Macroeconomics II

1
Macroeconomics II
by Professor Dr. Paul Bernd Spahnand
Dipl.-Volkswirt Jan Werner
Faculty of Economics and Business Administration
of the Johann Wolfgang
Goethe University   Frankfurt, 19. April 2004
Introduction and Overview
2
Structure

1. Introduction
2. Functions of money
3. Historical development of the forms of money
4. Measuring money
5. Function and Structure of Financial Markets
6. Conclusion

3
Introduction

• In a world of certainty ... there is no need for
  money. Charles Goodhart
• The Walras model assumes full information.
• All markets clear perfectly and instantaneously.
• Such an economy does not require money, because
  every good can function as a monetary unit.

Charles Goodhart born 1936
4
Introduction

• Money is what money does. Money is defined by
  its functions. John Hicks

John Hicks 1904-89
5
Functions of money

• Medium of exchange
• Unit of account
• Store of value
• Payment function

6
Functions of money

• Medium of exchange
• Indeed, where people are bound together by
  family, tribal or social ties, there is typically
  no need for money (kibbutz, monastery).
• In a barter economy, any good may take the role
  of a medium of exchange, but it is required that
  exchange intentions are mutually consistent
  double coincidence of wants.

7
Functions of money

• Medium of exchange
• One good often serves as a numéraire, which
  reduces the possible exchange relationships.
• Money decomposes one act of exchange into two
  such acts Good x ? Money ? Good y
• Money reduces the transaction costs.

8
Functions of money

• Moreover the money has to be equipped with the
• following criteria
• A standardised and well-known value,
• Widely accepted,
• Easy to divided,
• Easy to carry and
• Constant value, does not erode over time.

9
Functions of money

• Therefore precious metal play an important role
  as forms of money
• Money in his function of Unit of Account also
  reduces the transaction costs, because the number
  of prices are dropped.
• This function is especially for a complex economy
  important.

10
Functions of money

• Store of value
• Bridging the temporal gap between income flows
  and expenditures
• Many other store of values exist besides money
  like
• Real estate and properties,
• Gold and jewellery,
• Antiques, arts and images,
• Stocks and bonds

11
Functions of money

• Store of value
• Normally, money has the lowest valorisation of
  all stores of value
• Why do individuals hold money without interest?
• Money is extremely liquid
• In a hyperinflation money loses its liquidity

12
Functions of money

• Payment function
• This function allows the granting of credit, the
  transfer of credits and liabilities, and the
  redemption of debentures.
• The postulate is that credit money will be
  provided and is accepted in a society.
• The payment function can be ditto summarised to
  the prior functions of money.

13
Historical development of the forms of money

• Commodity money in a barter economy
• Goods with a use value like as salt, corn,
  spices, colours (e.g. indigo), cattle.
• Assets that are rare and tradeable such as
  gold, pearls, gems, feathers of rare bird, cowrie
  shells.
• In societies where people are considered
  assets, money could also be slaves, children,
  or women of marital age.

14
Historical development of the forms of money

• Metal money is a result of the desire store the
  money and lower transaction costs
• Durable assets sumptuous metals
• Assets with an aesthetic or ideal value such as
  jewellery, ritual gear and relics
• But the inhomogeneity of different forms of money
  requires a standard.

15
Historical development of the forms of money

• In the middelage the nations developed their own
  currency to strengthen their political power
• Portuguese escudo,
• French écu and
• Austrian Schilling
• Bullionist Debate in 18th century

16
Historical development of the forms of money

• The conception of Credit money / Fiat Money
  allows to introduce paper currency.
• The introduction of checks improved the
  efficiencey of the payments systems.
• Electronic Payment / Credit cards / EC-Card
• E-Money

17
Measuring money

• The Quantity theory of money is based on the
  following equation
• P ? y P ? T M ? V
• The real income y,
• The price level P,
• The number of transactions T,
• The velocity of circulation of money V and
• The contraction of the money stock M

18
Measuring money

• The contraction of the money stock M is divided
  by the central banks (EZB and Fed) in the
  following money aggregates
• M1 narrow money
• M2 intermediate money
• M3 broad money

19
Measuring money
20
Measuring money
Money demand in the Euro-area (end of September
2003)
Billion euros In of currency in circulation
Currency in circulation 364 100
M1 narrow money 2510 689
M2 inter-mediate money 5111 1404
M3 broad money 5989 1645
21
Function and Structure of Financial Markets

• See The economics of money, banking and
  financial markets" by Frederic S. Mishkin (2004,
  7.edition, Boston, ISBN 0-321-20463-8), page 24.

22
Function and Structure of Financial Markets

• Financial Markets can be classified as follow
• Debt Market
• Equity Market
• Primary Market
• Secondary Market
• Exchanges Market
• Over-the-Counter Market
• Money and Capital Market

23
Function and Structure of Financial Markets

• Why do Financial Intermediaries exists?
• To lower transaction costs
• developing expertise and taking advantage of
  economies of scale
• To reduce risk sharing
• portfolio diversification
• To solve the problems of asymmetric information
• adverse selection
• moral hazard

24
Function and Structure of Financial Markets

• Adverse Selection (before)
• Potential borrowers most likely to produce
  adverse outcomes are ones most likely to seek
  loans and be selected.
• Moral Hazard (after)
• Hazard that borrower has incentives to engage in
  undesirable (immoral) activities making it more
  likely that wont pay loan back.

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Conclusion

• Money is defined by three (alternatively four)
  functions.
• A complex economic requires an efficient form of
  money.
• Money supply can be measured by M1, M2 and M3.
• Indirect finance with the conception of Financial
  Intermediaries can lower the cost and can be more
  capable than direct finance.