Austrian Macroeconomics, Lecture 2 with Joe Salerno - Mises Academy
Austrian MacroeconomicsLecture 2
The Origin of Money• Money develops from barter due to– lack of coincidence of wants– lack of divisibilityExample: direct exchange vs. indirect exchangeC 1st A 2nd Beggs shoes wheatwheat → ← eggs → ← shoesWheat serves as a “medium of exchange.”
The Origin of Money cont’d• Media of exchange in history:–cattle in ancient Greece; leather in ancientRome; animal pelts, whiskey and tobaccoleaves in the American colonies; wampum(strings of beads) among American Indians;dried fish in Canadian maritime colonies;maize (corn) in Mexico; salt and ironfarming tools in parts of Africa; wives inancient Egypt; and cigarettes in GermanPOW camps.
The Origin of Money cont’d• Money evolves as more and more people andgroups begin to use and accept the samecommodity as a medium of exchange; throughthis self-reinforcing process the more thatpeople use a given good as a medium ofexchange the more generally acceptable thegood becomes and the more likely it is forother people to turn to this good as a mediumof in order to solve the problems of barter.
The Function of Money• Money:– is defined as the general medium of exchange accepted byall people in the economy.– always originates as a useful commodity. All money comesinto being as commoditiy money, historically, gold andsilver.– is not the product of a “social contract” or governmentfiat. Money cannot originate as paper fiat money.• Subsidiary functions of money:store of value; unit of account (tool of economic calculation).
Qualities of a Good Money• Generally acceptable—widely demandednonmonetary employments• Naturally scarce• Portable—a high value/weight ratio making it easy tocarry• Homogeneous—all units are identical to one another• Divisible—it can be divided into small units withoutloss of value• Durable— does not perish or deteriorate quicklywith use• Recognizable—easy to confirm or test itsauthenticity
Common Confusions about Money• Money is not wealth. Wealth is the total(estimated) market value of an indivdual’sassets.• Money is not income. Income is a sum ofmoney payments per unit of time.• Money does not “circulate.” At every momentall existing money is always money is alwaysowned by someone—is lying “idle” insomeone’s cash balance.
The Monetary Unit• For a commodity money such as gold themonetary unit is a unit of weight of gold.• For example:– U.S. $: 1834-1933 legally defined as $1:00 ≈ 1/20oz. gold (23.22 grains of gold)– British £: 1821-1931 legally defined as £1.00 ≈ ¼oz. gold; French franc as ₣1.00 ≈ 1/100 oz gold.• So “exchange rate” for 100 years:– $4:86/£ ( ¼ oz. gold ÷ 1/20 oz. gold)
Kinds of Money• Commodity Money: money consisting of atangible good supplied by the market.• Fiat Money: paper money decreed bygovernments as legal tender, which legallymust be accepted as payments for taxes andall private debts.
Features of Fiat Moneyfiat money is the logical and historical conclusion of theprocess of debasement of the currency.fiat monetary unit is a pure name which no longer isdefined by a specific quantity of a valuable commodityand can be affixed by government to a nearlyworthless item.– fiat money can therefore be created practicallywithout cost or limit.– can and has resulted in hyperinflation, a period ofinflation during which the value of money rapidly fallstoward zero as prices rise toward infinity.
The Value of MoneyPrices of Goods Purchasing Power of Money$1.00/1 Coke 1 Coke/$$10.00/1 pizza or 1/10th pizza/$$100.00/1 IPod or 1/100th IPod/$$1,000/1 laptop or 1/1,000th laptop/$A rise in prices causes a fall in the purchasing power of money$2.00/ 1 Coke ½ Coke/$$20.00/ 1 pizza or 1/20th pizza/$$200.00/1 IPod or 1/200th IPod/$$2,000/1 laptop or 1/2,000th laptop/$Inflation therefore leads to a “shrinking” dollar.
Measuring the Money Supply• Commodity Money:– the money supply is the total monetary gold inexistence in the economy, namely, the totalweight of gold coins and bullion available to beused as a medium of exchange.– the money supply (M) can be calculated bysumming up the cash balances or individual stocksof money (m) held by all people in the economy.– Thus: M = ∑ m.
Fed Measures of the U.S. Money Supply• M1: currency, demand deposits,traveler’s checks, and other checkable deposits.M1 = $2.3 trillion (June 2012)• M2: everything in M1 plus savings deposits,small time deposits, retail money market mutual funds,and a few minor categories.M2 = $9.9 trillion (June 2012)• MZM: M2 + instituional MMMFs – small time deposits
Salerno’s True Money Supply• TMS = M2 - MMMFs - small time deposits+ U.S. government deposits+ demand deposits due to foreign commercialbanks and official institutions+ time and savings deposits due to foreignbanks and official institutions
Logic of TMS Aggregate• For an item to be included in the money supply or monetaryaggregate it must fulfill the following criteria:– 1. it must be routinely and universally accepted inexchange for goods and services– 2. it must serve as the final means of payment in alltransactions, completing discharging the debt owedwithout creating a new debtOR– 3. it must be an instantly convertible claim to the generalmedium of exchange, meaning that it must beinterchangeable with the general medium of exchange ondemand at par (face value)
The Money Supply• The money supply (or money stock):the quantity of money available in the economy• What assets should be considered part of the moneysupply? Two candidates:– Currency: the paper bills and coins in the handsof the (non-bank) public– Demand deposits: balances in bank accounts thatdepositors can access on demand by writing acheck
Money Supply (MS)• In today’s world, MS determined by FederalReserve, although the banking system andconsumers have an influence MS• For now, we assume the Fed precisely controlsMS and sets it at some fixed amount.
Money Demand (MD)• Refers to how much wealth people want to holdin liquid form.• Depends on P:An increase in P reduces the value of money,so more money is required to buy g&s.• Thus, quantity of money demandedis negatively related to the value of moneyand positively related to P, other things equal.(These “other things” include real income,interest rates, availability of ATMs.)
The Money Supply-Demand DiagramValue ofMoney, 1/PPriceLevel, PQuantityof Money1 1¾ 1.33½ 2¼ 4As the value ofmoney rises, theprice level falls.
The Money Supply-Demand DiagramValue ofMoney, 1/PPriceLevel, PQuantityof Money1¾½¼11.3324MS1$1000The Fed sets MSat some fixed value,regardless of P.
The Money Supply-Demand DiagramValue ofMoney, 1/PPriceLevel, PQuantityof Money1¾½¼11.3324MD1A fall in value of money(or increase in P)increases the quantityof money demanded:
MS1$1000Value ofMoney, 1/PPriceLevel, PQuantityof Money1¾½¼11.3324The Money Supply-Demand DiagramMD1P adjusts to equatequantity of moneydemanded withmoney supply.eq’mpriceleveleq’mvalueofmoneyA
MS1$1000The Effects of a Monetary InjectionValue ofMoney, 1/PPriceLevel, PQuantityof Money1¾½¼11.3324MD1eq’mpriceleveleq’mvalueofmoneyAMS2$2000BThen the valueof money falls,and P rises.Suppose the Fedincreases themoney supply.
A Brief Look at the Adjustment ProcessHow does this work? Short version:– At the initial P, an increase in MS causesexcess supply of money.– People get rid of their excess money by spending iton g&s or by loaning it to others, who spend it.Result: increased demand for goods.– But supply of goods does not increase,so prices must rise.(Other things happen in the short run, which we willstudy in later chapters.)Result from graph: Increasing MS causes P to rise.
Monetary Adjustment Process• Excess Supply of Money• MS > MD → ↑DG → ↑P → ↓PPM → ↑Qdm→ MS = MD• Excess Demand for Money• MS < MD → ↓DG → ↓P → ↑ PPM → ↓Qdm→ MS = MD