1Money, Prices, and the Federal ReserveMoney, Prices, and the Federal ReservePrinciples of Macroeconomics Dr. Gabriel X. MartinezAve Maria UniversityChapter 23: Money, Prices, and Chapter 23: Money, Prices, and the Federal Reservethe Federal Reserve22IntroductionIntroductionIs Economics about Money?Is Economics about Money?What is Money?What is Money?Chapter 23: Money, Prices, and Chapter 23: Money, Prices, and the Federal Reservethe Federal Reserve33IntroductionIntroductionMoneyMoney––Any asset that is generally accepted in making Any asset that is generally accepted in making purchasespurchases––ExamplesExamplesPaper Currency, (worthless) Coins, and Checking Paper Currency, (worthless) Coins, and Checking AccountsAccountsBut alsoBut also––Bronze, Silver, and GoldBronze, Silver, and Gold––Cows, Clams, and Cocoa BeansCows, Clams, and Cocoa Beans––At different times and in different places, foreign currency, At different times and in different places, foreign currency, boulders, even tulip bulbs have been accepted as money.boulders, even tulip bulbs have been accepted as money.Chapter 23: Money, Prices, and Chapter 23: Money, Prices, and the Federal Reservethe Federal Reserve44Money and Its UsesMoney and Its UsesAn asset is money if it is An asset is money if it is …………A Medium of ExchangeA Medium of Exchange––If it is used in purchasing goods and services.If it is used in purchasing goods and services.……A Unit of AccountA Unit of Account––If it is a basic measure of economic value.If it is a basic measure of economic value.……A Store of ValueA Store of Value––If is serves as a means of holding wealth.If is serves as a means of holding wealth.Chapter 23: Money, Prices, and Chapter 23: Money, Prices, and the Federal Reservethe Federal Reserve55Money and Its UsesMoney and Its UsesWhy is barter inconvenient?Why is barter inconvenient?––Double coincidence of wants.Double coincidence of wants.Would a bartender accept an economics lecture?Would a bartender accept an economics lecture?––Less specializationLess specializationPeople try to do everything by themselves.People try to do everything by themselves.How does money solve this problem?How does money solve this problem?––Why is everyone willing to accept money?Why is everyone willing to accept money?––What if people refuse to accept your What if people refuse to accept your ““moneymoney””??Chapter 23: Money, Prices, and Chapter 23: Money, Prices, and the Federal Reservethe Federal Reserve66Money and Its UsesMoney and Its UsesIs cash money?Is cash money?Are checking accounts money?Are checking accounts money?Are savings accounts money?Are savings accounts money?Are 3Are 3--month certificates of deposit money?month certificates of deposit money?Are 1Are 1--year, negotiable, CDs money?year, negotiable, CDs money?Is a gold mine money?Is a gold mine money?Is a house money?Is a house money?2Chapter 23: Money, Prices, and Chapter 23: Money, Prices, and the Federal Reservethe Federal Reserve77Components of M1 and M2,Components of M1 and M2,July 2002 (billions of dollars)July 2002 (billions of dollars)M1Currency held by the publicplus Demand depositsplus Other checkable depositsplus Travelers’ checksM2M1plus Savings depositsplus Small-denomination time depositsplus Money market mutual funds1,197.8615.1303.8270.38.65,641.21,197.82,552.8920.8969.8Chapter 23: Money, Prices, and Chapter 23: Money, Prices, and the Federal Reservethe Federal Reserve88Money and Its UsesMoney and Its UsesM1M1------very liquidvery liquid––Sum of currency outstanding and balances held Sum of currency outstanding and balances held in checking accountsin checking accountsM2M2------less liquid, but less liquid, but ……––All the assets in M1All the assets in M1plus some additional plus some additional assets that are usable in making payments but assets that are usable in making payments but at greater cost or inconvenience than currency at greater cost or inconvenience than currency or checksor checksChapter 23: Money, Prices, and Chapter 23: Money, Prices, and the Federal Reservethe Federal Reserve99How do nonHow do non--cash assets that are also cash assets that are also money (e.g., checking accounts) come into money (e.g., checking accounts) come into existence?existence?Commercial Banks and the Creation Commercial Banks and the Creation of Moneyof MoneyPalazzo Ducale di VenetiaChapter 23: Money, Prices, and Chapter 23: Money, Prices, and the Federal Reservethe Federal Reserve1010Republic of VeniceRepublic of Venice––Central Bank issues 1 million guilders.Central Bank issues 1 million guilders.Commercial Banks and the Creation Commercial Banks and the Creation of Moneyof MoneyColonna di San TodaroBasilica di San MarcoColonna di San MarcoSource of pictures:www.VeNETia.itChapter 23: Money, Prices, and Chapter 23: Money, Prices, and the Federal Reservethe Federal Reserve1111Commercial Banks and the Creation Commercial Banks and the Creation of Moneyof MoneyPeople want to place their 1 million guilders People want to place their 1 million guilders in a bankin a bankWhy? Why do banks exist?Why? Why do banks exist?––They are safer than your pocket or couch.They are safer than your pocket or couch.––They are convenient (fund transfers, checkThey are convenient (fund transfers, check--writing).writing).––They may pay interest on your deposited funds.They may pay interest on your deposited funds.––They channel your savings to productive uses.They channel your savings to productive uses.Chapter 23: Money, Prices, and Chapter 23: Money, Prices, and the Federal Reservethe Federal Reserve1212AssetsCurrency 1,000,000 guildersLiabilitiesDeposits 1,000,000 guildersCentral Bank issues 1 million guilders.Citizens open accounts and deposit1 million guilders• Deposits are liabilities for the bank• The guilders are an asset for the bankConsolidated Balance Sheet of Consolidated Balance Sheet of Venetian Commercial Banks (Initial)Venetian Commercial Banks (Initial)3Chapter 23: Money, Prices, and Chapter 23: Money, Prices, and the Federal Reservethe Federal Reserve1313If a bank receives deposits If a bank receives deposits and keeps themand keeps them, , those guilders are the bankthose guilders are the bank’’s s