Chapter 2

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. 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 • 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