Transcript What is Money?

What is Money?
• This may seem an odd question, but it actually
has merit. Each economy or society that has
used money (and many did not) has had to
define exactly what money is and what the
relationship between money and people is.
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Money!
• Money is what money does. This Gumpian
explanation is as valid as any other I have run
across.
• To validate this, we can look at several
examples from history:
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A. cacao beans
B. cheese
C. gold/silver
D. paper
E. debt
Functions of Money
• In order to be money, whatever is serving in
that capacity must be able to serve as:
• 1. a medium of exchange-something that can
be used to buy and sell goods and services
that is acceptable to all. Without a medium of
exchange all trade for goods and services
would need to be coordinated by barter and
the coincidence of need
Functions of money
• 2.Money is also a unit of account, a yardstick
for measuring the value of the relative worth
of a wide variety of goods and services. As
well, this function of money allows us to figure
GDP, define debt, determine taxes, and figure
profits.
• 3. Money functions as a store of value.
Characteristics of Money
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Durability
Portability
Divisibility
Relative Scarcity
Authenticity
The supply of money
• So, if we need to use money where does it
come from and what does it consist of?
• Presently money in the US and most industrial
nations is the debt of governments and
financial institutions. This fact enables the
creation and destruction of money to
influence economic rhythms as deemed
necessary by those in control of it.
MONEY as DEFINED
• M1: 2,988,000,000,000.00
• The narrowest definition of the money supply
consisting of currency (coins and paper), all
checkable deposits in comercial backs and
thrifts/savings orgs upon which checks may be
drawn.
• Currency is the debt of government and
checkable deposits are the debt of financial
institutions. So all of our money is DEBT
Currency
• All coins are TOKEN money, that is, the
intrinsic value of the coin is less than the face
value.
• All paper money is Federal Reserve Notes
issued by the Federal Reserve System and are
essentially debt in small doses
Checkable Deposits
• Checkable deposits are non interest bearing,
non contractual deposits (for the most part) in
US banks or thrifts that are readily accessible
to pay for goods and services whether with
check or payment card. They are also largely
and quickly convertible into currency and coin.
More Money!!!
• M2 money supply:$11,820,000,000,000.00
M1 plus
a. savings deposits and money market
accounts
b. small time deposits (those worth less than
$100,000 or cds
c. Money market mutual funds
This definition of money is about twice as large
as M1 alone
A note about credit cards
• While credit cards may act like money and
people certainly use them as if they are
money, that isn’t the reality.
• Credits cards are really short term high
interest loans
• However, they do enable us as a society to
function with less “money”
What backs the money supply?
• The US backs its money supply with the
assurance that the government has the ability
to keep the value of the currency relatively
stable.
• There is no link between the supply of money
and any commodity.
• Money is only exchangeable for more paper
money.
So why does it have value at all?
• Why does US paper money have value and the
ones I can print up not have value?
• A. acceptability
• B. Legal tender
• C. Relative scarcity
POLICY
Stabilization of money’s value is a
requirement for 21st century governments.
They can accomplish this with a variety of
methods.
One method is appropriate FISCAL policy
Another is appropriate MONETARY policy
Demand for Money
• The Demand for Money: Two Components
There are two sources of money demand or two
reasons why do we want to hold M1 money in our
wallets, purses, and in our checking account, instead
of putting it in the bank to earn interest. They are the
(1) transactions demand and the (2) asset demand.
The (3) Total demand for money (keeping money in
our wallets and not in our savings account where
they can earn interest) then is the transactions
demand plus the asset demand.
harpercollege.edu/mhealy/eco212i/lectures
Transactions Demand
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Transactions Demand for Money (Dᴛ)
Definition: We keep M1 money in order to buy things
It is the demand for money as a medium of exchange
Transactions demand and nominal GDP
directly related: when GDP increases the transactions demand
for money also increases (shifts to the right).
• the main determinant of transactions demand is nominal GDP
• Transactions demand and interest rates
• we'll assume that they are unrelated, so on a graph the
transactions demand looks like:
harpercollege.edu/mhealy/eco212i/lectures
harpercollege.edu/mhealy/eco212i/lectures
Asset Demand For
Money
harpercollege.edu/mhealy/eco212i/lectures
• Asset demand (Dₐ)
• Definition: we keep some money so that we
can spend it later
• the demand for money as a store of value
• What determines how much money (M1) we
keep in our wallets, purses, and checking
accounts?
• The problem with holding money: is that you
are not earning interest on it
Continued Asset Demand
harpercollege.edu/mhealy/eco212i/lectures
• Asset demand and interest rates are inversely
related. If interest rates are high, people will
keep less in their pockets and more in their
savings accounts (and in other interest earning
assets)
• if interest rates are low, people will keep more
money in their pockets, because they are not
losing much and it is more convenient
harpercollege.edu/mhealy/eco212i/lectures
harpercollege.edu/mhealy/eco212i/lectures
Total Money Demand
• Total Money Demand
• Total MD = transactions demand + asset
demand
• Graphically: The black vertical Dt is the
transactions demand and the black,
downward sloping Da is the asset demand. If
we add them together we get the blue total
demand for money.
harpercollege.edu/mhealy/eco212i/lectu
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The Market for Money: Interaction of
Money Supply and Demand
• Now lets add the MS (money supply) The graph
below illustrates the money market. It combines
demand with supply of money.
• An increase in the MS will move the MS curve
to the right, decreasing interest rates. A
decrease in the MS will move the MS curve to
the left increasing interest rates.
The Federal Reserve and the Banking
System
• See:
http://www.federalreserveeducation.org/fed1
01/structure/
• Know:
• Board of governors
• Federal Open Market Committee (FOMC)
• 12 Federal Reserve BanksThe Federal Reserve
and the Banking System
Who runs the Federal Reserve
• 2. The central controlling authority for the system is
the Board of Governors and has seven members
appointed by the President for staggered 14 year
terms. Its power means the system operates like a
central bank.
• Board of Governors seven members
• appointed by the US president and confirmed by the
senate
• 14 year terms
• the US president selects the chairperson (currently
Janet Yellen).
FOMC
• 3. The Federal Open Market Committee (FOMC) includes the
seven governors plus five regional Federal Reserve Bank
presidents whose terms alternate. They set policy on buying
and selling of government bonds, the most important type of
monetary policy, and meet several times each year.
• FOMC 12 members:
• the 7 members of the BOG
• the president of the New York Federal Reserve Bank
• 4 of the other 12 Fed bank presidents on a rotating basis
• conduct open market operations (Open Market Operations
[OMO]
Fed Districts
Fed Actions and Powers
• 1.they act like a central bank coordinated by
the Fed BOG
• 2.quasi-public banks each Federal Reserve
Bank is owned by the private commercial
banks in its district
• 3.but the BOG, a government body, sets the
basic policies
• 4.making a profit is not their goal, any profits
go to the U.S. Treasury.. Goal is to help
economy
The Fed and its Powers
• 5. There are about 7,300 commercial banks in the
United States. They are privately owned and consist
of state banks (three-fourths of total) and large
national banks (chartered by the Federal
government).
• 6. Thrift institutions consist of savings and loan
associations, credit unions, and mutual savings
banks. They are regulated by the Treasury Dept.
Office of Thrift Supervision, but they may use
services of the Fed and keep reserves on deposit at
the Fed. Of the approximately 11,000 thrift
institutions, most are credit unions.
Fed Actions and Powers
• a bank for banks: banks keep deposits at the
Fed. these are the the RESERVES of the banks.
• banks take out loans from the Fed (the
Discount Rate [DR). In making loans, the
Federal Reserve is the "lender of last resort,"
meaning that the Fed is available to lend
money should other avenues (e.g. other
commercial banks) not be available.
Functions of the Fed and money
supply:
• 1. The Fed issues "Federal Reserve Notes," the
paper currency used in the U.S. monetary
system.
2. The Fed sets reserve requirements and
holds the reserves of banks and thrifts not
held as vault cash.
3. The Fed may lend money to banks and
thrifts, charging them an interest rate called
the discount rate.
Functions Continued
• 4. The Fed provides a check collection service
for banks (checks are also cleared locally or by
private clearing firms).
5. Federal Reserve System acts as the fiscal
agent for the Federal government.
6. The Federal Reserve System supervises
member banks.
7. Monetary policy and control of the money
supply is the "major function" of the Fed.
Controversy and the Fed
• Federal Reserve independence is important
but is also controversial from time to time.
Advocates of independence fear that more
political ties would cause the Fed to follow
expansionary policies and create too much
inflation, leading to an unstable currency such
as that in other countries
Controversy
• The Federal reserve is independent of political
control
• The BOG is appointed by the president for 14
year terms
• Advocates of independence fear that more
political ties would cause the Fed to follow
expansionary policies and create too much
inflation, leading to an unstable currency such
as exists in some other countries
Controversy
• Most countries maintain political control over
their central banks. There is currently a move
to rein in Fed independence by more
conservative members of Congress.
• The 12 members of the FOMC can decide to
decrease the MS (to fight inflation) and put
millions of people out of work and there is
little recourse.
• Politicians would prefer to have more say in
Fed policy decisions for a variety of reasons.
Summary
• Structure—The Federal Reserve is a
“decentralized central bank” with both private
and public elements operating independently
within the government.
• The Board of Governors of the Federal
Reserve is a government agency.
• The 12 Federal Reserve Banks are not
government agencies; they represent the
private component of the Fed.
Summary
• Monetary Policy—The primary focus
of monetary policy is price stability.
The body that is charged with setting
monetary policy is the Federal Open
Market Committee, which regulates
the amount of money and credit in
the economy.