Lesson summary: definition, measurement, and functions of money

What are monetary aggregates?

an overall measure of the money supply that includes different forms of money which are categorized based on liquidity; the most commonly used monetary aggregates are M1 and M2.

What is meant by money?

any asset that can serve the three functions of money; if a group of people got together and agreed that bubble gum wrappers serve as a 1) medium of exchange, 2) a store of value, and 3) a unit of account, then bubble gum wrappers are now money.

What is meant by M1?

assets that can be directly used to carry out the transactions motive of money; M1 is sometimes called "narrow money" because this is the narrowest definition of the money supply.

What are demand deposits?

deposits placed into banks that a bank must return to the account holder on demand; checking accounts are examples of demand deposits because the bank must allow you to withdraw it or use it at any time.

What is meant by M2?

financial assets that aren't directly used for a medium of exchange, but can be converted into cash or a checking account; M2M2M, 2 is sometimes called "near money" because it is nearly as liquid as M1M1M, 1, but not quite as liquid.

What is meant by the phrase "the transactions motive"?

when people hold money for the purpose of buying things.

What is the monetary base?

(also called high powered money and in some countries M0) the sum of currency in circulation and bank reserves held in vaults; only part of the monetary base (currency in circulation) is counted in the money supply.

What is meant by currency in vaults?

(also called reserves) money that banks keep within the bank, outside of circulation.

What is the money supply?

the total amount of money in an economy that can carry out the transactions motive; in most countries, the money supply is either the monetary aggregate M1 or M2?

What is ment by currency in circulation?

money outside of banks, such as money in your wallet or your couch cushions; the money in your pocket is currency in circulation, but your money in your bank account is outside of circulation.

What is fiat money?

money that gets its value entirely from its status as a means of payment; paper money is fiat money because its value for its use as a currency is far higher than the intrinsic value of a small scrap of paper.

What is commodity money?

money that has intrinsic value in other uses; gold and salt are examples of things that have been used as commodity money.

What is commodity backed money?

money that has no inherent value, but it has a value guaranteed by a promise that it can be converted into something of value; for example, if the nation of Johnsrudia uses bubble gum wrappers as its currency, but you can exchange those for their equivalent value in gold, this would be commodity backed money.

What makes an item a medium of exchange?

the ability for something to be used to purchase something else, such as "I can use this $5 bill to buy a grilled cheese and peanut butter sandwich"

What makes an item a store of value?

the ability to delay using money as a medium of exchange until later, such as "I am going to keep this $5 bill in my wallet so I can buy a grilled cheese and peanut butter sandwich tomorrow"

What makes an item a unit of account?

the ability to represent the value of an item, such as "this grilled cheese and peanut butter sandwich costs $5"

What is meant by required reserves?

the fraction of money a bank is required to put aside and not use for loans or any other purpose, usually required by banking regulations; this fraction is based on the amount of money that has been deposited into the bank, such as 20% of all deposits.