© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Chapter 2 Money and the Payments System

2-2 Money and the Payments System The Big Questions 1.What is money? 2.How do we use money? 3.How do we measure money?

2-3 Money and the Payments System A Roadmap Money and how we use it The Payments System The Future of Money Measuring Money

2-4 Money: The Definition Money is an asset that is generally accepted as payment for goods and services or repayment of debt.

2-5 Money: Characteristics 1.Means of payment Used in exchange for goods & services 2.Unit of account Used to quote prices 3.Store of value Used to move purchasing power into the future

2-6 Money: How We Pay for Things (I) Commodity Money: Objects with intrinsic value Fiat Money : Value comes from government decree (or fiat) Checks: Instructions to the bank to shifts funds from your account to that of the person or firm whose name is written in the “Pay to the Order of” line.

2-7 The Path of a Paper Check

2-8 Checks are legal proof of payment Customers wanted them back Starting in 2004 –Banks can transmit digital images –Substitute checks are proof of payment Paper checks are now disappearing

2-9 Money: How We Pay for Things (II) Credit Cards Debit Cards Electronic Funds transfers especially automated clearing house (ACH transactions) Stored Value Cards E-Money

2-10 Debit cards: –Like a check –Electronic message to your bank to transfer funds immediately Credit cards: –Deferred payment –Issuer makes payment for you –You have to pay it back

2-11 Scan the numbers at the bottom of the check. Check Conversion: Turns a check into an ACH transaction Similar to using a debit card

2-12 The Future of Money Which function of money will be with us for a long time? –Means of payment: disappearing –Unit of account: likely to remain –Store of value: disappearing

2-13 Technological advances create new methods of payment. Cell phones and other types of hand- held mobile devices are providing access to the payments system. What will be next?

2-14 Measuring Money Changes in the quantity of money are related to –Interest Rates –Economic Growth –Inflation How do we measure money?

2-15 Inflation and the Inflation Rate Inflation: The rate at which the general price level is increasing over time Inflation rate: The measure of the inflation process

2-16 Liquidity: Definition Liquidity a measure of the ease an asset can be turned into a means of payment (Money).

2-17 The Liquidity Spectrum

2-18 Measuring Money Different Definitions of money are based upon degree of liquidity. M1: Narrowest definition Only most liquid assets M2: Broader definition Includes assets not used as means of payment.

2-19 Monetary Aggregates

2-20 Growth Rates in M1 and M2

2-21 Money Growth and Inflation

2-22 Money Growth and Inflation When inflation is high, money growth helps forecast inflation. When inflation is low, the relationship is not as close.

2-23 In 2007 there was $2500 of U.S. currency in circulation for each U.S. resident. As much as 2/3rds of this is abroad

2-24 The CPI answers the question: "How much more would it cost for people to purchase today the same basket of goods and services that they actually bought at some fixed time in the past?“

2-25 Computing CPI Inflation –Survey people to see what they bought –Figure out what it would cost to buy the same basket of goods & service today. –Compute the percentage change in the cost of the basket of goods.

2-26 Measures of Inflation Fixed-weight Index - CPI Deflator – GDP or Personal Consumption Expenditure Deflator Chain-weight index – Half way between fixed-weight and a deflator.

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Chapter 2 End of Chapter