Chapter 2: Learning Objectives Functions and Efficiency of Money: from Barter to Monetary Exchange How should we Define Money? Canadian measures Monetary Standards & Systems: Types and Historical Experiences Consequence of Fiat Money: The Costs of Inflation

The Functions of Money Medium of Exchange How transactions are conducted Medium of account How the value of goods & services are denominated Store of value and a standard of deferred payment How the value of goods & services are maintained in monetary terms

Monetary Standards Commodity money Gold, Silver, and Bimetallic standards Gresham’s Law Fiat money Paper money standard Canada’s early paper money history The introduction of central banking

The Measurement of Money Taking an Empirical approach Institutional aspects: chartered vs. other types of financial institutions types of deposits and their evolution: the growth of electronic transactions (Table 2.1)

Transactions Data

The Measurement of Money Taking an Empirical approach Institutional aspects: chartered vs. other types of financial institutions types of deposits and their evolution: the growth of electronic transactions (Table 2.1) monetary aggregates: definitions and data Table 2.2 & Figure 2.1

The Canadian Money Supply: Key Measures, August 2004 TABLE 2.2 M1: Cash and demand deposits $162,368 M2: M1& savings deposits $623,318 M3: M2 & term deposits $868,017 M2+: M2 & other deposit-taking institutions $872,466 M2++: M2+ & MMMF and CSBs $1,262,935

Major Canadian Money Supply Aggregates

Currency in Circulation: Seasonally adjusted or unadjusted

The Measurement of Money Taking an Empirical approach Institutional aspects: chartered vs. other types of financial institutions types of deposits and their evolution: the growth of electronic transactions (Table 2.1) types of financial assets seasonal adjustment (Figure 2.2) Other refinements

Inflation Versus Deflation There are 2 types of inflation/deflation: Anticipated: there are NO surprise changes in prices Unanticipated: SOME price changes are NOT expected Most inflations/deflations are NOT FULLY anticipated

The Costs of Inflation Creditor vs. lenders: real interest rate effect Seigniorage: the profit from printing money “Shoe-leather” costs: frequent need for more cash Tax implications: paying tax on inflation “Menu” costs: cost of frequent price changes Accounting problems: historical vs current costs inflation level and volatility: positively related Inflation and Economic growth: negatively related

What’s Special About Deflation? When prices fall the REAL value of debt rises Debtors are penalized; borrowers benefit When prices fall EXPECTATIONS of additional reductions are possible Consumers postpone purchases with further negative economic implications If monetary policy responds by lowering interest rates they could fall to zero At zero (nominal) interest rates cannot become negative This is called the “zero lower bound”

Summary Monetary systems are more efficient than barter systems Money has 3 functions medium of exchange medium of account store of value Canadian definitions of the money supply include M1, M2, M2+, M3 Excessive monetary expansion leads to inflation which is socially costly Deflation is the opposite of inflation and can produce serious negative economic consequences