ECON 3150: Money & Banking

What is Money?

What is Money?

Two Main Issues:

1. Important Role of Money in the Economy

from a Microeconomic Perspective

2. How to Define & Measure Money

ECON 3150: Money & Banking

3-1
MUN, Dr. K.Chu

The Economist’s Meaning of Money

• Money - anything that is generally accepted in
payment for goods or services or in the
repayment of debts
• Wealth - the total collection of pieces of
property that serve to store value
• Income - flow of earnings per unit
of time
• Money ≠ Wealth; Money ≠ Income

ECON 3150: Money & Banking

3-2
MUN, Dr. K.Chu

Importance of Money as a Medium of Exchange

Money Facilitates Exchanges by Reducing:

1. Uncertainties:
Double Coincidence of Wants (DCW)
Double Coincidence of Time (DCT)
2. Transaction Costs:
Search Costs, Information Costs,
Computational Costs, Waiting Costs, etc

ECON 3150: Money & Banking

3-3
MUN, Dr. K.Chu

MUN, Dr. K. Chu 1

ECON 3150: Money & Banking
What is Money?

Money Economy Vs Barter

Number of Exchange Ratios/Relative Prices ( #)
in an economy with N goods :

• Barter: # = N (N -1) / 2

• Money Economy: # = N - 1

ECON 3150: Money & Banking

3-4
MUN, Dr. K.Chu

An Illustrative Example
Barter: Commodity Money:

• If N =2, # = 1 • If N =2, # = 1
• N = 3, # = 3, • N = 3, # = 2,
• N = 10, # = 45 • N = 10, # = 9
• N= 1000, # = 499,500 • N= 1000, # = 999
• N= 1 m, # = 499,999.5m • N= 1 m, # = 999,999

ECON 3150: Money & Banking MUN, Dr. K.Chu

3-5

Money vs. Barter

This Demonstrates that Money Improves Social
Welfare by:

• Lowering Transaction Costs

• Increasing Savings

ECON 3150: Money & Banking

3-6
MUN, Dr. K.Chu

MUN, Dr. K. Chu 2

ECON 3150: Money & Banking
What is Money?

What is Money in Practice?

Evolution of Payments System
1. Barter Economy
2. Fairground Economy
3. Trading Posts
4. Commodity Money: Precious metals like
gold and silver
5. Paper currency (fiat money)
6. Cashless Society: Checks & Electronic
money: Debit cards, Smart cards, E-cash,
Bitcoin, etc
Minimization of Transaction Costs
ECON 3150: Money & Banking
3-7
MUN, Dr. K.Chu

Why Define & Measure Money?

• A Monetary system is more efficient than a
Barter system

• Excessive monetary expansion leads to

inflation which is socially costly

ECON 3150: Money & Banking

3-8
MUN, Dr. K.Chu

Approaches to Defining Money

1. Functional Approach

2. Transaction Approach

3. Liquidity Approach

4. Statistical/Empirical Approach

ECON 3150: Money & Banking

3-9
MUN, Dr. K.Chu

MUN, Dr. K. Chu 3

ECON 3150: Money & Banking
What is Money?

Functions of Money
• Medium of Exchange - promotes economic
efficiency by minimizing the time & costs spent in
exchanging goods and services

• Unit of Account - used to measure value in

the economy

• Store of Value - used to save purchasing power;

most liquid of all assets but loses value during
inflation

ECON 3150: Money & Banking

3 - 10
MUN, Dr. K.Chu

Functional Approach
• Anything that performs the above functions
can be defined as money

• E.g. $20 bill is money

• Imprecise; (e.g. Government bond can be a

store of value)

ECON 3150: Money & Banking

3 - 11
MUN, Dr. K.Chu

Transaction Approach
• Emphasizes the role of money as a medium of
exchange
• $20 bill is accepted for buying goods &
services, but government bond is not.
• Also imprecise; financial assets (stores of
value) can be converted into banknotes
(medium of exchange)

ECON 3150: Money & Banking

3 - 12
MUN, Dr. K.Chu

MUN, Dr. K. Chu 4

ECON 3150: Money & Banking
What is Money?

Liquidity Approach
If money is not unique as a store of
value, why do people hold
money?

–The answer is liquidity: the relative

ease and speed with which an asset
can be converted into a medium of
exchange.
ECON 3150: Money & Banking
3 - 13
MUN, Dr. K.Chu

Liquidity Approach
Factors affecting an Asset’s Liquidity
1. Term to Maturity

2. Existence of Secondary Markets &

Transaction Costs

3. Capital Value Risk

ECON 3150: Money & Banking

3 - 14
MUN, Dr. K.Chu

Liquidity of Assets
• Cash Most Liquid by Definition

• In general, Order of Liquidity: Cash, Bank

Deposits, Government Bonds, Short-term
Financial Instruments, Long-term Financial
Instruments, Physical Assets (e.g. Houses), etc

• But No Unique Rankings, Depending on the

Relevant Factors

ECON 3150: Money & Banking

3 - 15
MUN, Dr. K.Chu

MUN, Dr. K. Chu 5

ECON 3150: Money & Banking
What is Money?

Liquidity Approach
• Include Liquid Assets in the definition of
money

• E.g. M2 = currency in circulation + bank

deposits

• Also imprecise b/c financial innovations

ECON 3150: Money & Banking

3 - 16
MUN, Dr. K.Chu

Empirical /Statistical Approach

• Focus on the relationship between money &
aggregate economic activity
• In practice, define money a/c to Institutional
aspects:
– Chartered Banks vs. other types of financial
institutions
– types of deposits
– types of financial assets

ECON 3150: Money & Banking

3 - 17
MUN, Dr. K.Chu

Money Supply in Canada

Bank of Canada uses several monetary

aggregates to measure money in Canada

M1+ : Narrow money

M2++ : Broadest form of money

ECON 3150: Money & Banking

3 - 18
MUN, Dr. K.Chu

MUN, Dr. K. Chu 6

ECON 3150: Money & Banking
What is Money?

Money Supply Definitions in Canada

ECON 3150: Money & Banking

3 - 19
MUN, Dr. K.Chu

The Canadian Money Supply:

Key Measures, December 2020 ($b)
M1+: Currency + all $1,390
chequable deposits
M2: currency + certain $2,118
deposits @ chartered
banks
M3: M2 & non-personal $2,926
term & F.C. deposits
M2+: M2 & deposits @ $2,626
near banks +MMMF
M2++: M2+ & Non- $3,946
MMMF & CSBs

ECON 3150: Money & Banking

MUN, Dr. K.Chu 3 - 20

Money Supply Changes

ECON 3150: Money & Banking

3 - 21
MUN, Dr. K.Chu

MUN, Dr. K. Chu 7

ECON 3150: Money & Banking
What is Money?

How Reliable are the Money Data?

• Revisions are issued because:
– Small depository institutions report
infrequently
– Adjustments must be made for seasonal
variations
• Probably should not pay much attention to
short-run movements in the money supply
but should be more concerned with longer-
run movements.
ECON 3150: Money & Banking
3 - 22
MUN, Dr. K.Chu

Why So Many Monetary Aggregates?

• Money Affects Aggregate Activity
• Want to Understand the Transmission
Mechanisms
• Formulation & Implementation of Monetary
Policy
• Unstable Relationships between Money &
Aggregate Activity b/c Financial Innovations &
Financial Deregulation

ECON 3150: Money & Banking

3 - 23
MUN, Dr. K.Chu

Conclusion
Due to the problems in defining & measuring
money precisely,

• The Conduct of Monetary Policy &

• Fed Watching

are both Art & Science

ECON 3150: Money & Banking

3 - 24
MUN, Dr. K.Chu

MUN, Dr. K. Chu 8