ECN 481 Don Dutkowsky Professor of Economics Office – 304 Maxwell Hall Phone

Roles of Money -- Facilitator of Trade n Medium of Exchange -- Money is exchanged for goods and services n Standard of Value -- Value is measured in dollars (the “price tag”)

Other Roles of Money n Standard of Deferred Payments -- Loans and financial instruments are denominated in terms of money. n Store of Value -- People can use money when they wish.

Definitions of Money n M1 = Currency held by the public + Travelers Checks + Demand Deposits + Other Checkable Deposits n M2 = M1 + Savings Deposits (including MMDAs) + Small Time Deposits + Retail Money Market Mutual Funds

Definitions of Money Supply Components n Currency Held by the Public -- Paper money held by consumers and firms. n Travelers Checks – Checks issued for travelers with safety features in case they get lost or stolen.

Demand Deposits and Checking Privileges n Demand Deposits (DD)-- Non-interest bearing deposits offered by commercial banks. They have checkable privileges with no restrictions on size of check or number of checks per month.

Other Checkable Deposits n Other Checkable Deposits (OCD) – Checkable deposits which are interest earning (NOW accounts) + checkable deposits offered by thrift institutions. They have no restrictions on size of check or number of checks per month.

Checkable Deposits n Checkable Deposits = DD + OCD n M1 = Currency Held by the Public + Travelers Checks + Checkable Deposits

Savings Deposits n Money Market Deposit Accounts (MMDA) -- Checkable deposits with a limit of maximum number of checks written per month. n Passbook Savings Deposits -- No checkable privileges, but funds can be withdrawn at any time without penalty.

One More Bank Deposit n Time Deposits (i.e. Certificates of Deposit)-- A contract specifying payment of principal and interest in an explicit way over a given interval. Withdrawal before maturity results in penalty. u Small (in M2): < $100,000 u Large: > $100,000

Types of Banks n Commercial Banks -- “full service” banks n Savings and Loans n Savings Banks n Credit Unions

Money Market Mutual Funds (MMMF) n private institutions (not banks) n pools investor funds n pays interest based upon overall portfolio n invests in short-term bonds Retail MMMF (in M2) u sold to consumers (as opposed to institutions) u offers restricted checkability

Issues -- Defining Money n above definitions, based on conceptual roles of money n have the definitions become less accurate in capturing roles, especially with financial innovation? n declining predictive ability of money

Alternative Approaches n Empirical Approach -- combine components in a way that best predicts key macro variables. n Weighted Aggregates -- give weights to the components based upon relative liquidity (e.g. M1 = Currency Held by the Public Travelers Checks DD +0.85OCD)

Using Money Supply in Monetary Policy n Consult several measures at once, to track portfolio changes u (e.g. movement from MMMF to OCD) n Seasonality n Data Revisions (advance, actual, or revised)

The Declining Influence of Money Supply in Monetary Policy n Federal Reserve pays considerably less attention to monetary aggregates than before n Relies much more heavily on Federal Funds rate, and adjusting the target levels.

Two Other Money Measures n MZM = M2 – (Small Time Deposits) + (Institutional MMMF) n M2M = M2 – (Small Time Deposits)