MONEY:

PRESENT AND Chapter 3

FUTURE
IMPORTANCE OF MONEY

Money is important.
Changes in the total quantity of money and
changes in the rate at which the quantity of
money grows affect important economic
variables,
Such as the rate of inflation, interest rates,
employment, national income, the exchange
value of a nation's money relative to the money
of another nation, and national output.
WHY IS IT IMPORTANT
TO DEFINE AND
MEASURE MONEY?
1. Because money supply and growth rate of
quantity of money affect important economic
variable (purchasing power).
2. Also affect the attainment of ultimate national
economic goal. Increase employment, price
stability, nor inflation, not deflation, eco
growth, and an Eq in international payments.
so, we require a meaningful definition what is
essential.
DEFINITION OF MONEY
Theoretical definition.
Knowledge base on logical or mathematical assumption.
Empirical definition.
Knowledge derived from investigation, observation, experiment.
1. A close correspondence must exist between theoretical and
empirical definition.
2. Fed must be able to control the empirical defined Q of money and
to meet the target.
3. Fed cannot achieve ultimate national goal.
4. In short successful monetary policy requires that fed properly
measure money and effectively control its growth rate.
TWO APPROACHES TO
DEFINING AND
MEASURING MONEY.
1. Transaction approach(classical) ---which stresses the role of
money as a medium of exchange
Only those commodity will be included in money which are just
medium of exchange.
People accept it as a mean of payment for goods and services.
So, M = CU+DD
CU: coins, currency notes, (issue by central bank)
DD: demand deposit,( issued by commercial bank)
Classical theorist define it.
TWO APPROACHES TO
DEFINING AND
MEASURING MONEY.
2. Liquidity approach( Keynes)
Stress the role of money as a store of value.
Most liquid approach for assets.
Liquidity is the property of all assets.
Example: stocks, bonds, non financial asset cars, house.
Each have store of value but have different liquidity.
Money is most liquid of all assets.
Because people do not need to convert money in something else
before buying goods and services.
 LIQUIDITY AND
MONEYNESS OF MONEY
ASSET.
 Using a liquidity definition of money to explain the role of money in the
economy leads one to broaden the definition of money beyond the
transactions approach.
The liquidity approach includes in the measurement of money those
assets that are highly liquid, that is, those assets that people can convert to
money quickly, without loss of nominal dollar value and without much
cost.
So , coins, paper money- as a medium of exchange meet this requirement.
On the other side Economists call those highly liquid assets for which
only slight capital gains or losses are possible near monies. Because they
are highly liquid, they become candidates for inclusion as money,
following the liquidity approach.
 HOW THE FED
MEASURE MONEY?
The Fed incorporates both the transactions approach and
the liquidity approach when it measures the quantity of
money.
The monetary base: the narrowest measure of "money"

Under a ‘gold standard’ the monetary base is the

amount of gold bullion.
In fiat money system, however, gold does not play a
direct role. So, a monetary base, is the quantity of
government-produced money.
In the United States, this money is equal to currency
plus the reserves of depository institutions.
HOW THE FED
MEASURE MONEY?
Monetary base:
1)the narrowest measure of “money”
2)Which is govt. produced money.
MB = currency + reserve of depositary institution,
1. Currency-- The following assets (owned by the nonfinancial
institution public) compose the amount of currency:
Currency= Notes + Coins
Notes: Fed issue notes by US treasury.
Coins: value of metal face value of coin. Disappeared from
circulation with passage of time.
HOW THE FED
MEASURE MONEY?
2. Reserve of depositary institution
Reserves of depository institutions are funds that these
institutions—financial firms such as commercial banks,
savings and loan associations, savings banks, and credit
unions, that issue highly liquid liabilities called "deposits'"—
hold with the Federal Reserve System, plus the vault cash
these institutions hold to meet the Fed's reserve requirements.
Hence, the monetary base satisfies the minimum
requirements of the transactions approach to
measuring money.
 TRANSACTION APPROACH
IS BENEFICIAL BECAUSE.
1. Money used to carryout transaction can easily be
controlled by central bank.
2. The relationship b/w money and economic objectives
can easily be predicted.
 Money as a medium of exchange= currency demand
deposit, traveler cheque.
 Money as a store of value= time deposit of
commercial bank + mutual saving banks accounts +
treasure bill.
 currency demand
deposit, traveler
cheque.
Money as a medium of exchange
 time deposit of
commercial bank +
mutual saving
banks accounts + Money as a store of value

treasure bill.
NEAR MONEY
Near money those assets which experience slight rise in value is
called near money.
For example ; gold, silver.
 The transaction approach; M1
Currency has increase in significance in USA.
M1= currency + transaction actions( demand
deposit + other check able deposit) + traveler
checks.
Transaction actions: although people use
currency for most transaction, because they
use in mainly small transaction. For large
transaction, individual usually transfer fund
from transaction accounts.
• Transaction accounts

Other checkable deposit

Demand deposit (DD)

Negotiable order of Automatic transfer system

withdrawal
(NOW) accounts.
1. Demand deposit (DD) could not pay Interest
rate
• People can convert such deposit to currency
on demand.
• Older money and borrowing texts emphasized
the distinctions b/w commercial bank and all
other depositary institution because
commercial bank are only who accept (DD)
until 1981.
• Savings banks, saving and loan association and
credit union( thrift institutions) now offer DD.
2. Other checkable deposit.
• Deposit accounts.
• Pay interest.
• Unlimited number of checks maybe written.
This includes,
A. Negotiable order of withdrawal (NOW)
accounts.
• Are interest bearing saving accounts on
which people may write checks.
B. Automatic transfer system,(ATS)
• Saving account
interest bearing + non interest
bearing.
• Funds automatic transfer from
saving to checking accounts.
• ATS use to avoid hassle and save
time
 Travelers check:
Medium of exchange utilize as an alternative to
hard currency.
• Travelers often used travelers checks on
vacation to foreign countries instead of cash.
• 1891, American Express introduced:
• It offers safe way to take currency overseas
 Why has there been such a large
expansion of the use of currency during
recent decades?
Ans: increased size of the so called underground
economy
The growth in the underground economy.
• Underground/subterranean economy
• Each transaction that individual do not report
to the FBR as income, drugs sales, tax
evasion, payment of wages to illegal
immigrates.
 M2; THE LIQUIDITY
APPROACH:
M2:
M1 Narrow definition of money- does not
include so called near money- liquid assets
So, need better def. which shows the changing in
eco activity.
The inclusion of near monies in the measure
of money provides a "better" definition of the
money supply for the purpose of explaining
changes in economic activity.
 DIFFERENCE B/W M1
AND M2
M1:
It is the physical money supply
It is not near money assets which can readily be converted into cash such as
bills of exchange
M2:
Include near money + cash and cheques deposits
In near money includes saving deposits + money market deposit cheques +
small denomination + overnight repurchase agreement+ overnight euro.
Not as suitable medium of exchange but quickly converted into cash
M2: THE LIQUIDITY
APPROACH
M2 consists of M1 plus the following:
1. Savings and small-denomination time deposits at
all depository institutions
2. Overnight repurchase agreements (RPs) at
commercial banks
3. Overnight Eurodollars held by U.S. residents
(other than banks) at Caribbean branches
of Fed member banks
4. Balances in money market mutual funds
5. Money market deposit accounts
M2: THE LIQUIDITY
APPROACH
Money Market deposit account:
Account issued by banks and thrift institutions. Accounts that exceed
limitation offer fee or
No minimum Maturity closed
Allow limited checking privileges
Pay on i rate
These accounts offer the benefit of saving and current account.
Customer earns interest rate
Offer increase in i than a regular saving account
Saving Accounts:
Two types
1. Statement Saving account:
Depositors receives monthly statement of deposit
i earned during month
2. Passbook saving deposits
Lower i rate
Do not receive monthly statements
Owner physically present a paper passbook each time he or
she make deposit
More popular
Small domination time deposits:
Saving Certificate + Small certificate of
deposits
Set maturities
Date of issue+ maturity date+ contractual
matters
Cannot with withdrawal before maturity
date.
Overnight Repurchase agreements:
A repurchase agreement at a commercial bank (REPO, or RP)
allows a bank to sell treasury or federal agency securities to its
customer
And then repurchase then a higher price that included
accumulated interest.
An overnight repurchase agreement permits the bank to sell
Treasury or federal agency securities to its customers,
coupled with an agreement to repurchase them at a higher
price the following day.
RPs help to fill a gap because existing laws do not allow
businesses to use NOW accounts; RPs are a financial
innovation that bypasses regulation.
Overnight Euro:
Type of short term loan which used in money market
where by the sellers of security agrees to buy in bank at
a specified price and time.
Sellers pay an i rate called repo rate. When buying bank
of securities.
Money Market Mutual funds:
Many individuals and institutions keep part
of their assets in the form of shares in money market
mutual funds.
These mutual funds hold only short-term debt
instruments. Most of these money market funds
allow checkwriting privileges, provided that the
size of the check exceeds some minimum,
People keep money in form of shares.
Short term debt instrumental 1day to1year
Which invent only in money market
Example: Short term obligation, Munciple Cheques
 M3: AN EVEN BROADER
DEFINITION OF MONEY
M3= M1+M2+ the following
1. Large denomination
2. Term Repurchase agreement at Commercial banks.
Saving Banks
3. Term Euro Dollars
4. Institution-only money market mutual fund
balances.
 DIFFERENCE BETWEEN
M2 AND M3
M2 included M1
Short term time deposits
24 hour money market funds

M3 include M1 and M2
Long term time deposits
More than 24 hour maturity
LARGE DENOMINATION:

Time deposits that have face values of $100,000 or more are large-
denominaton time deposits.
A major difference between large-denomination and small-denomination time
deposits is that the former are negotiable; people can buy and sell these
deposits with little difficulty and with no interest penalty.
A small-denomination time deposit is not negotiable.

Example: Jumbo certificate of deposits,

Issued to businessman that mature at specific date because to save idle
resources funds
Term Repurchase agreement at Commercial banks:
Similar to overnight Repo
But longer than overnight- Maturities may
range from a week to month.
Time period different
Term Euro dollars:
Same to overnight dollars but they
mature after a week or a month.

Institution-only money market mutual

fund balances.
These are accounts held at money market
mutual funds by institutions rather than
individuals.
DISTINGUISHES ITEMS BETWEEN B/W M3 AND M2 ?

What distinguishes items in M3 from those included

in M2?
The difference is liquidity. Term RPs and term
Eurodollars are less liquid than overnight RPs and
overnight Eurodollars because they have longer
terms to maturity. Likewise, large time deposits are
less liquid than small time deposits.
 A MEASURE OF
LIQUIDITY L:
L consists of M3 plus other liquid assets such
as term Eurodollars held by U.S. residents
other than banks, banker's acceptances,
commercial paper. Treasury bills and other
liquid Treasury
securities, and U.S. savings bonds.
WHAT IS THE 'BEST"
DEFINITION OF MONEY?
Which, then, is the best definition of money: Ml. M2. or
M3?
To answer this question, recall that we began this chapter by
noting that monetary' policy requires
(1) a close correspondence between the theoretical definition
and the empirical (measurable) definition of money,
(2) an ability on the part of the monetary authorities to
control the empirically defined money supply, and
(3) a close and predictable relationship between changes in
the empirically defined money supply and ultimate national
economic goals.
FINANCIAL
DEREGULATION AND
MONEY
M1 related closely to the transactions concept, many
people believed that it was the "best definition of
money."
In 1982 the Fed decided to deemphasize the Ml target
temporarily and concentrate on the broader monetary'
aggregates.
But in 1987 the Fed once more abandoned the Ml
targets, amid much controversy, in favor of M2 and
M3.
MONEY AND OTHER
ECONOMMIC
VERIAVLBLE.
A significant problem for choosing the best
measure of money is that there is mixed
evidence about which aggregate is most
closely and predictably related to national
economic goal.
In some period M1 seems to relate money
more closely; in other periods a narrower or
broad monetary aggregate seems to predict
better.
MONEY AND OTHER
ECONOMMIC
VERIAVLBLE.
In recent year the one point of which most
economics have agreed is that M1 has not very
good indicator of other economic variable.
Beyond this point, however this is sharp
disagreement. Other, In contrast, claim that a
broader aggregate such as M2 or M3 is preferable.
ALTERNATIVE TO SIMPLE-
SUM MONETARY
AGGREGATE.
Because the monetary base, M1, M2, M3, and L are sums of
different components, economics call them simple-sum
monetary aggregate.
In recent year economics have experimented with construction
of alternative monetary aggregate, called divisia aggregate.
These are constructed by converting conventional monetary
aggregates such as M1 into weighted averages of their
components.
 CONTROLLABILITY OF
MONETARY AGGREGATE.
One reason that is a simple sum
measure of money such as M1 or M2
continues to receive the most attention
from the FED is that experience with
three measure has taught the FED how
policy action influence them.
THE FUTURE OF
MONEY.
When the technology for making transaction
improve, society tend to adopt more “high tech”
means of trading goods and services, lowering
the minimum exchange cost. As a result the time
people spend making exchange falls.
We live in a high-tech or information age, it is
natural to expect that our society has found
imaginative to lower exchange cost and the
amount of time spent making exchanges.
THE FUTURE OF
MONEY.
Electro means of payment- payments through
transmitting electro impulses, instead of pieces of
paper or coins, over wires people and their
computer- accounted for less than one-half of one
percent of transaction in the US economy.
There are a verity of means of payment beside
cash and checks, credit cards with which many of
us are acquainted and money order.
THE FUTURE OF
MONEY.
People accomplish credit card or money order
transaction on paper these similar to cash or checks, are
non-electronic means of payment .
They can use the service of automated clearing houses,
which are electronic processing intermediaries between
sender of funds and ultimate receiver.
Alternatively, they can bypass these intermediaries by
sending fund directly, via wire transfer(for instance,
over telephone lines).
THE FUTURE OF
MONEY.
The technology also existed to transmit funds directly from a bank
account to a firm when a customer purchases a good or service. This
is called a point of sale transfer. A person and firm could
accomplish this by using a plastic card with an account number
magnetically encoded.
THE FUTURE OF
MONEY.
Some people also arrange for their
depositary institutions to pay some of
their bills from their deposit account,
automated teller machine bill payment
is one way to do this . people also do
not widely use this type of electronic
means of payment at present.
THE CASHLESS SOCIETY.

A couple of decade ago, one would commonly encounter speculation

that by the end of the twentieth century people would no longer use
cash and checks-nor any other forms of paper or coin- as a media of
exchange.
THE CASHLESS
SOCIETY.

A cashless society describes an economic state

whereby financial transactions are not conducted with
money in the form of physical banknotes or coins, but
rather through the transfer of digital information
(usually an electronic representation of money)
between the transacting parties.
Cashless societies have existed from the time when
human society came into existence, based on barter and
other methods of exchange, and cashless transactions
have also become possible in modern times using
digital currencies such as bitcoin
 Question
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