What is Money ?

Dr. Paul Lockard

Professor

Black Hawk College

Functions of Money

What is Money ?

Money is anything acceptable to sellers of goods and services

Functions of Money

• Medium of exchange

• Unit of account

• Store of value

Medium of Exchange

Something that is acceptable to sellers in exchange for their products

Unit of Account

A standard unit that provides a consistent way of quoting prices

Store of Value

Any asset that can be used to transport purchasing power from one place to another, or from one time period to another.

Characteristics of Money

Over time, what has been used for money has changed.

Characteristics of Money

Money has become more:• Widely acceptable

• Divisible

• Easy to carry and store

• Durable

• Cheaply made

Money Supply

Money Supply

M 1

The Money Supply: M1

Listed in order of importance

Currency

Other checkable deposits

Checkable deposits

Traveler’s checks

Currency

Paper bills and coins

Other checkable deposits

Checking accounts that pay interest

Checkable deposits

Checking accounts that pay no interest

Traveler’s checks

Issued by banks (US Bank)

or

Nonbanks (American Express)

Money Supply

M 2

The Money Supply: M2

Listed on order of importance:Savings depositsMoney market deposit accounts M1Small denomination time depositsMoney Market Mutual Funds

Savings Deposits

Old fashioned passbook accounts

Pays interest but cannot be used for purchases.

Money Market Deposit AccountsMMDA

Require a high minimum balance

Have limited check writing privileges

(usually 3-4 per month)

M 1

Everything in M 1 is part of M 2.

Small Denomination Time Deposits

Size of $100,000 or less.

Held by individuals.

Usually called certificates of deposit.

Deposits held for a fixed time period with a fixed and guaranteed interest rate.

Individual Money Market Mutual Fund Balances

Technically, these are shares in a mutual fund company that invests in short term credit.

Require a high minimum balance

Have limited check writing privileges

(usually 3-4 per month)

Money Supply

M Z M

The Money Supply: MZM

M 2

– Small CD’s

+ MMMF held by businesses

= MZM

The Money Supply: MZM

The logic of MZM is that the MMMF held by businesses are used for their purchases.

And small CD’s are a type of investment, rather than a source of spending.

Liquidity

Defined as:

The ease with which an asset can be converted quickly into cash with little or no loss of purchasing power.

Liquidity

Everything in M1 can be used to make purchases, right away.

Everything in M2 needs to be converted to something else before you can make a purchase.

Why are There Banks?

Banks bring together

savers

and

borrowers

Why are There Banks?

• Savers turn their funds over to banks to hold and pay interest

• Borrowers go to banks to obtain funds that they need

• Borrowers repay loans plus interest.• Banks use additional money to lend

again and pay interest to savers

Why are there banks?

• Savers $=> Banks $=> Borrowers

• Borrowers $ + $=> Banks $ +$=> Savers

What are financial intermediaries?

“Banks” = short hand for

financial intermediaries.

Financial Intermediaries

Include much more than banks:

• Commercial banks

-THE National bank

• Thrift institutions

- Include savings and loans and credit unions

- Mississippi Valley Credit Union

Financial Intermediaries

• Insurance Companies

- Metropolitan Life Insurance

• Pension Funds

- John Deere pension plan

Financial Intermediaries

Money Market Mutual Funds

– such as Magellan or Vanguard

• Securities Firms

– such as Goldman Sachs, Lehman Brothers

The US Banking Structure

Three parts:

• Central Bank – The Federal Reserve bank

• Commercial Banks

• Thrift Institutions – include savings and loans and credit unions

Long Run Trends in Financial Services

Long Run Trends

1. Relative decline in banks and thrifts

2. Consolidation among banks and thrifts

3. Barriers between banks and thrifts nearly completely broken down

4. Globalization of financial markets

5. Electronic payments

Long Run Trends

1. Relative decline of banks and thrifts

- In 1980, banks and thrifts had nearly 60% of financial assets

- As of 2005, that percentage had fallen to 24%

Long Run Trends

2. Consolidation

- Due to the S&L crisis of the 1980’s, many hundreds of savings & loans failed, or were forced to merge before they failed.

Long Run Trends

2. Consolidation

- Waves of mergers among banks of all types.

- We have 5200 fewer banks than in 1990.

Long Run Trends

3. Barriers between banks and thrifts nearly completely broken down

- All types of financial services are offered by all types of financial intermediaries now

Long Run Trends

4. Globalization of financial markets -

- Non US financial intermediaries of all types are found in many parts of the US

- and vice-versa

Long Run Trends

5. Electronic Payments

- Credit cards

- Debit cards

- Electronic money (Paypal)

- Smart cards

- Stored value cards

Long Run Trends

5. Electronic PaymentsCredit cards

-Credit cards are actually loans from the company to the cardholder.

-Act like M1

Long Run Trends

5. Electronic Payments

Debit cards

-Debit cards replace paper checks.

- Immediately deducted from checking accounts.

-Act like M1

Long Run Trends

5. Electronic Payments

Electronic Money

- Such as Paypal.

- A form of money, online.

- Acts like M1.

Long Run Trends

5. Electronic PaymentsSmart cards

- Contains computer chip.- Linked to your account.- Can download money from

your account to the smart card.

Long Run Trends

5. Electronic PaymentsValue added cards

- By with M 1.- Have a preset value in them,

use up. - Gift cards

Long Run Trends

5. Electronic Payments

All of these types of electronic payments have grown dramatically in recent years.

Reduces need for cash and/or checks