Money and Payment System in the U.S. This learning unit defines money and explains its key functions. It outlines the evolution of the U.S. payment system from commodity money to electronic payments. It also discusses how the money supply is measured through monetary aggregates like M1 and M2, and how these aggregates are used by the Federal Reserve to impact economic spending and conditions.

1. Learning Unit #2
Money and Payment System
in the U.S.

2. Objective of Learning Unit
• Define Money
• Understand Functions of Money
• Present Evolution of Payment System
• Explain Measurement of Money in Economy

3. Money
• Money: Anything that is generally accepted in
payment for goods or services or in the
repayment of debt
– Important!! Term “money” defined in Money &
Banking is different from commonly used word “money”
in everyday conversation!

4. Example of Money
So, what can you use for payment at Wal-Mart, McDonald’s, and
Exxon gas station?
– Currency (cash) including coins and bills
• Cash is an asset. If you have $20 bill, you can spend up to $20 worth
of goods and services (e.g. gasoline).
– Check & debit card (electronic version of check)
• A check is a means of payment, but it is worthless piece of paper
unless you write a payment and sign it.
• Can you write $23,770 check at Toyota dealer to purchase Prius? Yes,
only if you have that amount at your bank.
• You can write a check up to an amount in your checking account
without bouncing your check.
• Your checking account balance is money, not check itself.
– Credit card? Not really.

5. Money by Definition
Not every means of payment is money. Money by
definition must be
– An asset (for repayment of debt)
• A credit card is not money because the credit card is a
means of borrowing (not payment, but deferred
payment).
• Once charged, you are expected to pay your credit
card bill by check or cash (a.k.a. money).
– Generally accepted
• If you can use only one or few places, then it is not
money.
• Ex. Disney dollar is not money because it can be used
only at Disney store or Disney World.

6. Three Functions of Money
Money has three primary functions in any
economy.
• Medium of Exchange
– Anything used to pay for goods and services
• Unit of Account
– Anything used to measure value in economy
• Store of Value
– A repository of purchasing power over time

7. Money as Medium of Exchange
• Every modern economy needs money for efficient exchange of
goods and services among people.
• Barter exchange: Exchange goods for goods
Ex. You have a fish and wants to eat a loaf of bread.
(You) Fish  Bread (???)
You must find someone who has a loaf of bread and wants your fish. Is it easy
to find? It will take too long to find a perfect match (high transaction costs).
• Monetary exchange: Exchange of goods through money
Ex. You simply sell your fish to someone who has money (no need to have a loaf of
bread) and use the money to purchase a loaf of bread. Even though this involves
two exchanges, actually it will take less time for exchanges.
(You) Fish  Money (???)  Bread (???)
– Since money comes between two goods in exchange, it is a medium of exchange.
– Money increases efficiency in economy: people can spend more time for
production of goods and services rather than exchange.

8. Money is Means not Ends
• Money is important for any economy because of its
medium-of-exchange function.
→ Thus, money is defined as medium of exchange.
• Everyone likes to have money not because you feel
satisfaction of having money, but because you get
satisfaction by spending it!
– Money is not you end needs, but means (medium) to get
your ends.
– This is true for all financial assets (e.g. stock, bonds)
because financial assets do not provide satisfaction to
owner’s of the assets, but can be used to obtain end needs.

9. Criteria as Medium of Exchange
• Any commodity can be used as money, but to
function effectively as money it must be
– Widely Acceptable: this is the definition of
money itself (i.e. generally accepted).
– Easily Standardized: easy to recognize it as
money and simple to ascertain its value.
– Durable: should not deteriorate quickly.
– Easy to Carry: should not be too bulky or heavy.
– Divisible: easy to make change.

10. Examples of Medium of Exchange
Many commodities have been used as money
in various civilizations in history. Some form
of money is better medium of exchange than
others.
– Yap stone money
– American Indian wampum
– Cigarette in U.S. prisons
– Cowries seashell in the South Pacific and Africa
• Which is better medium of exchange, Yap stone
money or metal coin?

11. U.S. Dollar Bills
• In modern U.S. economy we use dollar bills and coins as
medium of exchange.
• Dollar bills are called “Federal Reserve Note” because they
are IOU (note payable) issued by the Federal Reserve Banks.
They are assets for holders (households, firms, governments,
and foreigners) of IOUs, but liabilities for issuers (the Federal
Reserves) of IOUs.

12. Money and Generally Accepted
• Money must be generally accepted by definition.
• In modern U.S. economy we use worthless paper
money rather than valuable commodity.
• We accept worthless paper money because we expect
they are accepted by others.
• If no one accepts money, money will seize its primary
function in an economy.
• The government guarantees its general acceptance by
making it “legal tender”.

13. Money as Unit of Account
• In the U.S. a value (price) of every good and
service is quoted in dollars and cents.
– By using “dollar and cent” as a standard unit of
value, we can easily compare value of one good
with others.
– Ex. How much is a Big Mac? Around $3.99. How
much is a cheeseburger? About $1.00. So, you
know which is more valuable.

14. Money As Store of Value
• Money can keep its purchasing power
over time.
• When you receive your paycheck, you
do not need to spend every dollar right
at that moment. You can keep it in
bank account or cash on hand, and
spend it later.
• Money is not unique in this function.
There are many assets (financial assets
and commodity) which can serve as
store of value.

15. Comparing Store of Value
Any assets can serve as store of value. One
may serve as a better store of value than
another.
− Ex. Your hardcover textbook can serve as store of value.
You spent $120 to get it, and will sell it at $40. It
preserves $40 value over time.
− Ex. Saving account, bonds, stocks, gold, house
• Liquidity: the relative ease and speed with which
an asset can be converted into medium of exchange
− Money is the most liquid store of value.
• Purchasing Power: Amount of goods and services
money can purchase.
− In an inflation, money loses purchasing power.

16. Evolution of Payment System
Over time, methods of payment evolve as the
technology and economy change.
Changes in payment system reduces transactions
cost (less time and effort to exchange) and create
even better medium of exchange.
• Traditional methods of payment
• Electronic payment

17. Traditional Methods of Payments
• Commodity Money
– Money made up of precious metals or other
valuable commodity
– Physical goods that have a value as a commodity
equal to its value as a medium of exchange
• Fiat money
– Paper currency decreed by government as legal
tender
– Money which does not have a value as a
commodity equal to its value as a medium of
exchange
• Checks

18. Electronic Payment (POS)
When you purchase goods and services at stores, you may
pay it electronically, where funds in your bank account are
automatically and immediately transferred to seller’s bank
account at point of sales.
• Debit cards
• Electronic check (conversion)
− Bank and account information are extracted from your
paper check (converting to electronic version of paper
check), and the fund will be transferred electronically.
− Paper checks are no longer used for settlement.
• Payment by smartphone
− At casher you just pass your smartphone to make a
payment.
− It transmits a bank account information (transfer funds
directly from your bank account), a cell phone account
information (charged to cell phone bill), a credit card
information, or a prepaid account information.

19. Electronic Payment (online)
When you shop online, you may make payments online
electronically.
• Electronic Funds Transfer (EFT) through Automatic Clearing House
(ACH)
− You provide your bank account information, then funds are transferred from
your bank account to seller’s account.
− You can set up at your bank to make a regular payment automatically through
EFT.
− Ex. Monthly automatic payment to your cell phone company.
• Electronic Bill Presentment and Payment (EBPP)
− You receive an electronic bill (e-mail) and with a click you can make a
payment online by providing your credit card information or setting up EFT
• Digital Wallet
− A computer software to store all of your financial information such as credit
card information or your bank account (EFT). When it comes to fill your
payment information during an online shopping, the program automatically fill
all information (Internet Explore can perform some of this function).

20. Electronic Money
Electronic money (e-money) is money that is stored electronically.
• Stored-value card: usually issued by service providers,
required to make deposits, and makes payments out of deposits
for a specific service.
− The balance information may be stored on a card or maintained at an
issuer’s server.
– Prepaid card: Ex. Metro Card, Telephone card
– Smart card: a card with integrated circuits to hold and process
information. Ex. Medical smart card
• Electronic cash (e-cash): money only existent in electronic
form and exchanged only electronically through online or by
electronic devises.
− Ex. PayPal, Bitcoin
So, what is AggieOne card?

21. Measuring Money Supply
• Money supply (Money aggregate): Amount of money
in economy
• Why measuring money supply?
– How people spend is an important factor affecting the
whole economy. How much people spend depends partly
on how much money they have for purchasing (medium of
exchange). Through the monetary policy the Federal
Reserve affects people’s spending by changing the amount
of money in the U.S. economy.
– In order to control money, the Federal Reserve must first
know how much money are in an economy.
Fed → Money → Spending → Economy

22. Two Approaches to Measure Money
Supply
• Money as medium of exchange
– Focus on the definition of money as medium of exchange and include
only assets that clearly act as a medium of exchange
M1 = Currency + Checkable deposits + Travelers Checks
• Money as monetary policy tool
– Focus on the measure of money supply which best predicts changes in the
economic condition
– Many people can spend more than they have in checking accounts or cash
by simply transferring funds from very liquid assets.
– Include highly liquid assets which can affect spending
M2 = M1 + CDs + Saving deposits
+ Money market accounts/mutual funds

23. Money Aggregates
• About one half of M1 is currency and other half is checkable deposits.
• About one quarter of M2 is M1, other three-quarters are CDs, saving
accounts, and money market account/mutual funds.

24. Money Supply Data
Money supply data are available on Internet:
• Barron’s reports the latest information of M1
and M2 in the U.S. economy.
– See “How to Interpret Money Supply of Barron’s”
on Blackboard
• Federal Reserve Bank of St. Louis provides
time-series data of various monetary
aggregates and their components since 1960s.
– See “How to Obtain M1 Data from FRED” on
Blackboard.

25. Selecting Monetary Aggregates
• These two money supply measurements do not always move
together in short time periods.
– If one up, the other down, which one should the Fed choose for
controlling the money?
• The Fed should not be concerned with changes in money
supply measurements in short time period.
– They are affected by numbers of factors.
– They are revised frequently: Ex. Initially reported up, but later changed
to down as more data become available.
• The Fed should keep its eye on their trends over long time
period and how they affect the whole economy over time.
– Many erratic factors affecting the money supply in short time period
offset each others over time.
– The money supply measurements move broadly together over long
time period.

26. Figure 1
Growth Rates of M1 and M2 Aggregates
• Both M1 and M2 moved roughly together from 1960 to 1990.
• Since 1990 M1 tends to move more erratically up and down than M2.
• Although they are apart, since 1995, both M1 and M2 show similar patterns of up and down
trends.

27. Disclaimer
Please do not copy, modify, or distribute this presentation
without author’s consent.
This presentation was created and owned by
Dr. Ryoichi Sakano
North Carolina A&T State University