1. The document discusses several key concepts related to money including its functions as a medium of exchange, unit of account, and store of value. It also discusses different monetary aggregates like M1, M2, and M3. 2. The quantity theory of money posits that the overall price level in an economy is determined by the supply of money, and that increasing the money supply will cause proportionate increases in the price level over the long run. 3. When the central bank increases the money supply, it can lead to inflation as prices rise in response to bring money supply and demand into equilibrium.

1. Money Money

2. Money Money: anything that functions as a means of payment (medium of exchange), unit of account, and store of value. GREATLY reduces transaction costs! Barter (trade) much less efficient for it demands a double coincidence of wants

3. Money Many items have played the role of money money Salt, olive oil, silver, gold, cigarettes, etc ideal money is easy to transport, widely recognized, and can not be counterfeited

4. Functions of money Medium of exchange-means of payment Unit of account-standardized means of measuring prices Store of value-must retain value

5. Measuring Money Not as easy as it would appear What should we use as money? Just currency? Currency and other stored money? Multiple definitions

6. Money Aggregates M1--currency and checkable deposits checkable deposits = deposits subject to check withdrawal Considered as Money Supply (MS)

7. Money definitions continued M2 = M1 + other highly liquid assets such as money market deposit accounts (individual small time deposits) M3= M2 + less liquid assets (Large and longer time deposits, term repo’s, institutional MM funds)

8. Evolution of payments system Money to electronic payments lose float, but gain efficiency Easy section on ATMs, electronic fund transfers etc.

9. Money Supply, Money Demand, and Monetary Equilibrium The money supply is a policy variable that is controlled by the Central Bank. Through instruments such as open-market operations, the CB directly controls the quantity of money supplied.

10. Money Supply, Money Demand, and Monetary Equilibrium Money demand has several determinants, including interest rates and the average level of prices in the economy.

11. People hold money because it is the medium of exchange. The amount of money people choose to hold depends on the prices of goods and services. Money Supply, Money Demand, and Monetary Equilibrium

12. Money Supply, Money Demand, and Monetary Equilibrium In the long run, the overall level of prices adjusts to the level at which the demand for money equals the supply.

13. Money Supply, Money Demand, and the Equilibrium Price Level A Money supply 0 1 (Low) (High) (High) (Low) 1/2 1/4 3/4 1 1.33 2 4 Money demand Quantity fixed by the CB Quantity of Money Value of Money (1/P) Price Level (P) Equilibrium value of money Equilibrium price level

14. The Effects of Monetary Injection A MS 1 0 1 (Low) (High) (High) (Low) 1/2 1/4 3/4 1 1.33 2 4 Money demand M 1 Quantity of Money Value of Money (1/P) Price Level (P) MS 2 1. An increase in the money supply... 2. ...decreases the value of money ... 3. …and increases the price level M 2 B

15. The Quantity Theory of Money How the price level is determined and why it might change over time is called the quantity theory of money. The quantity of money available in the economy determines the value of money. The primary cause of inflation is the growth in the quantity of money .

16. Velocity and the Quantity Equation The velocity of money refers to the speed at which the typical dollar bill travels around the economy from wallet to wallet.

17. Velocity and the Quantity Equation V = (P x Y)/M Where: V = velocity P = the price level Y = the quantity of output M = the quantity of money

18. Velocity and the Quantity Equation Rewriting the equation gives the quantity equation: M x V = P x Y

19. Velocity and the Quantity Equation The quantity equation relates the quantity of money ( M ) to the nominal value of output ( P x Y ).

20. Velocity and the Quantity Equation The quantity equation shows that an increase in the quantity of money in an economy must be reflected in one of three other variables: the price level must rise, the quantity of output must rise, or the velocity of money must fall.

21. Indexes (1960 = 100) 1,500 1,000 500 0 1960 1965 1970 1975 1980 1985 1990 1995 2000 Nominal GDP, the Quantity of Money, and the Velocity of Money Nominal GDP M2 Velocity

22. The Equilibrium Price Level, Inflation Rate, and the Quantity Theory of Money The velocity of money is relatively stable over time. When the CB changes the quantity of money, it causes proportionate changes in the nominal value of output (P x Y). Because money is neutral, money does not affect output.

23. Money and Prices During Four Hyperinflations (b) Hungary Money supply 1925 1924 1923 1922 1921 Price level 100,000 10,000 1,000 100 Index (Jan. 1921 = 100) (a) Austria 1925 1924 1923 1922 1921 100,000 10,000 1,000 100 Index (Jan. 1921 = 100) Price level Money supply

24. Money and Prices During Four Hyperinflations c) Germany 1 100 trillion 1 million 10 billion 1 trillion 100 million 10,000 100 1925 1924 1923 1922 1921 Price level Money supply d) Poland Money supply Price level Index (Jan. 1921 = 100) 100 10 million 100,000 1 million 10,000 1,000 1925 1924 1923 1922 1921 Index (Jan. 1921 = 100)

25. The Fisher Effect According to the Fisher effect, when the rate of inflation rises, the nominal interest rate rises by the same amount. The real interest rate stays the same.

26. 0 6 10 15 1960 1965 1970 1975 1980 1985 1990 1995 The Nominal Interest Rate and the Inflation Rate 3 12 Percent (per year) Inflation Nominal interest rate

27. Summary The overall level of prices in an economy adjusts to bring money supply and money demand into balance. When the central bank increases the supply of money, it causes the price level to rise. Persistent growth in the quantity of money supplied leads to continuing inflation.

28. Dissent on Keynes, Then and Now Is the market the source of macroeconomic instability? Roger W. Garrison 2009

29. Friedrich A. Hayek took issue with the structure of Keynes’s analytical framework: 1. Can we actually ignore the effects of changes in the interest rate in our accounting for the saving behavior of income-earners and the investment decisions of entrepreneurs? 2. In there an identifiable market process that can translate decisions to save into decisions to produce for the future. 3. How is economic stability affected by the overriding of market interest rates with interest rates imposed by policy makers?

30. Stock Market Crash

31. Unemployment

32. Bread Lines in New York

33. Prices were either too high or zero .

34. Food Lines in Paris

35. Oklahoma Dust Bowl

36. Make-shift Housing

37. Migrants Going West

38. Migrant Family in California

39. Despondency Dorothea Lange's "Migrant Mother," destitute in a pea picker's camp, because of the failure of the early pea crop. These people had just sold their tent in order to buy food. Most of the 2,500 people in this camp were destitute. By the end of the decade there were still 4 million migrants on the road.

40. The phenomenon of bust and depression was observed and argued about long before the Great Depression and long before Keynes wrote his General Theory . A fully satisfying explanation requires that we consider the phenomenon of boom, bust, and depression. But sorting out the differences between Milton Friedman and Maynard Keynes can be achieved with the narrower focus, i.e., bust and depression.

41. This focus suggests two questions in need of an answer: 1. What caused the bust? What was the triggering mechanism? What change in market conditions required adjustments of some kind on an economywide scale? 2. Why did it take so long for markets to adjust to the changed market conditions? If prices, wages, and interest rates needed to adjust, why didn’t they adjust?

42. 2. Why did it take so long for markets to adjust to the changed market conditions? If prices, wages, and interest rates needed to adjust, why didn’t they adjust? The adjustment of prices and wages did actually get underway. Prices started falling; wages started falling. People and their political leaders associated low prices and wages with bad times and high prices and wages with good times.

43. CCC Civil Conservation Corp

46. Make-Work Projects

47. 1938 Cadillac

50. New Deal-era promo for the NRA (National Recovery Administration). Producer: Metro-Goldwyn-Mayer Featuring: Jimmy Durante Click the “Blue Eagle” for the 2 min. 49 sec. video.

51. And just what was that general decline in demand all about? Was it really something inherent in market economies. Was it the unpredictable behavior of the investment community---as John Maynard Keynes claimed? Or was it some extra-market happening. Maybe some action of policymakers? Didn’t we have a similar decline in demand in the early 1920s---near the end of Warren G. Harding’s presidency?

52. Printing Money and Spending it. The Equation of Exchange And the Quantity Theory of Money

53. Pepe Smith earns a lot of money. Bill Gates has a lot of money. It’s better to buy a house when money is cheap. I need to cash a check to get some money. Money facilitates the exchange of goods and services.

54. Pepe Smith earns a lot of money. Bill Gates has a lot of money. It’s better to buy a house when money is cheap. I need to cash a check to get some money. Money facilitates the exchange of goods and services. CURRENCY CREDIT MONEY INCOME WEALTH

55. MV = PQ M is the money supply (outside the banking system). V is money’s velocity of circulation. P is the price level. Q is the economy’s output. PQ is total expenditures (E).

56. MV = PQ This is the “Equation of Exchange.” No economist, dead or living, has ever denied that MV actually does equal PQ. V = PQ/M

57. Y=MV=PQ=E E is total expenditures (PQ) Y is total income = nominal GDP Q is real income = real GDP = Y/P Case, Fair, and Oster use Y for real income. Friedman used a lower-case y for real income. Hence: Q = CFO’s Y = Friedman’s y.

58. Keynes believed that the velocity of money was subject to dramatic and unpredictable change. He believed that people “hoard” money, more so some times than others. (increased hoarding means a decrease in velocity.) In extreme episodes, people may be overcome by the “fetish of liquidity,” the fetish often accompanying the waning of animal spirits.

59. Milton Friedman (1912 - 2006) MV = PQ Inflation is always and everywhere a monetary phenomenon!!!