Money in Today’s World—An Introduction Chapter 1 Unit l Introduction PowerPoint Presentation by Charlie Cook The University of West Alabama

Fundamental Issues How have financial globalization and cybertechnologies acted together to alter the economic roles of banking institutions and money? What functions does money perform? How has money evolved? What are monetary aggregates, and how are they constructed? How do changes in payments technologies affect our definitions of money? © 2006 Thomson Business and Professional Publishing. All rights reserved.

Why should I take this course? For econ majors, this course relates to macroeconomics, international trade, and growth and development For business majors, constantly will be confronted with financial decisions For all other majors, we are all affected by the monetary system: you have checking accounts, will likely buy insurance, have mutual funds, etc. © 2006 Thomson Business and Professional Publishing. All rights reserved.

The Globalization of Money, Banking, and Financial Markets Changes in the diverse markets in which multinational firms operate affect the financial institutions that serve those firms. The blending of domestic and global financial markets has increased international competition among financial institutions. © 2006 Thomson Business and Professional Publishing. All rights reserved.

Money and Banking in the Digital Age Cybertechnologies: Technologies that connect savers, investors, traders, producers, and governments via computer linkages. © 2006 Thomson Business and Professional Publishing. All rights reserved.

Money and Banking in the Digital Age Implications of cybertechnologies: Major changes for both banks and their customers: more online banking, customers will have more services on their home computers Policymakers are affected: the nature of money is changing, what kinds of new regulations will be needed? © 2006 Thomson Business and Professional Publishing. All rights reserved.

Money: Its Functions, Forms, and Evolution Money: what is it? Any item that people are generally willing to accept in exchange for goods, services, and financial assets such as stocks or bonds. Anything that functions as a medium of exchange, store of value, unit of account, and standard of deferred payment. © 2006 Thomson Business and Professional Publishing. All rights reserved.

Money’s Functions Medium of exchange: Store of value: A fancy way of saying that money can be used as a means of payment to buy the things we want. This avoids the need for barter, which is the direct exchange of goods, services, and financial assets for one another. Barter is a very costly activity—why? Store of value: Can be held for future use without loss of value in the meantime. © 2006 Thomson Business and Professional Publishing. All rights reserved.

Money’s Functions Unit of account: Standard of deferred payment: Is recognized as a measure of the value of goods, services, and financial assets. Prices are stated in terms of money, for example in dollars. Standard of deferred payment: Is a means of valuing future receipts in loan contracts. © 2006 Thomson Business and Professional Publishing. All rights reserved.

Methods of Exchange and the Evolution of Money Barter and the double coincidence of wants: Before money there was barter: trading products for products. This requires a double coincidence of wants, which means two individuals are simultaneously willing and able to make a trade; we each have what the other wants. Commodity money: A good with a nonmonetary value that is also used as money. © 2006 Thomson Business and Professional Publishing. All rights reserved.

Methods of Exchange and the Evolution of Money Commodity standard: A money unit whose value is backed by the value of another physical good such as gold or silver. © 2006 Thomson Business and Professional Publishing. All rights reserved.

Different Types of Commodity Moneys Iron Corn Whale teeth Round stones with Copper Salt Boar tusks centers removed Brass Crystal salt bars Red woodpecker scalps Knives Gold Horses Feathers Pots Silver Sheep Leather Boats Wine Goats Pitch Slaves Rum Cows Glass Paper Molasses Tortoise shells Polished beads Playing cards Tobacco Snail shells (wampum) Cigarettes Rice Porpoise teeth Agricultural implements © 2006 Thomson Business and Professional Publishing. All rights reserved. Table 1–1

Methods of Exchange and the Evolution of Money Fiat money: A token that has value only because it is accepted as money. (most money today is fiat money) Electronic money (e-money): Money that people can transfer directly via electronic impulses. © 2006 Thomson Business and Professional Publishing. All rights reserved.

Commodity Money Standards Purchasing power of money: The value of money in terms of the amount of real goods and services it buys. Gold standard: A monetary system in which the value of money is linked to the value of gold. Bimetallic standard: A monetary system in which the value of money depends on the values of two precious metals, such as gold and silver. © 2006 Thomson Business and Professional Publishing. All rights reserved.

Commodity Standards Gold bullion: Monetary base: Within a gold standard, the amount of gold used as money. Monetary base: A “base” amount of money that serves as the foundation for a nation’s monetary system. Under a gold standard, the amount of gold bullion is the monetary base In a fiat money system, the sum of currency in circulation plus reserves of banks and other depository institutions is the monetary base. © 2006 Thomson Business and Professional Publishing. All rights reserved.

The Use Of Coins Seigniorage: Debasement: The difference between the market value of money and the cost of its production, which is gained by the government that produces and issues the money. Debasement: A reduction in the amount of precious metal in a coin that the government issues as money. © 2006 Thomson Business and Professional Publishing. All rights reserved.

The Move to Fiat Money After 1971, the U.S. renounced the gold standard. Other nations followed. In some countries that have resorted to excess printing of money, this has led to high rates of inflation. E-Money Perhaps the future of money, uses microchips to store money values. Check out http://www.e-gold.com/ © 2006 Thomson Business and Professional Publishing. All rights reserved.

Money in Circulation: what do we count? Liquidity: The ease with which an asset can be sold or redeemed for a known amount of cash at short notice and at low risk of loss of nominal value. Monetary aggregate: A grouping of assets sufficiently liquid to be defined as a measure of money. © 2006 Thomson Business and Professional Publishing. All rights reserved.

The Monetary Base Currency: Depository financial institutions: Coins and paper money. Depository financial institutions: Financial institutions that issue checking and savings deposits that are included in measures of money and that legally must hold reserves on deposit with Federal Reserve banks or in their vaults. Reserves: Cash held by depository institutions in their vaults or on deposit with the Federal Reserve System. Monetary base equals currency plus these reserves. © 2006 Thomson Business and Professional Publishing. All rights reserved.

M1: A Basic Definition of “Cash” Currency, traveler’s checks, and transactions deposits. Transactions deposits (checking accounts): Demand deposits: Non-interest-bearing checking accounts. Negotiable-order-of-withdrawal (NOW) accounts: Interest-bearing checking deposits. Automated-transfer-system (ATS) account: An interest-bearing savings account and non-interest-bearing checking account. © 2006 Thomson Business and Professional Publishing. All rights reserved.

Components of the Monetary Base and M1 ($ Billions) SOURCE: Board of Governors of the Federal Reserve System, H.6(508) Statistical Release, June 9, 2006. © 2006 Thomson Business and Professional Publishing. All rights reserved. Figure 1–1

M2: Cash Plus Other Liquid Assets M1 plus savings and small-denomination time deposits and balances of individual and broker-dealer money market mutual funds. Savings deposits: Interest-bearing savings accounts without set maturities. Money market deposit accounts: Savings accounts with limited checking privileges. Small-denomination time deposits: Deposits with set maturities and denominations of less than $100,000. © 2006 Thomson Business and Professional Publishing. All rights reserved.

M2: …Other Liquid Assets Money market mutual funds: Pools of funds from savers that managing firms use to purchase short-term financial assets such as Treasury bills and commercial paper. © 2006 Thomson Business and Professional Publishing. All rights reserved.

The Components of M2 ($ Billions) Small-denomination time deposits 867.0 Savings deposits and money market deposits 3,574.8 Individual and broker-dealer money market mutual funds 707.8 M2 $6,514.7 SOURCE: Board of Governors of the Federal Reserve System, H.6(508) Statistical Release, June 9, 2005. © 2006 Thomson Business and Professional Publishing. All rights reserved. Table 1–2

Comparing the Monetary Base, M1,and M2 ($ Billions) SOURCES: Board of Governors of the Federal Reserve System, H.6(508) Statistical Release and H.3(502) Statistical Release, June 9, 2005. © 2006 Thomson Business and Professional Publishing. All rights reserved. Figure 1–2

M3: The Broadest Monetary Aggregate M2 plus large-denomination time deposits, Eurodollars and repurchase agreements, and institution-only money market mutual funds. Large-denomination time deposits: Deposits with set maturities and denominations greater than or equal to $100,000. Repurchase agreements: Contracts to sell financial assets with a promise to repurchase them at a later time. Eurodollars: Dollar-denominated deposits located outside the U.S. © 2006 Thomson Business and Professional Publishing. All rights reserved.

The Components of M3 ($ Billions) Large-denomination time deposits 1,203.4 Repurchase agreements and Eurodollar deposits 853.6 Institution-only money market mutual funds 1,039.3 M3 $9,611.0 SOURCE: Board of Governors of the Federal Reserve System, H.6(508) Statistical Release, June 9, 2005. © 2006 Thomson Business and Professional Publishing. All rights reserved. Table 1–3

Annual Growth Rates of M1 and M2. The Federal Reserve’s two key monetary aggregates often grow at different rates. SOURCES: 2005 Economic Report of the President, Economic Indicators, various issues. © 2006 Thomson Business and Professional Publishing. All rights reserved. Figure 1–3

Money in the Digital Economy Nonelectronic payments Currency Credit-card Money orders Electronic payments Wire transfers: Payments made via telephone lines or through fiberoptic cables. © 2006 Thomson Business and Professional Publishing. All rights reserved.

Electronic versus Nonelectronic Payments As panel (a) indicates, nonelectronic transactions account for nearly all payments in the United States. Panel (b), however, shows that the bulk of the dollar value of exchanges is accomplished through electronic means of payment. SOURCES: Authors’ estimates. © 2006 Thomson Business and Professional Publishing. All rights reserved. Figure 1–4

Money in the Digital Economy Electronic Payments (cont’d) Automated clearinghouses: Institutions that process payments electronically on behalf of senders and receivers of those payments. Point-of-sale (POS) transfer: Electronic transfer of funds from a buyer’s account to the firm from which a good or service is purchased at the time the sale is made. Automated bill payment: Direct payment of bills by depository institutions on behalf of their customers. © 2006 Thomson Business and Professional Publishing. All rights reserved.

Money in the Digital Economy Computer shopping Internet-based financial exchanges Innovations in electronic payments technology As assets become more liquid, the meaning and measurement of “money” may change the composition of future monetary aggregates. © 2006 Thomson Business and Professional Publishing. All rights reserved.