ECON 1110 Lecture Notes 05 Supplement

ECON 1110 Lecture Notes 05 Supplement - ECON 1110...

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ECON 1110 Intermediate Macroeconomics James R. Maloy Autumn 2010 Additional Lecture Notes for Topic 5: Supplement on Money Supply Readings: Froyen Chapter 16 (8 th Ed. Ch. 17) Bain and Howells, Monetary Economics , Chapter 3 (photocopied handout on courseweb) The section below on the base-multiplier method comes from the latter source. My money review notes gave the basics of the money multiplier process, although you could also read the relevant section in Froyen as well to get a better handle on the basic concepts. The material in this handout is slightly more advanced. I. The Functions of Money Money is most generally defined as anything that performs the functions of money. These functions are: 1. A means of exchange: A monetary economy is much more conducive to exchange than a barter economy. 2. A store of value: Money is a type of financial asset. It is a store of wealth for the future. 3. A unit of account: Prices are measured in terms of money. It is an effective way of comparing apples to oranges. II. Definitions of Money Money is extremely difficult to define. Obviously, currency is money. However, what about bank deposits, time/savings deposits, and credit? Indeed, there is no general consensus about the definition of money amongst nations—it generally depends on the habits and institutions of each. These definitions are also subject to constant revisions—for example, new innovations (such as debit cards) often take the
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place of older forms of money (such as cheques). However, most nations generally have three main measures of money: 1. Monetary base (M0): Currency outside of the central bank and commercial bank deposits at the central bank. 2. Narrow money (M1): M0 + demand deposits accounts at commercial banks 3. Broad money (M2, M3 or M4): M1 + time/long-term savings deposits at commercial banks. Indeed, broad money has become more important in recent years as advanced banking methods, such as internet banking and financial market deregulation, make it very easy to move wealth between time deposits and demand deposits. Since it is increasingly easy to make purchases on credit, many economists are suggesting that the amount people can borrow on credit cards should be considered money as well. III. The Base-Multiplier Approach to Determining the Money Supply The base-multiplier (BM) approach should be familiar from first year. It is the idea that the money supply (either M1 or M3) is some multiple of the monetary base, i.e. M = m * B where M is the money supply, m is the money multiplier and B is M0. You should recall how the deposit creation model works. Suppose that the government conducts a monetary expansion by buying a bond from an individual and paying this person in money, therefore increasing the monetary base. (More on this process in the next topic) Now suppose that this person deposits this money in a bank, which then loans it to an individual to buy a car. The car manufacturer deposits this money in its bank, thus increasing bank deposits again. This bank then loans out the carmaker’s deposit to
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This note was uploaded on 03/10/2012 for the course ECON 1110 taught by Professor Tedloch-temzelides during the Spring '08 term at Pittsburgh.

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ECON 1110 Lecture Notes 05 Supplement - ECON 1110...

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