2. MONEY Definition of money –the part of wealth used to facilitate transactions Note that in economics, money has a different meaning than expressions like: “She makes a lot of money” “We’re cash. We’re cash. We’re money” Consider some examples of money –examples: commodity money and paper money –

3. Stone money of Yap Island

4. Ancient Chinese bronze money

7. A100 billion mark note!! German Reichsbank, 1923 !!

8. Most of money today consists of deposits at banks Money supply = currency + deposits M1 = currency plus checking deposits M2 = M1 plus time deposits, savings deposits difficult to determine which is the best measure of money

9. Three functions of money medium of exchange store of value unit of account

10. General principle of monetary economics A higher rate of money growth ultimately causes higher inflation, ceteris paribus –check intuition with case of commodity money

11. Quantity equation of money MV = PY where M = money supply, P = price level, Y = real GDP, and V = velocity = PY/M growth rate form of quantity equation money growth + velocity growth = inflation + real GDP growth –examples 4 +.5 = 2 + 2.5 –Change 8 +.5 = 6 + 2.5

12. What is the empirical evidence? Does the quantity equation of money work? Very well for big changes of over long run –The German hyperinflation,1923 (see graph) –American revolutionary war –Great Inflation of the 1970s (see graph) –Russia, Argentina and Brazil –Take a careful look at the G-7 graph Less reliable in the short run –Difficult to measure money –Changes in M will affect Y

13. Inflation in Germany, 1923

15. Money growth and inflation 1973-1991

16. Long run versus short run effect of changes in money growth Inflation does not usually increase right away –takes more than a year In the meantime, other things are affected –employment, production Makes money a difficult public policy issue, –money has long been central in political debates, as the following video nicely illustrates

17. When he gets to Washington how the Democrats will run. For Republicans McKinley leads the way. What a glory that will be. We’ll regain prosperity, when McKinley and protection win the day

18. We will answer their demands for a gold standard by saying to them: You shall not press down upon the brow of labor this crown of thorns. You shall not crucify mankind on a cross of gold.

19. Sound the good old bugle with the bimetallic ring. Silver free from sea to sea with lusty voices sing. Our banner with its silver stars, the waving breezes fling. Marching with Bryan to victory.

20. Lessons from this piece of American history An economic issue became a great political issue to run on Increasing money growth by coining silver would be more inflationary than the gold standard--and people knew it! Increase in inflation was attractive to some Democrats (debtors versus creditors) Several years later legislation was passed to establish a central bank in the United States

21. The Central Bank The agency of government given responsibility of controlling the money supply--we will see how next time. In the United States, the central bank is the Federal Reserve System: –Simply called the Fed –Has a great degree of independence Let’s check it out on the web

24. END OF LECTURE