Topic 8 Money Overview Money Money Demand Money Supply Money Multiplier Equilibrium Agenda Overview Some motivating questions Money how economists define it Money Demand Central Banks and the Money Supply Banks and the Money Supply Money Multiplier Money Market Equilibrium Interest Rate Money Money Demand Money Supply Money Multiplier Equilibrium Motivating Questions Why are we all so comfortable carrying around pieces of paper that have no intrinsic value What makes people want to hold more or less money Why do central banks matter Overview Money Money Demand Money Supply Money Multiplier Equilibrium Money Is it correct to say he makes a lot of money Not if you re talking to an economist Overview Money Money Demand Money Supply Money Multiplier Equilibrium What is money Money Anything that performs the following actions Medium of Exchange Unit of Account Store of Value Medium of Exchange An item that buyers give to sellers in exchange for goods and services USA Medium of Exchange Federal Reserve Note Unit of Account The measure people use to post prices and record debts Store of Value An item used to transfer purchasing power from the present to the future Overview Money Money Demand Money Supply Money Multiplier Equilibrium More specifically Overview Examples of money Currency coins and paper bills cigarettes shells beads Not Money Gift cards not a common medium of exchange Credit Cards not really a method of payment but a method of deferring payment Money Money Demand Money Supply Money Multiplier Equilibrium MONEY IS NOT INCOME You shouldn t say How much money do you make at your job You make income So what do economists call money There are different groups of things we call money Overview Money Money Demand Money Supply Money Multiplier Equilibrium Components of Money Supply Overview M1 currency and checkable deposits Currency held by public token money Paper currency is issued by Fed M2 M1 Savings Deposits Small Time Deposits Money Market Mutual Funds Difference is in Liquidity Liquidity How easy it is to convert an asset into the economy s medium of exchange Houses and cars are the least liquid items Money Money Demand Money Supply Money Multiplier Equilibrium What backs the money supply Overview Commodity Money a commodity with intrinsic value i e cigarettes gold etc Fiat Money money without intrinsic value but is money by government decree USA dollar is fiat money People get nervous about this Currency is a liability debt of Federal Reserve Banks In a sense they owe you purchasing power Money Money Demand Money Supply Money Multiplier Equilibrium Gold standard Used to be that the Federal Reserve owed you gold rather than purchasing power So the value of gold in Fort Knox or elsewhere equaled the value of money in circulation This ended in 1971 Why do you think it ended Overview Money Money Demand Money Supply Money Multiplier Equilibrium Pros and Cons of Commodity Money Pros 1 Money has some inherent value Cons 1 Limits amount of money that can be printed 2 Resources could be better used 3 Value of resource may not be stable e g sudden change in amount of gold Overview Money Money Demand Money Supply Money Multiplier Equilibrium Money Demand What makes people want to hold more or less money Overview Money Money Demand Money Supply Money Multiplier Equilibrium Why do people hold money For 2 reasons 1 To undertake transactions this money is usually held as currency rather than a checking account etc 2 As a store of assets this money is usually in a checking or savings account Note a stock or bond is NOT counted as money Overview Money Money Demand Money Supply Money Multiplier Equilibrium So what changes money demand Money demand for transactions reason 1 is usually constant e g you need to withdraw 50 a week for transactions Money demanded for asset holdings depends on the opportunity cost of holding money Overview Money Money Demand Money Supply Money Multiplier Equilibrium Money demand is downwardsloping Higher interest rate means higher opportunity cost of holding money So higher interest rate means lower money demand Overview Money Money Demand Money Supply Money Multiplier Equilibrium Another way to think about this Money is a good and people want a certain amount of it The interest rate is the price of money what you give up by having cash instead of putting the money in a savings account Lower prices mean higher demand Overview Money Money Demand Money Supply Money Multiplier Equilibrium Money Supply How much money should be printed and in circulation Overview Money Money Demand Money Supply Money Multiplier Equilibrium Central Bank and Money Supply Name of USA central bank Federal Reserve Bank the Fed Someone has to regulate our money since it s a fiat currency The Fed is quasi public Any profits go to the Treasury so no profit motive It s not controlled by politicians Overview Money Money Demand Money Supply Money Multiplier Equilibrium Federal Reserve Independence Fed Board of Governors make the decisions Governors appointed for 14year terms Bank is technically private What do you think the Fed would do if it were controlled by the president Most likely follow expansionary policies when election is coming up boosting the economy but creating too much inflation leading to unstable currency Overview Money Money Demand Money Supply Money Multiplier Equilibrium Fed s functions with regards to money supply 1 Supervising banks a Lend Money b Check collection and cashing 2 Controlling the Money Supply a Issue Currency b Set Reserve Requirements hold reserves c Conduct Open Market Operations Overview Money Money Demand Money Supply Money Multiplier Equilibrium Banks and the Money Supply How to banks make profit Primarily from interest on loans and securities they hold So banks will lend out as much money as possible to maximize profit How much can they lend out Depends on the Reserve Requirement Overview Money Money Demand Money Supply Money Multiplier Equilibrium Reserve Requirement Reserve Requirement RR minimum fraction of checkable deposits a bank must keep in reserve on deposit at the Fed or as Federal Reserve Notes in its own bank vault Excess Reserves The quantity of money a bank holds that exceeds its required reserves Leftovers Overview Money Money Demand Money Supply Money Multiplier Equilibrium Examples Suppose I deposit 1000 in a bank How much can the bank lend out if RR 0 RR 100 RR 50 Fractional Reserve Banking A banking system in which banks are only
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