1. BuffDaniel Presents
Money and Banking
Chapter 2
Money

2. What is Money?
Anything generally accepted as payment

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

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

13. 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

14. 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