The Demand andThe Demand and
Supply of MoneySupply of Money
Smi%
$$ demanded
Dm
i%1

Amount of money in circulation isAmount of money in circulation is
constantly changing. The amountconstantly changing. The amount
depends on how much money is desireddepends on how much money is desired
by individuals and businesses.by individuals and businesses.
Supply of money automaticallySupply of money automatically
expands and contracts with the needsexpands and contracts with the needs
of business.of business.
Supply of Money:Supply of Money:

What is ourWhat is our
Money Supply?Money Supply?
Typically, what the FEDTypically, what the FED
calls M1 moneycalls M1 money

M1 MoneyM1 Money
• CurrencyCurrency (held outside of banks)(held outside of banks)
• Demand DepositsDemand Deposits
• Traveler’s checksTraveler’s checks
• Other checkable depositsOther checkable deposits
– Money Market FundsMoney Market Funds

M1 MoneyM1 Money
1.1. Coin about 2-3% of total M1Coin about 2-3% of total M1 forfor
convenience money; often called tokenconvenience money; often called token
money because intrinsic value is less thanmoney because intrinsic value is less than
the face value.the face value.
2.2. Paper money is 46% of total M1Paper money is 46% of total M1
in the form of Federal Reserve Notesin the form of Federal Reserve Notes
NOTE: M1NOTE: M1 excludesexcludes currency held in thecurrency held in the
bank vault or deposited in Federalbank vault or deposited in Federal
Reserve Banks or held by US TreasuryReserve Banks or held by US Treasury
√√ CurrencyCurrency

Checks are 52% of total M1Checks are 52% of total M1, used for, used for
90% of transactions (offered by commercial90% of transactions (offered by commercial
banks, thrift institutions, and credit unions);banks, thrift institutions, and credit unions);
calledcalled demand depositsdemand deposits, Automatic Transfer, Automatic Transfer
Service and Share Draft Accounts.Service and Share Draft Accounts.
NOTE: Currency and checkable depositsNOTE: Currency and checkable deposits
owned by the US Treasury, the FED,owned by the US Treasury, the FED,
commercial banks and other financialcommercial banks and other financial
institutions are not counted as M1.institutions are not counted as M1.
M1 MoneyM1 Money √√ Checkable DepositsCheckable Deposits

Near Monies…Near Monies… highly liquidhighly liquid
financial assets that do not directlyfinancial assets that do not directly
function as medium of exchangefunction as medium of exchange
but can be easily converted intobut can be easily converted into
currency or checkable deposits.currency or checkable deposits.
M2 and M3 Money SupplyM2 and M3 Money Supply

1)1) Spending habitsSpending habits: the greater the: the greater the
amount of financial wealth held as nearamount of financial wealth held as near
money, the greater the willingness tomoney, the greater the willingness to
spend out of current incomespend out of current income
2)2) StabilityStability: easy conversion from near: easy conversion from near
money to M1 supply may force inflationmoney to M1 supply may force inflation
to occurto occur
3)3) Policy:Policy: complicates actions to becomplicates actions to be
taken.taken.
Importance of Near MoniesImportance of Near Monies

M2 MoneyM2 Money
M1 plus:M1 plus:
savings accounts, money marketsavings accounts, money market
mutual funds, money marketmutual funds, money market
deposit accounts, and small-deposit accounts, and small-
denomination time depositsdenomination time deposits

M2 plus:M2 plus:
savings instruments greatersavings instruments greater
than $100,000.than $100,000.
M3 MoneyM3 Money
WeWe do not includedo not include less liquidless liquid
assets like Treasury Bills and USassets like Treasury Bills and US
Savings Bonds.Savings Bonds.

MIMI
• Checkable depositsCheckable deposits
• Travelers checksTravelers checks
• CurrencyCurrency
• Money market accountsMoney market accounts
• Savings depositsSavings deposits
• Small time depositsSmall time deposits
• Large time depositsLarge time deposits
M2M2
M3M3
++
++
MM
OO
NN
EE
YY
MM
EE
AA
SS
UU
RR
EE
SS

Does gold or silverDoes gold or silver
back up our money?back up our money?
No, our money is notNo, our money is not
backed up by anythingbacked up by anything

…… Paper Money is the circulatingPaper Money is the circulating
debt of the Federal Reserve Banks.debt of the Federal Reserve Banks.
…… Checkable Deposits are the debtsCheckable Deposits are the debts
of commercial banks and thriftof commercial banks and thrift
institutions.institutions.
…… Paper Money has no intrinsicPaper Money has no intrinsic
value; it cannot be redeemed in goldvalue; it cannot be redeemed in gold
or other “valued” item.or other “valued” item.
Money as DebtMoney as Debt

√√ Acceptability : confident money is tradableAcceptability : confident money is tradable
for goods and servicesfor goods and services
√√ Legal tender: matter of law (creditor mustLegal tender: matter of law (creditor must
accept or forfeit right to sue or chargeaccept or forfeit right to sue or charge
interest) and government will accept money ininterest) and government will accept money in
payment of taxes.payment of taxes. Checks do not have thisChecks do not have this
status.status.
√√ Relative scarcity: demand (utility related toRelative scarcity: demand (utility related to
acceptance for goods and services) and supplyacceptance for goods and services) and supply
(controlled by FED) relationship(controlled by FED) relationship
Value of MoneyValue of Money

√√ Purchasing power of money is thePurchasing power of money is the
real value.real value.
√√ The amount a dollar will buyThe amount a dollar will buy
varies inversely with the price level.varies inversely with the price level.
D = 1/PD = 1/P D=Value of the $D=Value of the $
P= Price levelP= Price level
Money and PricesMoney and Prices

•Inflation is the result of a society’s spendingInflation is the result of a society’s spending
beyond its capacity to produce.beyond its capacity to produce.
•HH & BS are willing to accept currency andHH & BS are willing to accept currency and
checkable deposits as long as they know it cancheckable deposits as long as they know it can
be spent without a loss of purchasing power.be spent without a loss of purchasing power.
•In inflation… the rapid loss of purchasingIn inflation… the rapid loss of purchasing
power will cause money to lose its function as apower will cause money to lose its function as a
medium of exchange.medium of exchange.
•Money will serve its function as a store ofMoney will serve its function as a store of
value as long as there is no unreasonable lossvalue as long as there is no unreasonable loss
in value by storing it.in value by storing it.
Inflation and Acceptability

√√ Major backing for money is theMajor backing for money is the
government’s ability to keep the value ofgovernment’s ability to keep the value of
money stable.money stable.
√√ This means appropriate fiscal policy andThis means appropriate fiscal policy and
wise management of the money supplywise management of the money supply
through sound monetary policy.through sound monetary policy.
√√ In US, a blend of legislation, governmentIn US, a blend of legislation, government
policy, and social practice stops the unwisepolicy, and social practice stops the unwise
expansion of the money supply which couldexpansion of the money supply which could
change money’s value in exchange.change money’s value in exchange.
Stabilization of Money’s ValueStabilization of Money’s Value

•• amount of money demanded by individuals andamount of money demanded by individuals and
businesses to buy and sell goods and servicesbusinesses to buy and sell goods and services
√√ Medium of exchange function of moneyMedium of exchange function of money
√√ variesvaries directlydirectly with GDPwith GDP
Demand for MoneyDemand for Money
Transaction demandTransaction demand
i%
$$ demanded
Dt

•• amount of money demanded by individuals andamount of money demanded by individuals and
businesses to store wealthbusinesses to store wealth
√√ Store of value function of moneyStore of value function of money
√√ variesvaries inverselyinversely with GDPwith GDP
Demand for MoneyDemand for Money
Asset demandAsset demand
i%
$$ demanded
Da

Combining the transactionCombining the transaction
demand and the asset demanddemand and the asset demand
creates the total demand forcreates the total demand for
money. This is the moneymoney. This is the money
market and determines themarket and determines the
equilibrium interest rate.equilibrium interest rate.
Demand for MoneyDemand for Money
Total Demand (DTotal Demand (Dmm))

i%i%11
Money Demand CurveMoney Demand Curve
MM22MM11
DD
i%i%22
i%i%
Q of MQ of M

i%
$$ demanded
Dm
i%1
Sm
The Money MarketThe Money Market
Supply ofSupply of
money is amoney is a
vertical linevertical line
since monetarysince monetary
authoritiesauthorities
(FED) and(FED) and
financialfinancial
institutionsinstitutions
have providedhave provided
the economythe economy
with a certainwith a certain
stock of money.stock of money.