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ECN 481

ECN 481. Don Dutkowsky Professor of Economics Office – 304 Maxwell Hall Phone -- 443-1918. Roles of Money -- Facilitator of Trade. Medium of Exchange -- Money is exchanged for goods and services Standard of Value -- Value is measured in dollars (the “price tag”). Other Roles of Money.

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ECN 481

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  1. ECN 481 Don Dutkowsky Professor of Economics Office – 304 Maxwell Hall Phone -- 443-1918

  2. Roles of Money -- Facilitator of Trade • Medium of Exchange -- Money is exchanged for goods and services • Standard of Value -- Value is measured in dollars (the “price tag”)

  3. Other Roles of Money • Standard of Deferred Payments -- Loans and financial instruments are denominated in terms of money. • Store of Value -- People can use money when they wish.

  4. Definitions of Money • M1= Currency held by the public + Travelers Checks + Demand Deposits + Other Checkable Deposits • M2 = M1 + Savings Deposits (including MMDAs) + Small Time Deposits + Retail Money Market Mutual Funds

  5. Definitions of Money Supply Components • Currency Held by the Public -- Paper money held by consumers and firms. • Travelers Checks – Checks issued for travelers with safety features in case they get lost or stolen.

  6. Demand Deposits and Checking Privileges • Demand Deposits (DD)-- Non-interest bearing deposits offered by commercial banks. They have checkable privileges with no restrictions on size of check or number of checks per month.

  7. Other Checkable Deposits • Other Checkable Deposits (OCD) – Checkable deposits which are interest earning (NOW accounts) + checkable deposits offered by thrift institutions. They have no restrictions on size of check or number of checks per month.

  8. Checkable Deposits • Checkable Deposits = DD + OCD • M1 = Currency Held by the Public + Travelers Checks + Checkable Deposits

  9. Savings Deposits • Money Market Deposit Accounts (MMDA) -- Checkable deposits with a limit of maximum number of checks written per month. • Passbook Savings Deposits -- No checkable privileges, but funds can be withdrawn at any time without penalty.

  10. One More Bank Deposit • Time Deposits (i.e. Certificates of Deposit)-- A contract specifying payment of principal and interest in an explicit way over a given interval. Withdrawal before maturity results in penalty. • Small (in M2): < $100,000 • Large: > $100,000

  11. Types of Banks • Commercial Banks -- “full service” banks • Savings and Loans • Savings Banks • Credit Unions

  12. Money Market Mutual Funds (MMMF) • private institutions (not banks) • pools investor funds • pays interest based upon overall portfolio • invests in short-term bonds Retail MMMF (in M2) • sold to consumers (as opposed to institutions) • offers restricted checkability

  13. Issues -- Defining Money • above definitions, based on conceptual roles of money • have the definitions become less accurate in capturing roles, especially with financial innovation? • declining predictive ability of money

  14. Alternative Approaches • Empirical Approach -- combine components in a way that best predicts key macro variables. • Weighted Aggregates -- give weights to the components based upon relative liquidity (e.g. M1 = Currency Held by the Public + 0.98Travelers Checks + 0.95DD +0.85OCD)

  15. Using Money Supply in Monetary Policy • Consult several measures at once, to track portfolio changes • (e.g. movement from MMMF to OCD) • Seasonality • Data Revisions (advance, actual, or revised)

  16. The Declining Influence of Money Supply in Monetary Policy • Federal Reserve pays considerably less attention to monetary aggregates than before • Relies much more heavily on Federal Funds rate, and adjusting the target levels.

  17. Two Other Money Measures • MZM = M2 – (Small Time Deposits) + (Institutional MMMF) • M2M = M2 – (Small Time Deposits)

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