ECN 481 Don Dutkowsky Professor of Economics Office – 304 Maxwell Hall Phone -- 443-1918 Roles of Money -Facilitator of Trade Medium of Exchange -Money is exchanged for goods and services Standard of Value -Value is measured in dollars (the “price tag”) Other Roles of Money Standard of Deferred Payments -- Loans and financial instruments are denominated in terms of money. Store of Value -- People can use money when they wish. Definitions of Money M1 = Currency held by the public + Travelers Checks + Demand Deposits + Other Checkable Deposits M2 = M1 + Savings Deposits (including MMDAs) + Small Time Deposits + Retail Money Market Mutual Funds Definitions of Money Supply Components Currency Held by the Public -- Paper money held by consumers and firms. Travelers Checks – Checks issued for travelers with safety features in case they get lost or stolen. Demand Deposits and Checking Privileges Demand Deposits (DD)-Non-interest bearing deposits offered by commercial banks. They have checkable privileges with no restrictions on size of check or number of checks per month. Other Checkable Deposits Other Checkable Deposits (OCD) – Checkable deposits which are interest earning (NOW accounts) + checkable deposits offered by thrift institutions. They have no restrictions on size of check or number of checks per month. Checkable Deposits Checkable Deposits = DD + OCD M1 = Currency Held by the Public + Travelers Checks + Checkable Deposits Savings Deposits Money Market Deposit Accounts (MMDA) -Checkable deposits with a limit of maximum number of checks written per month. Passbook Savings Deposits -- No checkable privileges, but funds can be withdrawn at any time without penalty. One More Bank Deposit Time Deposits (i.e. Certificates of Deposit)-- A contract specifying payment of principal and interest in an explicit way over a given interval. Withdrawal before maturity results in penalty. Small (in M2): < $100,000 Large: > $100,000 Types of Banks Commercial Banks -“full service” banks Savings and Loans Savings Banks Credit Unions Money Market Mutual Funds (MMMF) private institutions (not banks) pools investor funds pays interest based upon overall portfolio invests in short-term bonds Retail MMMF (in M2) sold to consumers (as opposed to institutions) offers restricted checkability Issues -- Defining Money above definitions, based on conceptual roles of money have the definitions become less accurate in capturing roles, especially with financial innovation? declining predictive ability of money Alternative Approaches Empirical Approach -combine components in a way that best predicts key macro variables. Weighted Aggregates -- give weights to the components based upon relative liquidity (e.g. M1 = Currency Held by the Public + 0.98Travelers Checks + 0.95DD +0.85OCD) Using Money Supply in Monetary Policy Consult several measures at once, to track portfolio changes (e.g. movement from MMMF to OCD) Seasonality Data Revisions (advance, actual, or revised) The Declining Influence of Money Supply in Monetary Policy Federal Reserve pays considerably less attention to monetary aggregates than before Relies much more heavily on Federal Funds rate, and adjusting the target levels. Two Other Money Measures MZM = M2 – (Small Time Deposits) + (Institutional MMMF) M2M = M2 – (Small Time Deposits)