THE FUNCTIONS OF MONEY
- Medium of Exchange
Money is a medium of exchange that is usable for buying and selling of goods and services.
- Unit of Account
Society uses monetary units – dollars, in the United States – as a yardstick for measuring the relative worth of a wide variety of goods, services and resources.
- Store of Value
Money also serves as a store of value that enables people to transfer purchasing power from present to the future.
THE SUPPLY OF MONEY
- Money Definition M1
M1 – narrowest definition of the U.S. money supply. It consists of:
- Currency in the hands of the public
- All checkable deposits
- Money Definition M2
Near- monies – are certain highly liquid financial assets that do not function directly or fully as a medium of exchange but can be readily converted into currency or checkable deposits.
3 categories of near-monies:
· Savings deposits, including money market deposit accounts.
· Small time deposits
· Money market mutual funds
- Money Definition M3
It includes large time deposits, usually owned by businesses or certificates of deposit.
WHAT “BACKS” THE MONEY SUPPLY?
- Money as Debt
Debt – are promises to pay
- Value of Money
· Acceptability – we accept money in exchange because we are confident that it will be exchangeable for real goods, services, and resources when we spend it.
· Legal Tender – a legal designation of a nation’s official currency. Payment of debts must be accepted in this monetary unit, but creditors can specify the form of payment, for example, “cash only” or “check or credit card only”.
· Relative Scarcity – with a reasonably constant demand for money, the supply of money will determine the value or “purchasing power” of the monetary unit.
- Money and Prices
· Purchasing Power of the Dollar – the amount of the dollar will buy varies inversely with the price level, that is, a reciprocal relationship exists between the general price level and the purchasing power of the dollar.
· Inflation and Acceptability – runaway inflation may significantly depreciate the value of money between the time it is received, and the time it is spent.
· Stabilization of Money’s Value: It requires:
-Appropriate Fiscal Policy
-Intelligent management or regulation of the money supply (monetary policy)
THE DEMAND FOR MONEY
- Transactions Demand, Dt – the amount of money people want to hold for use as medium of exchange; varies directly with the nominal GDP.
- Asset Demand, Da – the amount of money people want to hold as store of value; this amount varies inversely with the interest rate.
- Total Money Demand, Dm – the sum of the transactions demand for money and the asset demand for money.
THE MONEY MARKET
- Adjustment to a Decline in the Money Supply
A decline in the supply of money will create a temporary shortage of money and increase the equilibrium interest rate. Generalization: Lower bond prices are associated with high interest rates.
- Adjustment to an Increase in the Money Supply
Corollary : Higher bond prices are associated with lower interest rates.
FEDERAL RESERVE AND THE BANKING SYSTEM
- Board of Governors
-The central authority of the U.S. money and banking system of the Federal Reserve System.
- Federal Open Market Committee (FOMC)
The FOMC is made up of 12 individuals:
-The seven members of the Board of Governors
-The president of the New York Federal Reserve Bank
-Four of the remaining presidents of Federal Reserve Banks on a 1-year rotating basis.
- The 12 Federal Reserve Banks
· Central Bank – a bank whose chief function is the control of the nation’s money supply, in the United States, the Federal Reserve System.
· Quasi-Public Bank – a bank that is privately owned by governmentally controlled, each of the U.S. Federal Reserve Banks.
· Bankers’ Bank – a bank that accepts the deposits of and make loans to depository institutions, in the United States, a Federal Reserve Bank.
· Commercial Bank – a firm that engages in the business of banking.
· Thrift institution – a savings and loan association, mutual savings bank, or credit union.
- Fed Functions and Money Supply
· Issuing currency
· Setting reserve requirements and holding reserves
· Lending money to banks and thrifts
· Providing for check collection
· Acting as fiscal agent
· Supervising banks
· Controlling the money supply
RECENT DEVELOPMENTS IN MONEY AND BANKING
- \Relative decline in traditional banking
- \Consolidation within the banking industry
- \ Convergence of services by banks, thrifts, insurance companies, pension funds and mutual funds
- \ Globalization of banking
- \Widespread emergence of electronic transactions
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