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WHAT IS MONEY?

Econ-190.2: Monetary, fiscal, and development policy

Introduction
What is money?

- is the stock of assets that can be readily used to make

transactions.
- a particular form of wealth that is universally accepted in
exchange

• without money, barter would facilitate trade

 problematic: double-coincidence of wants

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Functions of money
1. As a store of value
- money is a way to transfer purchasing power from the
present to the future
- it is not a perfect store of value due to inflation
- many such assets have advantages over money as a
store of value: they often pay a higher interest rate
than money and experience price appreciation, among
others
- but money has one desirable property which others do
not have: liquidity: the relative ease and speed with
which an asset can be converted into a medium of
exchange

Functions of money
2. As a unit of account
- money provides the terms in which prices are quoted and
debts are recorded
- money is the yardstick with which we measure economic
transactions
- it solves the problem in a barter economy
- it reduces transaction costs in an economy by reducing the
number of prices that need to be considered

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Functions of money
3. As a medium of exchange
- money is what we use to buy goods and services
- it promotes economic efficiency by minimizing the time
spent in exchanging goods and services
- for a commodity to function effectively as money, it has to
meet several criteria:
a. it must be easily standardized
b. it must be widely accepted
c. it must be divisible, so that it is easy to “make change”
d. it must be easy to carry
e. it must not deteriorate quickly

Evolution of the payments system

1. commodity money
- goods with intrinsic value
- ex: precious metals, shells, etc Source: http://www.nbbmuseum.be/2007/01/cowry-shells.htm

- problem: can be very heavy and hard to transport from

one place to another
2. commodity-standard
- paper money (notes) redeemable in some commodity
(e.g., a gold-standard)
3. fiat money
- money that has no intrinsic value
- established as a money by government decree
- problem: easily stolen; expensive to transport because of
its bulk

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Evolution of the payments system

4. checks
- is an instruction from you to your bank to transfer money
from your account to someone else’s account when she
deposits the check
- it allow transactions to take place without the need to
carry around large amounts of currency
- problem: it takes time to get checks from one place to
another (or to be credited to another person’s account)
5. electronic money/electronic payment
- money that exists in electronic form

Measuring quantity of money

Basic components

1. currency – sum of outstanding paper money and

coins. Daily transactions usually use currency as
medium of exchange.

2. demand deposits – funds people hold in their checking

accounts

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Measuring quantity of money

What is included in the money supply?
Financial assets are all forms of liabilities of some entities, e.g., the
government, private corporations, banks, foreign governments, and
foreign banks. Some (but not all) of these liabilities are accepted as
means of exchange and are part of money:
• Notes and coins (liabilities of the central bank)
• Savings accounts (liabilities of commercial banks)
• Checking accounts (liabilities of commercial banks)
• Time deposits (liabilities of banks)

The rule is: the easier it is for holders of these liabilities to call them,
the closer these are to money.

Measuring quantity of money

What is included in the money supply?
Using this definition, credit cards are not part of the money supply.
After all, when you pay with a credit card, the liability is yours, not
anyone else’s.

By contrast, a debit card is immediately connected to the money

supply (e.g., it’s connected to a savings or current account) – but
you should not double count it.

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Measuring quantity of money

Measures of the monetary aggregates (Fed)
M1 = Currency + Demand deposits + Traveler’s checks
+ Other checkable deposits

M2 = M1 + small-denomination time deposits and repurchase

agreements + savings deposits and money market
deposit accounts + money market mutual fund shares
(noninstitutional)

M3 = M2 + large-denomination time deposits and repurchase

agreements + money market mutual fund shares
(institutional) + repurchase agreements + Eurodollars

Total US money supply

Measuring quantity of money

Measures of the monetary aggregates (BSP)
M1 or Narrow Money = Currency + Demand deposits

M2 or Broad Money = M1 + peso savings + time deposits

M3 or Broad Money Liabilities = M2 + peso deposit substitutes

(e.g. promissory notes and
commercial papers)

M4 = M3 + transferable + other deposits in foreign currency

Total PHL money supply

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END