Principles of Money

1
Chapter 2

• Principles of Money

2
Learning Objectives

• How money is defined by its functions.
• How to apply the definition in measuring what
  money is and what it is not.
• Why the Federal Reserve publishes numerous
  measures of monetary aggregates including M1, M2,
  and M3.
• The meaning of domestic nonfinancial debt (DNFD)
• The role of technology in the evolution of the
  payments system
• How the existence of money facilitates the
  development of an economy.

3
Defining Money

• Means of payment
• Must perform these functions
• Medium of exchange
• Store of value
• Unit of account (measure of value)

4
Monetary Aggregates

• Problems in measuring quantity of money
• What serves as means of payment changes over time
• Gold/silver to paper currency to checkable
  deposits
• Some means of payment difficult to classify
• MMDAs

5
Federal Reserve Monitoring

• Money supply integral part of decision making
• Track several different measures
• Refine measures as system changes
• Changes in outstanding credit also affects money
  supply
• Track unpaid loans and debts

6
Monetary Aggregates

• M1 (closest to definition of money)
• Currency in circulation checkable deposits
• M2 (near money)
• M1 small savings/time deposits individual
  MMMF
• M3 (broadest measure)
• M2 large time deposits Term repos
  institutional MMMF

7
Domestic Nonfinancial Debt

• Federal
• Credit market debt of U.S./state/local
  governments
• Nonfederal
• Corporate bonds
• Mortgages
• Consumer credit (including bank loans)
• Other bank loans
• Commercial paper
• Other debt instruments

8
Monetary Aggregates

• What are the current levels (8-16-04)?
• M1 1,337 billion
• M2 6,295 billion
• M3 9,280 billion

9
The Relative Size of the Monetary Aggregates and
DNFD as of August 2001(in Billions of Dollars)



18,889.7
19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0

Billions of Dollars
7,673.9
5,284.9
1,142.9
M1
M2
M3
DNFD
10
Economy and Monetary Aggregates/DNFD

• M1 measure of transactions money
• Ms, M3, DNFD linked to economic activity

11
The Monetary Aggregates and DNFD, 1960-2001
Billions of Dollars
18,000 15,000 12,000 9,000 6,000 3,000 0
DNFD
M3
M2
M1
1960 1965 1970 1975 1980 1985 1990 1995 2001
Year
Through August 2001.