What Is Money?

1. Mishkin/Serletis The Economics of Money, Banking, and Financial Markets Fifth Canadian Edition Chapter 3 What Is Money?

2. Learning Objectives • Describe the meaning of the word money • Distinguish among the three primary functions of money • Illustrate how information technology has paved the way for • Explain money measurement matters

3. Meaning of Money • What is it? • Money (or the “money supply”): anything that is generally accepted in payment for goods or services or in the repayment of debts. • A broad definition

4. Meaning of Money (cont’d) • Money (a stock concept) is different from: • Wealth • the total collection of pieces of property that serve to store value • Income • flow of earnings per unit of time • a flow concept

5. Functions of Money: Medium of Exchange • Medium of Exchange: • eliminates the trouble of finding a double coincidence of needs (reduces transaction costs) • promotes specialization • A medium of exchange must • be easily standardized • be widely accepted • be divisible • be easy to carry • not deteriorate quickly

6. Functions of Money: Unit of Account • Unit of Account: • used to measure value in the economy • reduces transaction costs

7. Functions of Money: Store of Value • Store of Value: • used to save purchasing power over time. • other assets also serve this function • money is the most liquid of all assets but loses value during inflation • hyperinflation is when the inflation rate exceeds 50% per month

8. Evolution of the Payments System • Commodity Money • valuable, easily standardized and divisible commodities • e.g. precious metals, cigarettes • Fiat Money • paper money decreed by governments as legal tender

9. Evolution of the Payments System (cont’d) • Cheques • an instruction to your bank to transfer money from your account • Electronic Payment • e.g. online bill pay • E-Money (electronic money): • debit card • stored-value card (smart card) • e-cash

10. FYI Are We Headed for a Cashless Society? • Predictions of a cashless society have been around for decades • E-money might be more convenient and efficient than a payments system based on paper • Several factors work against the disappearance of the paper system • The use of e-money will likely still increase in the future

11. Measuring Money • How do we measure money? Which particular assets can be called “money”? • Construct monetary aggregates using the concept of liquidity • M1+ • the narrowest definition is called M1+ • includes: currency + chequable deposits • these assets are all extremely liquid

12. Measuring Money (cont’d) • M2 • adds to M1+ other assets that are not so liquid • currency + chequable deposits + non-personal demand and notice deposits + fixed term deposits

13. Measures of Monetary Aggregates

14. Growth Rates of Monetary Aggregates • Does it matter which measure of money is considered? • Aggregates can move in different directions in the short run (see figure 3-2) • Conclusion: the choice of monetary aggregate is important for policymakers

15. Growth Rates of M2, M1++, M2++

16. FYI:Where Are All the Dollars? • The more than $1500 of currency held per person in the Canada is a surprisingly large number • Where are all these dollars and who is holding them? • criminals • foreigners

17. Money as a Weighted Aggregate • The Bank of Canada’s money supply measures are ‘simple-sum’ indices, the index M = x1 + x2 + … + xn , were xj is one of the n monetary components of the monetary aggregate M • Weighted monetary aggregates seem to predict inflation and the business cycle somewhat better than the conventional measures

18. How Reliable are the Money Data? • Revisions are issued because: • small depository institutions report infrequently • adjustments must be made for seasonal variation • We probably should not pay much attention to short-run movements in the money supply numbers but should be concerned only with longer-run movements