Chapter 3: What is Money? ALOMAR_212_2

What is Money? Historical Preview: From barter system, gold, silver, and banknotes to paper money, checks, and credit cards. Money: different forms, still important in our life. ALOMAR_212_2

Currency: Dinar bills and coins are one type of money Definition: Anything that is generally accepted in payment for goods or services or in the repayment of debts. Money vs. Currency Currency: Dinar bills and coins are one type of money Checks, checking account deposits, are all other forms of payment for purchases ALOMAR_212_2

Income: Flow of earnings per unit of time, Money is Stock Money vs. Wealth Stocks, bonds, house … Wealth: Total collection of pieces of property that serve to store value. And it includes money. Money vs. Income Income: Flow of earnings per unit of time, Money is Stock ALOMAR_212_2

2- Functions of Money: 1- Medium of exchange: More efficient than barter system because of the transaction costs" (TC) involved. Remember, with barter system people have to satisfy "double coincidence of wants" ALOMAR_212_2

Money promotes economic efficiency by allowing people to specialize. Money promotes economic efficiency by eliminating much of transaction costs (TC) involved in exchanging goods and services. Money promotes economic efficiency by allowing people to specialize. ALOMAR_212_2

C. Divisible "easy to make change" D. Easy to curry For any commodity to function effectively as money, the following must exist: A. Standardize B. Widely accepted C. Divisible "easy to make change" D. Easy to curry E. Not deteriorate quickly. ALOMAR_212_2

2- Unit of account: used to measure value of goods and services. If we have a barter economy with 3 goods, we need 3 pieces of information to tell us how to exchange one for another (relative price) But what if we have 50 goods? N(N-1)/2 With money, all items are valued with one unit. Therefore, money reduces TC. ALOMAR_212_2

3- Store of value: Storage of purchasing power over time. Used to save purchasing power from time income is received until the time it spent. Any asset can be used is a store of value (some even pay higher interest than money, no depreciation) But why do we hold money? ALOMAR_212_2

Liquidity: the relative ease and speed with which an asset can be converted into a medium of exchange. Money is the most liquid asset of all because it dose not have to be converted into anything. ALOMAR_212_2

Depend on the price level (Inflation). It’s a medium of exchange while other assets involve TC to be converted into money. How efficient? Depend on the price level (Inflation).   ALOMAR_212_2

3- Evolution of the Payment System: The evolution of the payment system. Precious metals, paper assets, and the future? For any asset to function as money, it must be universally accepted. ALOMAR_212_2

Paper currency: that is convertible into coins and precious metals. Commodity Money: money made up of precious metals or another valuable commodity. (very heavy and difficult to transport). Paper currency: that is convertible into coins and precious metals.    Fiat Money: paper currency decreed by governments as legal tender but not convertible into coins or precious metal. ALOMAR_212_2

The problem with paper currency: easily stolen, expensive to transport large quantities. Checks: are a type of IOU payable on demand that allows transactions to take place without the need to curry currency. Read: Electronic Money (p.5557). ALOMAR_212_2

4- Measuring Money: What makes an asset money is that people believe it will be accepted by others when making payment. The Central Bank (CB) is responsible for Monetary Policy and they measure money in the economy. ALOMAR_212_2

Monetary aggregates measures of the money supply: M1: currency + demand deposits + other checkable deposits.   M2: M1 + small denomination time deposits + saving deposits and money market deposit  accounts + money market mutual fund shares M3: M2 + large denomination time deposits + money market mutual fund shares + term repurchase agreements + term Eurodollars ALOMAR_212_2

Monetary aggregates measures of the money supply: M1: currency + demand deposits + other checkable deposits.   ALOMAR_212_2

Monetary aggregates measures of the money supply: M1: currency + demand deposits + other checkable deposits.   100% Liquid ALOMAR_212_2

Monetary aggregates measures of the money supply: M1: currency + demand deposits + other checkable deposits.  M2: M1 + small denomination time deposits + saving deposits and money market deposit  accounts + money market mutual fund shares ALOMAR_212_2

Monetary aggregates measures of the money supply: M1: currency + demand deposits + other checkable deposits.  M2: M1 + small denomination time deposits + saving deposits and money market deposit  accounts + money market mutual fund shares M2 is less Liquid than M1 ALOMAR_212_2

Monetary aggregates M1: currency + demand deposits + other checkable deposits.   M2: M1 + small denomination time deposits + saving deposits and money market deposit  accounts + money market mutual fund shares M3: M2 + large denomination time deposits + money market mutual fund shares + term repurchase agreements + term Eurodollars ALOMAR_212_2

Monetary aggregates M1: currency + demand deposits + other checkable deposits.   M2: M1 + small denomination time deposits + saving deposits and money market deposit  accounts + money market mutual fund shares M3: M2 + large denomination time deposits + money market mutual fund shares + term repurchase agreements + term Eurodollars M3 is less Liquid than M2 ALOMAR_212_2

Which monetary aggregate to use? Question: Which monetary aggregate to use? ALOMAR_212_2

An Overview of the Financial System Next Lecture: Ch. 2 An Overview of the Financial System ALOMAR_212_2