The Definition of Money
Lecture 1
Copyright, 1996 © Dale Carnegie & Associates, Inc.
Introduction
This lecture examines the definition of money.
What is meant by money?
Why is it important that we define it
correctly?
What are the problems associated with
measuring money
Financial Innovation &
Deregulation
• Global markets have seen financial
innovation and deregulation.
• This has led to the breakdown in the
traditional relationships between the
measures of money and economic activity.
• This has raised the issue as to what is meant
by money.
Definition - a procedure
• One of two procedures.
• Attach labels to real world objects Nominalist.
• Attach labels to concepts and then search
for the corresponding real world entity Empiricist.
Characteristics of Money
•
•
•
•
Medium of Exchange - (concrete)
Unit of Account - (abstract)
Store of Value.
“Nothing is more ultimate than money.
Instead of going out of existence, unwanted
money gets passed around until it ceases to
be unwanted” Yeager
Artificial historical
framework
• Commodity money - problem of jointness
• Localised issue - reputation
• Government issue - legal tender
Forms of money
• No generalised market for titles - (Paul
Davidson)
• Legal restrictions - (Neil Wallace)
• Means of Final Payment - (Charles
Goodhart)
Liquidity
• Separation of money from other assets is its
superiority in liquidity
• potential to liquidate - use in transactions
• term to maturity - low capital risk
Pesek and Saving -1
• Money is contrasted with debt. Debt pays
interest while money does not. Debt is
Inside money
• Non-interest bearing deposits are an asset to
the holder but a liability to no one, while
interest bearing deposits are a debt like a
bond
Pesek and Saving - 2
• Interest payment on deposits loses its
property of ‘moneyness’
• Demarcation between ‘money’ and ‘debt’
• moneyness measured by (rd-rm)
• debtedness measured by rd
Critique
• Friedman & Schwartz - transactions
services have become a ‘free good’,
available without cost to the holder
• ‘moneyness’ is a joint product with
‘debtedness’
• Newlyn suggests - criterion of ‘neutrality’
Empirical measures - Constant
Elasticity of Substitution
technology


ˆ
M  M 1  M

1
  1 
2
Other empirical approaches
- Laumas
n
k
i 0
j 0
Y   i M 1t i    j M 2t  j
Divisia - 1
• di - rate of growth of the ith medium of
exchange
• Di - stock of the ith medium of exchange
• marginal cost = interest income foregone =
‘user cost of money’
• wi = DiUi and Ui = Rmax - Ri
Divisia - 2
m
w
d
 ii
w
 i
i  1,2,....n
Divisia - 3
Asset
Notes and Coin
Non-interest bearing demand deposits
Interest bearing demand deposits
Time deposits
Building Society deposits
Treasury Bills
Net interest cost
Treasury Bill Rate
Treasury Bill Rate
TBR – Demand deposit rate
TBR – Time deposit rate
TBR – BS share rate
TBR – TBR
Conclusion
• The definition of money has become
important for 2 reasons
• 1 Trends in financial innovation have
blurred the distinction between money and
non-money
• 2 measuring money is important for policy
How can the emergence of
money be explained?
• Money must emerge as an optimal exchange
system from a world of barter.
• What are the specific properties of money
that make its use general?
• Money is a social phenomenon - exists only
in societies where exchange takes place.
Classical View
• Money exists on efficiency grounds.
• The problem of double coincidence of
wants
• The search for a trading partner involves
costs. The longer the search time the lower
the transaction cost.
• But the longer the search time, the higher
the waiting cost
A Dynamic Model
Niehans - Assumptions
by
• All exchanges involve transactions costs
• lower transactions costs involved with using
good xn
• The greater the frequency of exchange, the
lower the transactions cost.
U  U ( x1 , x2 , x3 )
E  Z
x1 Ex2  { x1 , x2  Z }
x1 Ex2
x1 Ex3
x2 Ex3
Efficiency gain for n good
world
1
2
n( n  1)
n 1
•Trades
with barter
•Trades with
money
Clower – Cash in Advance
Model
•
•
•
•
Goods buy money
Money buys goods
But goods do not buy goods
How can the Classical transactions costs
approach give us Clower’s result?
Evolution of Money
• By assumption 1 – all transactions incur costs
• By assumption 2 – a) x3Ex2 and b) x1Ex3 incur
lower costs than c) x1Ex2
• Therefore a) and b) will be more frequent than c)
• By assumption 3 the costs of a) and b) will fall
relative to c)
• In the limit c) dissappears
Niehans – Evolution of
Money
•x2
•E
•x 1