Money. Money Supply and Money Demand

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Money. Money Supply and Money Demand

• Frederick University
• 2014

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Money the Payments System

• meaning of money
• functions of money
• forms of money
• measuring money

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without money

• barter for stuff
• -- need double coincidence
• of wants
• -- inefficient
• more time shopping,
• less time producing

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example

• I have exam 2,
• want to trade it for soda

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• You have to want the exam
• be willing to give up soda
• AND
• I have to want the soda
• be willing to give up exam

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double coincidence of wants
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The Meaning of Money

• anything commonly accepted
• in exchange for goods/services
• many objects throughout history

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examples

• livestock
• shells
• metals
• cigarettes

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to act as money, must be

• measurable
• divisible
• widely accepted
• durable

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Forms of Money

• commodity money
• has its own value as a good
• -- gold silver coins

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• Paper money
• - a substitute for the commodity money
• - freely convertible

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• credit money (fiat money)
• -- no value other than
• fact that its accepted
• in exchange for
• goods and services

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Our money is fiat money!

• NOT backed by gold
• coins do not contain silver or gold

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fiat money is more efficient

• commodity money has
• opportunity cost
• you could use it
• for something else

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debit or credit cards?

• NOT money
• payment mechanisms

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money, income, wealth

• money
• what is accepted as payment
• income
• earnings during time period (year)
• wealth
• accumulated assets at a point in time

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• money, wealth are STOCKS
• amount at a point in time
• income is a FLOW
• amount during a time period

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examples

• I own 2 million in diamonds.
• I am wealthy
• I have no money

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• I win 25 million in lottery
• I put it under my bed
• I quit my job
• I am wealthy
• I have a lot of money
• my income is zero

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• software engineer
• earnings 100,000/yr
• blows it all, every paycheck
• high income
• no wealth

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Functions of Money

• money is a means of payments
• (medium of exchange)
• -- accepted as payment for
• goods and services
• -- main function of money

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• money is a unit of account
• -- money is used to
• measure value

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• if something costs 5,
• not that valuable
• if something costs 500,
• thats valuable

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• money is a store of value
• -- use money to save,
• accumulate wealth,
• buy stuff later
• -- money is liquid asset

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• money is NOT always
• a good store of value
• -- political instability
• -- poor economy
• -- high inflation

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example

• Historically, the U.S. dollar has been a good
  store of value
• but when the started falling in value, this
  changed

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Measuring Money

• How much money do we need?
• The quantity of money (money supply) depends on
  the value of goods and services that will be
  bought
• P x Q

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Measuring Money

• and on the velocity of money circulation the
  number of transactions, served by the same money
  asset (V)

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example

• I buy from George coffee with a 2 coin
• George buys from Maria a newspaper with the same
  2 coin
• Maria buys from Sofia a sandwich with the same 2
  euro coin
• One and the same 2 coin serves 3 transactions
• Therefore, for these transactions we do not need
  6 but only 2
• The velocity of circulation (V) is 3
• The greater the velocity, the smaller the
  quantity of money needed.

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The quantity of money

• M (P x Q) V
• or
• MV PQ

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Measuring Money

• Money aggregates
• amount of cash (coins and banknotes)
• BUT
• other forms of money too (quasi - money

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M1 (high power money)

• currency in circulation (cash)
• demand deposits
• checkable deposits
• travelers checks

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M2

• M1
• savings deposits
• small time deposits

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Comparing measures

• get larger
• M1 lt M2
• add less liquid assets to larger measures

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Which measure is best?

• move together in general
• BUT behavior can vary in short-term
• M2 most watched

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Money Demand

• Money demand the quantity of liquidity that the
  public would like to hold at every level of the
  interest rate, ceteris paribus

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Motives for money demand

• Transactionary
• to pay purchases

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• Precautionary
• because of the possible lack of synchronization
  of payments

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• Speculative (liquidity preference)
• because holding money has an opportunity cost
• money has time value it may bring interest
• on the one hand, people are motivated to have
  liquidity,
• on the other hand, they want extra income
  (interest)
• when the interest rates fall, people will be
  willing to convert part of their interest bearing
  assets into liquidity
• when the interest rates increase, the liquidity
  preference diminishes.

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Equilibrium on the Money Market

• i

MS
MD
M/P
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Factors, Determining Money Demand

• Nominal GDP
• Current transactions
• Expectations
• Frequency of payments
• Synchronization of payments
• Wealth

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Financial Institutions

• Banking institutions
• The Central bank
• Commercial Banks
• Nonbanking
• Insurance funds
• Pension funds
• Investment funds
• Mortgage funds
• Brokering houses
• Mutual funds

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Commercial Banks

• The Balance sheet of a commercial bank

liabilities
assets
deposits
loans
reserves
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The Money Tree
Deposit Multiplier Maximum increase in money
supply as a result of the increase in the
reserves of the banking system
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The Deposit Multiplier

• 1000 new reserves enter Commercial Bank ?

Reserves (safety)
1000 800 640 512
200
Loans (income)
800
DM ?D/ ?R
160
640
128
512
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The Central Bank

• Functions
• Control on money supply
• Supervision of Commercial Banks
• Banker of the government
• Providing cash
• Lender of last resort
• Monetary policy
• Control on reserves
• Foreign currency policies and external payments

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The Central Bank

• Central Bank
• Liabilities
• Coins and notes
• Deposits of the CBs
• Assets
• Foreign currency
• Government bonds
• Loans to the Treasury and to CBs