Chapter 3 What Is Money?

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 3-2 Meaning of Money Money (money supply)—anything that is generally accepted in payment for goods or services or in the repayment of debts; a stock concept, not the same with wealth (stock) or income (flow) Wealth—the total collection of pieces of property that serve to store value Income—flow of earnings per unit of time

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 3-3 Functions of Money Medium of Exchange—promotes economic efficiency by minimizing the time spent in exchanging goods and services  Must be easily standardized  Must be widely accepted  Must be divisible  Must be easy to carry  Must not deteriorate quickly Unit of Account—used to measure value in the economy  # of trading ratios under a barter system = N x (N-1) / 2 Store of Value—used to save purchasing power; most liquid of all assets but loses value during inflation Standard of deferred payments

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 3-4 Evolution of the Payments System Commodity Money (precious metals: gold and silver…) Paper Currency (fiat money) Checks Electronic Payment E-Money (Debit cards, Stored-value cards, Smartcards, E-cash…)

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 3-5 Stocks vs. Flows stockflow a person ’ s wealtha person ’ s saving # of people with# of new college college degreesgraduates the govt. debtthe govt. budget deficit FlowStock More examples:

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 3-6

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 3-7 M1 M1 = narrowest definition of money supply, containing only those items that satisfy the definition of money M1 = Currency + travelers ’ checks +demand deposits + other checkable deposits Credit cards? Not money.

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 3-8 M2 and M3 M2 = M1 + small-denomination time deposits and repurchase agreements + savings deposit balances + Noninstitutional money market mutual fund shares M3 = M2 + large-denomination time deposits and repurchase agreements + institution-only money market mutusal fund shares + Eurodollars

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 3-9 How Reliable are the Money Data? Revisions are issued because:  Small depository institutions report infrequently  Adjustments must be made for seasonal variation We probably should not pay much attention to short-run movements in the money supply numbers, but should be concerned only with longer-run movements

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 3-10

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 3-11