Introduction to Macroeconomics

Group 3 - Money and Prices in the Long Run

Pablo Winant

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The Meaning of Money

Central Banking

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The Meaning of Money
Why not barter? What is money?

• Primitive economies: gifts, barter

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Why not barter? What is money?

• Primitive economies: gifts, barter

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Why not barter? What is money?

• Primitive economies: gifts, barter

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Why not barter? What is money?

• Problems with barter:

• needs coincidence of wants
• circular exchanges are uncertain

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Why not barter? What is money?

• Problems with barter:

• needs coincidence of wants
• circular exchanges are uncertain

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Why not barter? What is money?

• Problems with barter:

• needs coincidence of wants
• circular exchanges are uncertain

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Why not barter? What is money?

• Problem solved with:

• medium of exchange

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Why not barter? What is money?

• Problem solved with:

• medium of exchange
• store of value

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Why not barter? What is money?

• Problem solved with:

• medium of exchange
• store of value

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Why not barter? What is money?

• Problem solved with:

• medium of exchange
• store of value

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Why not barter? What is money?

• Problem solved with:

• medium of exchange
• store of value

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Why not barter? What is money?

• Problem solved with:

• medium of exchange
• store of value
• accounting measure: public prices

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Why not barter? What is money?

• Problem solved with:

• medium of exchange
• store of value
• accounting measure: public prices
• These 3 are precisely the functions of money.

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Kinds of money: some definitions

Wealth: all the stores of value one owns

• examples: jewellery, T-bills, house

Liquidity: the ease with which a store of value can be converted in a medium of
exchange

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Kinds of money: some definitions

Many kinds of money:

• commodity money: money that has intrinsic value
• examples: gold (gold standard), silver, salt, phone credits, ...

• fiat money: money without intrinsic value, but declared to be legal tender
• normal case: euro,

• more complicated case: parallel moneys (Argentina 90s)

• peer-to-peer money: bitcoin

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Central Banking
Money in the economy

• In the Eurozone, official money is the Euro.

• Money supply (M1: 9705 billons E)

• currency (coins, banknotes) (1305 billions E)
• overnight deposits (8400 billions E)

• Other aggregates (quasi-money):

• M2 (13200): M1 + deposits with agreed maturity up to two years, deposits
redeemable at notice of up to three months
• M3 (13900) : M2 + repos, money mutual funds, debt securities with maturities <
2yr

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Central Banks

• The Central Bank is a financial institution which controls the amount of

money in the economy (monetary policy)
• its mandate usually includes price stability
• ideally independent from the government

• Famous Central Banks

• European Central Bank for Eurozone, represents Eurosystem’s central banks
• United Kingdom: Bank of England
• Federal Reserve System: the CBs from all states are represented in the federal
reserve board.

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How does the Central Bank affect money supply?

• Central Bank can print money, but how to inject it in the economy?

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How does the Central Bank affect money supply?

• Central Bank can print money, but how to inject it in the economy?
• Helicopter Drops (or cheques...)
• ex: Coronavirus stimulus cheques in the US (1200$/adult)

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How does the Central Bank affect money supply?

• Central Bank can print money, but how to inject it in the economy?
• Helicopter Drops (or cheques...)
• ex: Coronavirus stimulus cheques in the US (1200$/adult)
• Open Market operations
• Central Bank buys less liquid assets at market price (typically government
bonds) in exchange for fresh money

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How does the Central Bank affect money supply?

• Central Bank can print money, but how to inject it in the economy?
• Helicopter Drops (or cheques...)
• ex: Coronavirus stimulus cheques in the US (1200$/adult)
• Open Market operations
• Central Bank buys less liquid assets at market price (typically government
bonds) in exchange for fresh money

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How does the Central Bank affect money supply?

• Central Bank can print money, but how to inject it in the economy?
• Helicopter Drops (or cheques...)
• ex: Coronavirus stimulus cheques in the US (1200$/adult)
• Open Market operations
• Central Bank buys less liquid assets at market price (typically government
bonds) in exchange for fresh money
• Quantitative Easing is a special example
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Fractional Reserve Banking

• Money supply consists in currency and in deposits

• Deposits are backed by reserves
• 100% reserves system: 1 euro in deposit corresponds to 1 euro in reserves
reserves
• fractional reserves system: banks lend so that deposits
<1
• What limits money creation by banks?
• possibility all clients withdraw their funds at the same time: Bank Run
• prudence and regulation set minimum reserve ratio

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Fractional Reserve Banking

• Money supply consists in currency and in deposits

• Deposits are backed by reserves
• 100% reserves system: 1 euro in deposit corresponds to 1 euro in reserves
reserves
• fractional reserves system: banks lend so that deposits
<1
• What limits money creation by banks?
• possibility all clients withdraw their funds at the same time: Bank Run
• prudence and regulation set minimum reserve ratio

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Fractional Reserve Banking

• Money supply consists in currency and in deposits

• Deposits are backed by reserves
• 100% reserves system: 1 euro in deposit corresponds to 1 euro in reserves
reserves
• fractional reserves system: banks lend so that deposits
<1
• What limits money creation by banks?
• possibility all clients withdraw their funds at the same time: Bank Run
• prudence and regulation set minimum reserve ratio

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Central Banks Intervention

Central Banks intervene in several ways to control money supply:

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Central Banks Intervention

Central Banks intervene in several ways to control money supply:

1. outright open market operations

• buy securities to increase money supply
• sell to decrease money supply

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Central Banks Intervention

Central Banks intervene in several ways to control money supply:

1. outright open market operations

• buy securities to increase money supply
• sell to decrease money supply
2. providing liquidity on the interbank market
• banks lend to each other on a day-to-day basis to control the amount of
reserves
• CB can provide a cash loan in exchange of a collateral (repurchase agreement)
• set interest rates on the repo markets (refinancing rate)

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Central Banks Intervention

Central Banks intervene in several ways to control money supply:

1. outright open market operations

• buy securities to increase money supply
• sell to decrease money supply
2. providing liquidity on the interbank market
• banks lend to each other on a day-to-day basis to control the amount of
reserves
• CB can provide a cash loan in exchange of a collateral (repurchase agreement)
• set interest rates on the repo markets (refinancing rate)
3. set reserve requirements for commercial banks
• control private money creation
• problem: this works only when banks are willing to lend as much possible

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Takeways

• The functions of money

• the kinds of money
• how the central bank intervene
• commercial banks create money

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