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2 Chapter Money and the Payments System Main Questions 1. What is money? 2. How do we use money? 3. How do we measure money? Chapter 3 2 Money: The Definition Money is an asset that is generally accepted as payment for goods and services or repayment of debt. Chapter 3 3 Functions of Money 1. Means of payment Used in exchange for goods & services 2. Unit of account Used to quote prices 3. Store of value Used to move purchasing power into the future Chapter 3 4 Money: How We Pay for Things (I) Commodity Money Objects with intrinsic value. Rarely used in today s economy. Chapter 3 5 Money: How We Pay for Things (II) Fiat Money Value comes from government decree (or fiat). In 2007 there was $2500 of U.S. currency in circulation for each U.S. resident. As much as 2/3rds of this is abroad Chapter 3 6 Money: How We Pay for Things (III) Checks: Instructions to the bank to shifts funds from your account to that of the person or firm whose name is written in the Pay to the Order of line. Chapter 3 7 The Path of a Personal Check Chapter 3 8 Money: How We Pay for Things (IV) Credit Cards: deferred payments Debit Cards: like a check Electronic Funds transfers especially automated clearing house (ACH transactions) Stored Value Cards E-Money Chapter 3 9 Measuring Money Money is not income nor wealth. Changes in the quantity of money are related to Interest Rates Economic Growth Inflation How do we measure money? Chapter 3 10 Inflation and the Inflation Rate Inflation: The rate at which the general price level is increasing over time Inflation rate: Consumer price index (CPI) GDP deflator Chapter 3 11 Liquidity: Definition Liquidity a measure of the ease an asset can be turned into a means of payment (Money). Chapter 3 12 The Liquidity Spectrum Chapter 3 13 Money Measuring Different Definitions of money are based upon degree of liquidity. M1: Narrowest definition Only most liquid assets M2: Broader definition Includes assets not used as means of payment. Chapter 3 14 Monetary Aggregates Chapter 3 15 Growth Rates in M1 and M2 Chapter 3 16 Money Growth and Inflation Chapter 3 17 Money Growth and Inflation When inflation is high, money growth helps forecast inflation. When inflation is low, the relationship is not as close. Chapter 3 18 Summary Money: the medium of exchange Money usually consists of currency (cash) and some other liquid financial assets such as bank deposits. Your bank account deposits are different from cash. Personal checks, ATM card, mobile wallet , etc. give us easy access to our deposits to make payments. They are payment technologies, not money itself. Changes in the quantity of money is closely related to the rate of inflation M1 = Currency + Checking Accounts Deposits M2 = M1 + some saving account deposits Chapter 3 19 Discussions Will there ever be a cashless society? As of March 2007, 13 of the 27 countries of the European Union have adopted the euro . What are the advantages of a common currency for someone who is traveling through Europe? Chapter 3 20 Discussions Under what circumstances might currency be a good option as a store of value? Chapter 3 21 Discussion Over a 9-year period in the 16th century, King Henry VIII reduced the silver content of the British pound to one-sixth its initial value. Which money, the old or the new pounds, would people use for business transactions in England? Chapter 3 22 Discussion During the on-going financial crisis and economic recession, there are a lot of comments about government pumping money into the economy . What does money really mean here? Chapter 3 23

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