Goodhart)
Liquidity Separation of money from other assets is its superiority in liquidity potential to liquidate - use in transactions term to maturity - low capital risk
Pesek and Saving -1 Money is contrasted with debt. Debt pays interest while money does not. Debt is Inside money Non-interest bearing deposits are an asset to the holder but a liability to no one, while interest bearing deposits are a debt like a bond
Pesek and Saving - 2 Interest payment on deposits loses its property of moneyness Demarcation between money and debt moneyness measured by (r d -r m ) debtedness measured by r d
Critique Friedman & Schwartz - transactions services have become a free good, available without cost to the holder moneyness is a joint product with debtedness Newlyn suggests - criterion of neutrality
Empirical measures - Constant Elasticity of Substitution technology
Divisia - 1 d i - rate of growth of the i th medium of exchange D i - stock of the ith medium of exchange marginal cost = interest income foregone = user cost of money w i = D i U i and U i = R max - R i
Conclusion The definition of money has become important for 2 reasons 1 Trends in financial innovation have blurred the distinction between money and non-money 2 measuring money is important for policy
How can the emergence of money be explained? Money must emerge as an optimal exchange system from a world of barter. What are the specific properties of money that make its use general? Money is a social phenomenon - exists only in societies where exchange takes place.
Classical View Money exists on efficiency grounds. The problem of double coincidence of wants The search for a trading partner involves costs. The longer the search time the lower the transaction cost. But the longer the search time, the higher the waiting cost
A Dynamic Model by Niehans - Assumptions All exchanges involve transactions costs lower transactions costs involved with using good x n The greater the frequency of exchange, the lower the transactions cost.
Efficiency gain for n good world Trades with barter Trades with money
Clower – Cash in Advance Model Goods buy money Money buys goods But goods do not buy goods How can the Classical transactions costs approach give us Clowers result?
Evolution of Money By assumption 1 – all transactions incur costs By assumption 2 – a) x 3 Ex 2 and b) x 1 Ex 3 incur lower costs than c) x 1 Ex 2 Therefore a) and b) will be more frequent than c) By assumption 3 the costs of a) and b) will fall relative to c) In the limit c) dissappears