money is essential for keeping a robust

flow of economic activity going

in a world without money I would be

standing outside the gates of Wellesley

College the institution where I have

taught for the past 20 years holding a

sign that says have economics need

chocolate

I would be waiting for lonely at times

for a passerby carrying a board that

says have chocolate need economics

this is what economists call a double

coincidence of wants I want what you

have and you want what I have

but money is a medium of exchange that

cuts through this double coincidence of

wants in effect it allows me to

metaphorically carry around a board that

says have economics need money

meet up with my employer whose board

says have money need economics

and then take my new board which says

have money need chocolate and walk to my

favorite store in town which does in

fact have a board that says have

chocolate need money

finding easier and easier ways for

people to use this medium of Exchange

debit cards credit cards venmo Apple pay

has become a key feature of the modern

economy

money has been an essential part of

economic interactions from the very dawn

of civilization

in the ancient cities of Mesopotamia

people use silver as money to buy Goods

they needed for daily economic activity

the term shackle which meant one-third

of an ounce of silver came into use at

that time as the first known form of

money

gold silver and bronze coins were used

in ancient civilizations in China India

Egypt and Asia Minor

these coins played an important role in

increasing economic activity because

they could be carried around easily were

durable and could be easily divided into

smaller units

properties that we use even today to

characterize what can be used as money

money was also useful for political

influence and control the images of

kings and rulers were placed on coins

taxes could more efficiently and easily

be collected from the populace in the

form of coins which in turn could be

used to attract more soldiers for armies

to conquer new lands or to defend

existing ones

but money was not always synonymous with

precious metals

Furs in cold climates livestock for milk

meat and animal hides salt along Inland

trade routes are all examples of

Commodities that were used as money

because of the intrinsic value they

provided

in fact the word salary which comes from

the Latin word for salt remains an

integral part of our economic vocabulary

today

some forms of money were even more

exotic shells were used as money in both

North America and China

in the South Pacific island of Yap giant

Stone wheels that weigh more than a ton

were used as money

in Eastern Europe behind the Iron

Curtain vodka became a valued commodity

currency since it could be exchanged for

Western Goods when mere paper money in

the form of Russian rubles or East

German marks could not

in prisoner of war camps in World War II

the currency of choice was cigarettes

whereas in prisons today packets of

mackerel fillets are used as money to

trade goods and services

mackerel Rose to prominence after

smoking was prohibited in prison and

prisoners were no longer allowed to buy

cigarettes at the prison commissary

economists think of money as performing

three functions in the economy

money serves as a medium of Exchange

a store of value and a unit of account

the medium of exchange refers to the

willingness of someone to accept the

money in exchange for the good or

service they have to offer

this is what economists consider to be

the most important defining feature of

money

for instance if you went shopping at the

local mall with bags of salt cans of

mackerel or cartons of cigarettes or a

prized milk cow chances are you would

not be leaving them all with the latest

fashions from Zara or a new Xbox game

from GameStop because the owner of the

mall store has little use for a few

dozen extra packs of mackerel

but if you lived at a time or in a place

where those goods could be exchanged for

other goods and services then they would

indeed be accepted as money

a value aspect is also extremely

important for money

a farmer can sell her produce for money

after the Harvest and use the money to

buy things for her family during the

growing season

storing the Harvest is much harder

because of the cost and also because of

natural spoilage

one of the reasons why cigarettes and

foil packs of mackerel are valued in

prison is because they have a longer

shelf life than other Goods that one

could buy at a commissary or one was

given access to In A POW Camp

the store of value aspect is closely

linked to the medium of exchange aspect

we also see the store of value function

Illustrated in currencies of countries

where inflation rates are extremely high

people try to get rid of the paper

currency as soon as they can because the

loss of value makes it undesirable as a

medium of Exchange

feature of money is that the money could

be divided into smaller amounts a metal

coin with half an ounce of silver could

be exchanged for two coins each with a

quarter ounce of silver for example

but this is probably the least important

attribute of money
after all not all Commodities used as

money could easily be divided this way

livestock giant Stone wheels and

unopened foil packs of mackerel are

examples of money that endured despite

not being very good units of account

beginning around the 1800s paper notes

began to be used as money and soon began

to overtake the use of coins

paper money was easier to produce

transport and divide but had the obvious

drawback of not being a commodity there

was no intrinsic value of the note

itself

for people to be comfortable accepting

paper money as a medium of exchange for

the conveniences they needed to be

convinced that the paper money retained

its store or value feature

to this extent the amount of paper

currency that governments could issue

was linked by law to the supply of a

commodity like gold or silver

in the 19th and early 20th centuries

many countries were on a gold standard

which meant that the price of gold in

terms of paper money was fixed by the

government

in the United States under the gold

standard the price of gold was set to 21

dollars per ounce which meant that the

government agreed to buy and sell gold

at that price in exchange for paper

currency

the gold standard collapsed in 1933

the bread and wood system that began in

1945 was based on gold and the US dollar

at a time when the United States

controlled two-thirds of the world's

gold

technically the United States dollar was

fixed to gold at a price of 35 dollars

per ounce but this rate became

increasingly difficult to maintain over

the 1960s as the money supply of U.S

dollars increased creating a mismatch

between the price at which gold could be

directly bought or sold on the World

Market and the rate at which dollars

could be converted to Gold through the

Bretton Woods system

the U.S ended dollar convertibility to

gold in 1971. other countries severed

all links between their money and the

dollar under Breton Woods by 1973.

as a result the currency the coins and

paper money we use today are what we

call Fiat money as opposed to commodity

money the currency has value simply

because people value it as a medium of

Exchange

if you closely examine a dollar bill you

will notice that there is nothing that

says it is convertible to gold or silver

or anything with intrinsic value

instead it says that the note is quote

legal tender for all debts public and

private unquote in other words the US

dollar is valued mostly because of its

value as a medium of exchange both now

and in the future

in the modern economy money is not

merely coins and paper money

instead the bulk of what we consider to

be money comes in the form of deposits

at Banks or other financial institutions

we use various instruments checks debit

cards venmo PayPal to access this money

directly for transactions bypassing the

need to First convert the bank deposits

into paper money by stopping at a bank

or an ATM

in the modern economy money gets

categorized by the Federal Reserve

according to how liquid it is that is

how easy it is to use in transactions

prior to May of 2020 the official

categorizations were M1 which defined

currency and checking account balances

held in banks by individuals and firms

as well as Travelers checks and M2 which

was defined as everything in M1 plus

savings deposits time deposits like

certificates or deposits which cannot be

accessed for a specific period of time

and other deposits where check writing

is limited

intuitively the distinction between the

two is that items in M2 that are not in

M1 are not as liquid that is they cannot

be as easily accessed and used for

conducting transactions as those assets

in M1

Financial innovation has always been

blurring the line between what is M2 and

what is M1 a young person today will not

know what a traveler's check is the

widespread growth in the use of credit

cards and ATM cards during the 1990s has

greatly reduced what used to be a ritual

of international travel as a result

using Travelers checks for doing an

economic transaction in the 2020s would

be much harder than it would have been

in 1990.

similarly in mid-2020 the Federal

Reserve removed the Restriction of a

maximum of six withdrawals a month that

they had imposed on savings account

as a result people could effectively

access the money in certain types of

savings accounts just as easily as they

could access their checking account

balances or the currency in their

wallets this meant that savings account

balances that used to be considered as

M2 were now labeled as M1

this change is vividly seen in the

difference between the M1 and M2 series

for the United States

prior to May 2020 M1 was around 4

trillion dollars and M2 was around 16

trillion dollars

after the recategorization M1 and M2 are

almost identical at around 20 trillion

dollars

given that nominal GDP that same year

was around 22 trillion dollars

effectively about 20 trillion units of

money support 22 trillion dollars worth

of economic activity

currency is only about 10 percent of the

value of M2 around 2.5 trillion dollars

worth of notes and coins that circulate

in the economy

[Music]

thank you