BuffDaniel Presents Money and Banking Chapter 2 Money

What is Money? Anything generally accepted as payment

Evolution of the Payments system – decline in exchange costs Barter – trading, requires a coincidence of wants, cumbersome, goods have different values and are indivisible Definitive money is money that does not have to be converted into a more basic medium of exchange. Commodity money – commodity and money, physical good such as gold and silver A system in which the definitive money is money authorized by a central bank or governmental body as legal tender—that is, the money must be accepted to discharge debts and tax payments must be in cash or checks denominated in that money—are known as a fiat money system. Fiat money – paper and coins in most cases 1. Actual value is less tan the face value 2. Federal Reserve Notes Commodity Standard – precious metals (if 2 metals are used – bimetallic standard such as gold and silver

Electronic transfers: Transfer of funds over the internet Checks – called demand deposits. Checks are promises to pay definitive money on demand and are drawn on money deposited with a financial institution. Electronic transfers: Transfer of funds over the internet Electronic money (e-money) Debit cards Store valued cards (phone cards) Electronic cash (e-cash) – Used for internet purchases Cashless society (20 years) New methods of robbery Can’t bounce a check Reduced privacy Can’t earn interest on float (days until the check is cashed) Checking printing companies etc. will go out of business Onine Banking

Terms Money Market – market for financial assets (instruments) of less than one year Capital Markets - market for financial assets (instruments) of more than one year Wealth – total collection of property of value Income – flow of earnings in a time period

Financial Markets – systems where funds are transferred from savers to borrowers Bond market – a security with a claim on future assets or income Interest rate – percentage return Stock market – Ownership of a corporation Dividend – share of profits Foreign Exchange Market – trading in currencies Exchange Rate Financial intermediaries – transfer funds Banks, credit unions, brokers, insurance companies, pension funds, mutual funds Financial Innovation – New products and services for the banking public

Functions of Money Money acts as a medium of exchange, which is anything that is generally accepted as payment for goods and services or in the settlement of debts. Generally accepted: The good must be acceptable to most traders. Standardized: It should be of standardized quality. Convenient and portable: It should be valuable relative to its weight. Divisible Durable Money is a unit of account, which is a way of measuring value in the economy in terms of money. Money is a store of value, in that it is an asset or a thing of value that can be owned and is, therefore, a component of wealth. – method to hold wealth Liquidity – ease at which something can be converted into a medium of exchange Inflation – increasing price level reduces value of wealth Hyperinflation – 50 % increase + per month Money offers a standard of deferred value in credit transactions. Contracts specify that loans must be repaid with money

Who Controls our Money Supply Federal Reserve System – our central Bank (FED) Board of Governors Major Functions Regulates lending Controls the Money Supply to stabilize the economy Controls bank reserves and hence lending

Economic Terms Inflation – increase in the average level of prices Hyperinflation – rapidly increasing inflation Deflation – decreasing average level of prices Disinflation – decreasing inflation GDP – market value of all final goods and services produced in a year in a country Business cycles – expansions and contractions in the economy Unemployment – looking for a job but can’t find one Federal Funds market – market where banks borrow from each other Federal funds rate – rate at which banks borrow from each other on overnight loans Velocity – “speed” of money – the rate at which money changes hands Reserves – Money in the vaults of banks

Measuring Money Monetary Base = Currency ( paper and coins) + Reserves of Depository Institutions Monetary aggregates M1 = Currency ( paper and coins) + Demand deposits ( checks) + Traveler’s checks + NOW accounts M2 = M1 + Savings + Small Time Deposits + Money Markets Accounts + Money Market Mutual Funds M3 = M2 + Large Time Deposits + Other Large Deposits L = M3 + Bonds and securities

Macroeconomic Money Markets Demand for Money (Keynes Liquidity Preference) Types Transaction Motive – to buy things – f(income) Precautionary Motive - cushion against the unexpected – f(income) Speculative Motive – saving and investing – f(interest rates) Portfolio of Investments Model Md = f(I, Y) Graph Results Demand for money is sensitive to interest rates Demand for money is not constant

Determinants of Demand for Money Prices Income Substitutes Credit cards Debit Cards Interest Rates Rates of Return

Supply of Money Money Market and AD/AS Established and controlled by the FED Dynamic – designed to change the level of MB and R to change the interest rate Defensive – designed to offset other things that may change the level of MB and R to counteract changes in the demand for money Increase in the demand for money FED must react Money Market and AD/AS Determines the interest rate

Transmission Mechanisms Main: M → ir → I & C → AD → GDP Transmission mechanism: M → ir → I → GDP Monetary Chain Change the money supply Change the interest rate Change in borrowing Change in spending (C & I) Change aggregate demand Change GDP, price level, and unemployment