What is Money?

“Money is what money does.”

“Money is a belief that has to be shared with other people….Otherwise money’s useless: you can’t eat or wear it, buy love with it (though you may broaden your chances), and you don’t take it with you when you die. Money can be anything you like-gold or silver, peas or paper, tiny shells or massive stones or nothing at all but surf on the electronic highway. But everyone must agree on what it is: we accept money because we believe others in turn will accept it too . It works because it works.”

Jason Goodwin, Greenback, page 5

What is money?Functions and Characteristics of MoneyDefinitionsCommodity Money, Fiat Money, Legal TenderMoney and PricesThe Demand for MoneyThe Money Market

Why Did Money Develop?Barter, swapping goods

and services for other goods and services, is likely to be difficultBarter requires a

coincidence of wantsTrade is unlikely if there

is no coincidence of wants

Many societies have used many things as money, including :stones shellselephant tail bristlesgold and silver coins furssalt whales’ teeth pieces of paper

Functions of MoneyMedium of exchange

Money can be used for buying and selling goods and services

Money allows society to avoid the difficulties associated with barter

Unit of accountMoney can be used to judge the relative value of

different goods and servicesMoney assists consumers and producers in making

rational decisionsStore of value

Money can be used to transfer purchasing power from the present into the future

Characteristics of “Good” MoneyDivisible

It can be broken into smaller unitsRelatively scarce

There is not as much of it as everyone wantsDurable

It lasts a long timePortable

It is easy to carryDesirable

It is something that people wantDistinguishable

It is easy to recognize and difficult to fake

Money Definitions

M1M2

Money Definitions – M1M1 is the “narrowest” definition of money in the

United StatesM1 includes:

Currency (coins and paper money) in the hands of the public

All checkable deposits (all deposits in commercial banks and savings institutions on which checks of any size can be drawn).

Traveler’s checks

M1= $1.386 trillion (as of June 2008)

More on the Components of M1

Coins and Paper MoneyCoins represent 2-3% of M1Paper currency represents a little less that

50% of M1U.S. coins in circulation are token money

because the value of the metal in the coin is worth less that the value of the coin

All paper money is in the form of Federal Reverse Notes

There is more than $750 billion in currency in circulation

More on Components of M1

Checkable depositsCheckable deposits represent slightly

less than 50% of M1Checks represent a convenient, safe

way of transporting money and making payments

People can generally convert checkable deposits quickly into paper money and coin, therefore checks drawn on these deposits are viewed as equivalent to currency

Money Definition – M2

M2 is a “broader” definition of money and includes M1, plus a number of “near-monies”Savings deposits, including money market

accounts (MMA)Small (less than $100,000) time deposits (CD’s)Money market mutual funds (MMMF’s)

These “near-monies” can be easily converted into currency

M2= $7.666 Trillion (as of 2008)

Commodity MoneyAnything that serves as money

and has an alternative use Corn, tobacco, and salt are some

examples of commodities that have been used as money at different times and places

Precious metal have also been used as commodity

Fiat MoneyAny item without intrinsic value, which has

been declared to be money by the governmentFederal Reserve Notes are fiat money; they

have no intrinsic value

"Fiat money is similar to representative money except it can't be redeemed for a commodity, such as gold or silver. The Federal Reserve notes we use today are an example of fiat money." [

Legal TenderFederal Reserve notes are legal tender

Legal tender means that paper currency must be accepted in payment of a debt, or else the creditor forfeits the privilege of charging

Coins and checks are not legal tender, yet they are widely excepted.

Money and PricesInflation is a rise in the general level of

pricesDisinflation is a reduction in the level of

inflationDeflation is a decline in the general level

of pricesWe CAN MEASURE THE GENERAL LEVEL OF PRICES WITH THE CONSUMER PRICE INDEX (CPI)

Money and PricesVery high levels of

inflation can result in a breakdown in

money’s function as a medium of exchange

A breakdown in money’s function as a store of value

A breakdown in money’s function as a unit of account

The Demand for MoneyTransactions Demand for Money

People hold money because it is convenient for purchasing goods and services

Transactions demand for money varies directly with nominal GDP

Asset Demand for Money People hold their financial assets in many forms including

corporate stock, bonds, and money Asset demand varies inversely with interest rates