WHAT IS MONEY? Chapter 3 The Economics of Money, Banking,

Mishkin/Serletis
The Economics
of Money, Banking,
and Financial Markets
Fifth Canadian Edition
Chapter 3
WHAT IS MONEY?
Copyright © 2014 Pearson Canada Inc.
Learning Objectives
1. Describe the meaning of the word money
2. Distinguish among the three primary functions of
money
3. Illustrate how information technology has paved the
way for e-money, e-banking, and e-commerce
4. Explain money measurement matters
Copyright © 2014 Pearson Canada Inc.
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Meaning of Money
• What is it?
• Money (or the “money supply”): anything that is
generally accepted in payment for goods or services or
in the repayment of debts.
• A broad definition
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Meaning of Money (cont’d)
• Money (a stock concept) is different from:
– Wealth
• the total collection of pieces of property that serve to store value
– Income
• flow of earnings per unit of time
• a flow concept
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Functions of Money: Medium of Exchange
• Medium of Exchange:
– eliminates the trouble of finding a double coincidence of
needs (reduces transaction costs)
– promotes specialization
• A medium of exchange must
–
–
–
–
–
be easily standardized
be widely accepted
be divisible
be easy to carry
not deteriorate quickly
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Functions of Money: Unit of Account
• Unit of Account:
– used to measure value in the economy
– reduces transaction costs
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Functions of Money: Store of Value
• Store of Value:
– used to save purchasing power over time.
– other assets also serve this function
– money is the most liquid of all assets but loses value during
inflation
– hyperinflation is when the inflation rate exceeds 50% per
month
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Evolution of the Payments System
• Commodity Money
– valuable, easily standardized and divisible commodities
– e.g. precious metals, cigarettes
• Fiat Money
– paper money decreed by governments as legal tender
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Evolution of the Payments System (cont’d)
• Cheques
– an instruction to your bank to transfer money from your
account
• Electronic Payment
– e.g. online bill pay
• E-Money (electronic money):
– debit card
– stored-value card (smart card)
– e-cash
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FYI Are We Headed for a Cashless Society?
• Predictions of a cashless society have been around for
decades
• E-money might be more convenient and efficient than
a payments system based on paper
• Several factors work against the disappearance of the
paper system
• The use of e-money will likely still increase in the future
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Measuring Money
• How do we measure money? Which particular assets
can be called “money”?
• Construct monetary aggregates using the concept of
liquidity
• M1+
– the narrowest definition is called M1+
– includes: currency in circulation + chequable deposits at
chartered banks, TMLs, and CUCPs
– these assets are all extremely liquid
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Measuring Money (cont’d)
• M2
– Currency in circulation + personal deposits at chartered banks
+ non-personal demand and notice deposits at chartered
banks + fixed term deposits
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Measures of Monetary Aggregates
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Growth Rates of Monetary Aggregates
• Does it matter which measure of money is considered?
• Aggregates can move in different directions in the
short run (see figure 3-2)
• Conclusion: the choice of monetary aggregate is
important for policymakers
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Growth Rates of M2, M1++, M2++
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FYI: Where Are All the Dollars?
• The more than $1500 of currency held per person in
the Canada is a surprisingly large number
• Where are all these dollars and who is holding them?
– criminals
– foreigners
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Money as a Weighted Aggregate
• The Bank of Canada’s money supply measures are
‘simple-sum’ indices, the index
M = x1 + x2 + … + xn ,
where xj is one of the n monetary components of the
monetary aggregate M
• Weighted monetary aggregates seem to predict
inflation and the business cycle somewhat better than
the conventional measures
Copyright © 2014 Pearson Canada Inc.
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How Reliable are the Money Data?
• Revisions are issued because:
– small depository institutions report infrequently
– adjustments must be made for seasonal variation
• We probably should not pay much attention to shortrun movements in the money supply numbers but
should be concerned only with longer-run movements
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