Chapter 3: What is Money?

Evolution of the Payments System

Commodity Money: valuable, easily standardized and divisible commodities (e.g. precious metals, cigarettes) Fiat money: paper money decreed by the government as legal tender Checks: an instruction to your bank to transfer money from your account -Important: made payment safer, easier to do large payments Electronic payment (e.g. online bill pay) E-money (electronic money): -Debit card -Stored value card (smart card) aka gift card -E-cash

Functions of Money

(1) Medium of Exchange -Eliminates trouble of finding coincidence of needs -Promotes specialization -Medium of exchange must be: easily standardized, widely accepted, divisible, easy to carry (2) Unit of Account -All goods/services priced in terms of asset (allows to compare relative value) -Reduces transaction costs (3) Store of Value -Used to save purchasing power over time -Money is most liquid of all assets, but loses value during inflation

Measuring Money (monetary aggregates)

Construct monetary aggregates using the concept of liquidity M1 (most liquid assets): -Currency -Traveler's checks -Demand deposits (no interest) -other checkable deposits (interest, but more restrictions) M2 (adds to M1 other, less liquid assets): -M1 -Small denomination time deposits (CDs < $100,000) -Savings deposits and money market deposit accounts -Money Market Mutual Funds (same as MMDAs but issued by different types of intermediaries)

M2 vs M1: Does it matter which is considered?

M2 and M1 can move in different directions in short run (because M1 more volatile) (usually move together in long run) Conclusion: choice of aggregates is important for policymakers

Money defined

Money: anything that is generally accepted in payment for goods or services or in the repayment of debt Money is a stock concept (measured at a point in time). Different from: -Wealth: total resources owned by the individual, includes all assets (includes money, also stock concept) -Income: flow variable (measured over period of time), flow of earnings over a period of time

Are we headed for cashless society?

Predictions been around for decades, but none come to fruition Although e-money more efficient and convenient than system based on paper, several factors work against disappearance of paper system Still, use of e-money likely to grow in future

Where are all the US dollars (currency)?

The more than $2000 of USD held per person in US is surprisingly high Where are all these dollars and who is holding them? -Criminals -Foreigners