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What is money?

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Adapted from a presentation from the Philadelphia Fed

Adapted from a presentation from the Philadelphia Fed


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  • 1. What is money? Ms. Ross As adapted from Federal Reserve Workshop
  • 2. “ Money is what money does .”
  • 3. Why did money develop?
    • Barter, swapping goods and services for other goods and services, is likely to be difficult.
    • -- Barter requires a coincidence of wants.
    • -- Trade is slowed if there is no coincidence of wants
    • Many societies have used many things as money, including stones, shells, elephant tail bristles, gold and silver coins, furs, salt, whales’ teeth, and pieces of paper.
  • 4. Functions of Money
    • Medium of Exchange
    • -- Money can be used for buying and selling goods and services.
    • -- Money allows society to avoid the difficulties associated with barter.
    • Unit of Account
    • -- Money can be used to judge the relative value of different goods and services.
    • -- Money assists consumers and producers in making rational decisions.
  • 5. Functions of Money
    • Store of value
    • -- Money can be used to transfer purchasing power from the present into the future.
  • 6. Characteristics of “Good” Money
    • Divisible
    • Relatively Scarce
    • Durable
    • Portable
    • Desirable
    • Distinguishable
  • 7. Money Definitions
    • M1
    • M2
    • M3
  • 8. M1 – Money Definition
    • M1 is the “narrowest” definition of money in the United States.
    • M1 is the “most liquid”
    • M1 includes
    • --Currency (coins and paper money) in the hands of the public
    • -- All checkable deposits (all deposits in commercial banks and savings institutions on which checks of any size can be drawn.
    • M1 = 1.372 trillion (as of March, 2008)
  • 9. More on Components of M1
    • Coins + paper money
    • -- coins represent 2-3% of M1
    • -- paper currency represents a little less than 50% of M1
    • -- US coins in circulation are token money because the value of the metal in the coin is worth less than the value of the coin.
    • -- All paper money is in the form of Federal Reserve Notes
    • -- There is more than 700 billion in currency in circulation
  • 10. More on Components of M1
    • Checkable Deposits
    • -- Checkable deposits represent about 50% of M1.
    • -- Checks and debit cards represent a convenient, safe way of transporting money and making payments.
    • -- People can generally convert checkable deposits quickly into paper money and coin. Therefore, checks drawn on these deposits are viewed as equivalent to currency .
  • 11. M2 – Money Definition
    • M2 is a “broader” definition of money and includes M1, plus a number of “near-monies”:
    • -- Savings deposits, including money market deposit accounts (MMDA’s)
    • -- small (less than $100,000) time deposits (CD’s)
    • These “near-monies” can be easily converted into currency and checkable deposits.
    • M2 = $7.6616 trillion ( March 2008)
  • 12. M3 – Money Definition
    • M3 is an even “broader” definition of money and includes M2 and :
    • -- Large ($100,000 or more) time deposits
    • -- Balances in institutional money funds
    • -- Repurchase liabilities issues by depository institutions
    • -- Eurodollars
    • M3 = $9.727 trillion (as of July 14, 2005)
  • 13. Commodity Money
    • Commodity money is anything that serves as money and has an alternative use.
    • -- Corn, tobacco, and salt are some examples of commodities that have been used as money at different times and places in the world.
    • -- Precious metals have also been used as commodity money
  • 14. Fiat Money
    • Fiat money is any item, without intrinsic value, which has been declared to be money by the government.
    • Federal Reserve Notes are fiat money; they have no intrinsic value.
  • 15. Legal Tender
    • Federal Reserve Notes are legal tender.
    • Legal tender means that paper currency must be accepted in payment of a debt, or else the creditor forfeits the privilege of charging interest and the right to sue the debtor for non-payment.
    • Coins and checks are not legal tender, yet they are widely accepted.
  • 16. MV=PQ
    • M: the supply of money in the economy
    • V: the velocity of money, or the number of times a year that the average dollar is spent on final goods and services
    • P: the overall price level in the economy
    • Q: the quantity of all goods and services produced; also known as real output
  • 17. MV=PQ
    • This is a simple model of a macro economy during a time period.
    • MV represents the total amount spent by buyers in the economy.
    • PQ represents the total amount received by sellers.
    • Therefore MV should be roughly equal to PQ
  • 18. MV=PQ
    • If there is a change in one of the variables, there must be a change in one of the other variables to keep MV equal to PQ.
  • 19. Money and Prices
    • There exists a negative relationship between prices and the value of the dollar.
    • -- Higher prices lower the value of the dollar because more dollars are needed to buy a particular amount of goods, services, or resources
    • -- Lower prices tend to raise the value of the dollar because fewer dollars are needed to buy a particular amount of goods, services, or resources.
  • 20. Money and Prices
    • Very high levels of inflation can result in:
    • -- A breakdown in money’s function as a medium of exchange.
    • -- A breakdown in money’s function as a store of value.
    • -- A breakdown in money’s function as a unit of account.