PowerPoint Presentation by Charlie Cook Copyright © 2004 South-Western. All rights reserved. Chapter 1 Money— An Introduction

Copyright © 2004 South-Western. All rights reserved.1–2 Fundamental Issues 1.How have financial globalization and cyber technologies acted together to alter the economic roles of banking institutions and money? 2.What functions does money perform? 3.How has money evolved? 4.What are monetary aggregates, and how are they constructed? 5.How do changes in payments technologies affect our definitions of money?

Copyright © 2004 South-Western. All rights reserved.1–3 Money and Banking in the Digital Age Cybertechnologies:  Technologies that connect savers, investors, traders, producers, and governments via computer linkages. Electronic money (e-money):  Money that people can transfer directly via electronic impulses. Wire transfers:  Payments made via telephone lines or through fiber-optic cables.

Copyright © 2004 South-Western. All rights reserved.1–4 Money Money:  Anything that functions as a medium of exchange, store of value, unit of account, and standard of deferred payment. Purchasing power of money:  The value of money in terms of the amount of real goods and services it buys.

Copyright © 2004 South-Western. All rights reserved.1–5 Money Barter:  The direct exchange of goods, services, and financial assets. Double coincidence of wants:  The situation when two individuals are simultaneously willing and able to make a trade; a requirement for barter.

Copyright © 2004 South-Western. All rights reserved.1–6 Money’s Functions Medium of exchange:  A means of payment. Store of value:  Held for future use without loss of value in the meantime. Unit of account:  A measure of the value of goods, services, and financial assets. Standard of deferred payment:  A means of valuing future receipts in loan contracts.

Copyright © 2004 South-Western. All rights reserved.1–7 The Evolution of Money Commodity money:  A good with a nonmonetary value that is also used as money. Commodity standard:  A money unit whose value is fully or partially backed by the value of some other physical good such as gold or silver. Fiat money:  A token that has value only because it is accepted as money.

Copyright © 2004 South-Western. All rights reserved.1–8 Different Types of Money Table 1–1 IronCornWhale teethRound stones with CopperSaltBoar tuskscenters removed BrassCrystal salt barsRed woodpecker scalpsKnives Gold HorsesFeathersPots SilverSheepLeatherBoats WineGoatsPitchSlaves RumCowsGlassPaper MolassesTortoise shellsPolished beads Playing cards TobaccoSnail shells(wampum)Cigarettes RicePorpoise teethAgricultural implements

Copyright © 2004 South-Western. All rights reserved.1–9 Commodity Standards Gold standard:  A monetary system in which the value of money is linked to the value of gold. Gold bullion:  Within a gold standard, the amount of gold used as money. Bimetallic standard:  A monetary system in which the value of money depends on the values of two precious metals, such as gold and silver.

Copyright © 2004 South-Western. All rights reserved.1–10 Commodity Standards 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  In a fiat money system, the sum of currency in circulation plus reserves of banks and other depository institutions.

Copyright © 2004 South-Western. All rights reserved.1–11 The Use Of Coins Seigniorage:  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.

Copyright © 2004 South-Western. All rights reserved.1–12 Money in Circulation 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.

Copyright © 2004 South-Western. All rights reserved.1–13 The Monetary Base Currency:  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.

Copyright © 2004 South-Western. All rights reserved.1–14 M1: A Basic Definition of “Cash” M1:  Currency plus 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.

Copyright © 2004 South-Western. All rights reserved.1–15 Components of the Monetary Base and M1 ($ Billions) Figure 1–1 SOURCE: Board of Governors of the Federal Reserve System,H.6(508) Statistical Release, August 1,2002.

Copyright © 2004 South-Western. All rights reserved.1–16 M2: Cash Plus Other Liquid Assets M2:  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.

Copyright © 2004 South-Western. All rights reserved.1–17 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.

Copyright © 2004 South-Western. All rights reserved.1–18 The Components of M2 ($ Billions) Table 1–2 M1 $1,187.3 Small-denomination time deposits924.9 Savings deposits and money market deposits2,511.4 Individual and broker-dealer money market mutual funds944.6 M2$5,568.2 SOURCE: Board of Governors of the Federal Reserve System,H.6(508) Statistical Release, August 1,2002.

Copyright © 2004 South-Western. All rights reserved.1–19 Comparing the Monetary Base, M1,and M2 ($ Billions) Figure 1–2 SOURCES: Board of Governors of the Federal Reserve System,H.6(508) Statistical Release and H.3(502) Statistical Release, August 1, 2002.

Copyright © 2004 South-Western. All rights reserved.1–20 M3: The Broadest Monetary Aggregate M3:  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.

Copyright © 2004 South-Western. All rights reserved.1–21 The Components of M3 ($ Billions) Table 1–3 M2$5,568.2 Large-denomination time deposits810.6 Repurchase agreements and Eurodollar deposits594.0 Institution-only money market mutual funds1,180.8 M3$8,153.6 SOURCE: Board of Governors of the Federal Reserve System,H.6(508) Statistical Release, August 1,2002.

Copyright © 2004 South-Western. All rights reserved.1–22 Annual Growth Rates of M1 and M2. Figure 1–3 SOURCES: 2002 Economic Report of the President, Economic Indicators, various issues.

Copyright © 2004 South-Western. All rights reserved.1–23 Money in the Digital Economy Electronic Payments  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.

Copyright © 2004 South-Western. All rights reserved.1–24 Electronic versus Nonelectronic Payments Figure 1–4 SOURCES: Authors’ estimates.