Money. Money Supply and Money Demand Frederick University :091

Money & the Payments System meaning of money functions of money forms of money measuring money meaning of money functions of money forms of money measuring money

11:093 without money barter for stuff -- need “double coincidence of wants ” -- inefficient: more time shopping, less time producing

11:094 example I have exam 2, want to trade it for soda

11:095 You have to want the exam & be willing to give up soda AND I have to want the soda & be willing to give up exam

11:096 double coincidence of wants

11:097 The Meaning of Money anything commonly accepted in exchange for goods/services many objects throughout history

11:098 examples livestock shells metals cigarettes

11:099 to act as money, must be measurable divisible widely accepted durable

11:0910 Forms of Money commodity money has its own value as a good -- gold & silver coins

11:0911 Paper money - a substitute for the commodity money - freely convertible

11:0912 credit money (fiat money) -- no value other than fact that it’s accepted in exchange for goods and services

11:0913 Our money is fiat money! NOT backed by gold coins do not contain silver or gold

11:0914 fiat money is more efficient commodity money has opportunity cost: you could use it for something else

11:0915 debit or credit cards? NOT money payment mechanisms

11:0916 money, income, & wealth money what is accepted as payment income earnings during time period (year) wealth accumulated assets at a point in time

11:0917 money, wealth are STOCKS amount at a point in time income is a FLOW amount during a time period

11:0918 examples I own € 2 million in diamonds. I am wealthy I have no money

11:0919 I win € 25 million in lottery I put it under my bed I quit my job I am wealthy I have a lot of money my income is zero

11:0920 software engineer earnings € 100,000/yr blows it all, every paycheck high income no wealth

11:0921 Functions of Money money is a means of payments (medium of exchange) -- accepted as payment for goods and services -- main function of money

11:0922 money is a unit of account -- money is used to measure value

11:0923 if something costs €5, not that valuable if something costs € 500, that’s valuable

11:0924 money is a store of value -- use money to save, accumulate wealth, buy stuff later -- money is liquid asset

11:0925 money is NOT always a good store of value -- political instability -- poor economy -- high inflation

11:0926 example Historically, the U.S. dollar has been a good store of value but when the $ started falling in value, this changed…

11:0927 Measuring Money How much money do we need? The quantity of money (money supply) depends on the value of goods and services that will be bought … = P x Q

11:0928 Measuring Money and on the velocity of money circulation = the number of transactions, served by the same money asset (V)

11:0929 example I buy from George coffee with a €2 coin George buys from Maria a newspaper with the same €2 coin Maria buys from Sofia a sandwich with the same €2 euro coin One and the same €2 coin serves 3 transactions Therefore, for these transactions we do not need €6 but only €2 The velocity of circulation (V) is 3 The greater the velocity, the smaller the quantity of money needed.

11:0930 The quantity of money M = (P x Q) : V or MV = PQ

11:0931 Measuring Money Money aggregates amount of cash (coins and banknotes) BUT other forms of money too (quasi - money

11:0932 M1 (h igh power money) = currency in circulation (cash) + demand deposits + checkable deposits + traveler’s checks

11:0933 M2 = M1 + savings deposits + small time deposits

11:0934 Comparing measures get larger M1 < M2 add less liquid assets to larger measures

11:0935 Which measure is best? move together in general BUT behavior can vary in short-term M2 most watched

11:0936 Money Demand Money demand – the quantity of liquidity that the public would like to hold at every level of the interest rate, ceteris paribus

11:0937 Motives for money demand  Transactionary to pay purchases

11:0938  Precautionary because of the possible lack of synchronization of payments

11:0939  Speculative (liquidity preference) because holding money has an opportunity cost money has time value – it may bring interest on the one hand, people are motivated to have liquidity, on the other hand, they want extra income (interest) … when the interest rates fall, people will be willing to convert part of their interest bearing assets into liquidity … when the interest rates increase, the liquidity preference diminishes.

11:0940 Equilibrium on the Money Market i M/P MS MD

11:0941 Factors, Determining Money Demand Nominal GDP Current transactions Expectations Frequency of payments Synchronization of payments Wealth

11:0942 Financial Institutions Banking institutions:  The Central bank  Commercial Banks Nonbanking:  Insurance funds  Pension funds  Investment funds  Mortgage funds  Brokering houses  Mutual funds

11:0943 Commercial Banks The Balance sheet of a commercial bank liabilities assets depositsloans reserves

11:0944 The Money Tree Deposit Multiplier – Maximum increase in money supply as a result of the increase in the reserves of the banking system

11:0945 The Deposit Multiplier € 1000 new reserves enter Commercial Bank “А” Reserves (safety) Loans (income) … DM = ΔD/ ΔR

11:0946 The Central Bank Functions: Control on money supply Supervision of Commercial Banks Banker of the government Providing cash Lender of last resort Monetary policy Control on reserves Foreign currency policies and external payments

11:0947 The Central Bank Central Bank Liabilities: Coins and notes Deposits of the CBs Assets: Foreign currency Government bonds Loans to the Treasury and to CBs