What is money?
Ms. Ross
As adapted from Federal Reserve
Workshop
“Money is what money does.”
Why did money develop?
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Barter, swapping goods and services for
other goods and services, is likely to be
difficult.
-- Barter requires a coincidence of wants.
-- Trade is slowed if there is no coincidence of wants

Many societies have used many things as
money, including stones, shells, elephant tail
bristles, gold and silver coins, furs, salt,
whales’ teeth, and pieces of paper.
Functions of Money

Medium of Exchange
-- Money can be used for buying and selling goods and services.
-- Money allows society to avoid the difficulties associated with
barter.
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Unit of Account
-- Money can be used to judge the relative value of different goods
and services.
-- Money assists consumers and producers in making rational
decisions.
Functions of Money
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Store of value
-- Money can be used to transfer purchasing power from
the present into the future.
Characteristics of “Good” Money
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Divisible
Relatively Scarce
Durable
Portable
Desirable
Distinguishable
Money Definitions
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M1
M2
M3
M1 – Money Definition
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M1 is the “narrowest” definition of money in
the United States.
M1 is the “most liquid”
M1 includes
--Currency (coins and paper money) in the hands of the
public
-- All checkable deposits (all deposits in commercial
banks and savings institutions on which checks of any
size can be drawn.
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M1 = 1.372 trillion (as of March, 2008)
More on Components of M1
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Coins + paper money
-- coins represent 2-3% of M1
-- paper currency represents a little less than 50% of M1
-- US coins in circulation are token money because the
value of the metal in the coin is worth less than the value
of the coin.
-- All paper money is in the form of Federal Reserve
Notes
-- There is more than 700 billion in currency in circulation
More on Components of M1
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Checkable Deposits
-- Checkable deposits represent about 50% of M1.
-- Checks and debit cards represent a convenient, safe
way of transporting money and making payments.
-- People can generally convert checkable deposits
quickly into paper money and coin. Therefore, checks
drawn on these deposits are viewed as equivalent to
currency.
M2 – Money Definition

M2 is a “broader” definition of money and
includes M1, plus a number of “near-monies”:
-- Savings deposits, including money market deposit
accounts (MMDA’s)
-- small (less than $100,000) time deposits (CD’s)
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These “near-monies” can be easily converted
into currency and checkable deposits.
M2 = $7661.6 trillion ( March 2008)
M3 – Money Definition

M3 is an even “broader” definition of money
and includes M2 and :
-- Large ($100,000 or more) time deposits
-- Balances in institutional money funds
-- Repurchase liabilities issues by depository institutions
-- Eurodollars

M3 = $9.727 trillion (as of July 14, 2005)
Commodity Money

Commodity money is anything that serves as
money and has an alternative use.
-- Corn, tobacco, and salt are some examples of
commodities that have been used as money at different
times and places in the world.
-- Precious metals have also been used as commodity
money
Fiat Money
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Fiat money is any item, without intrinsic
value, which has been declared to be money
by the government.
Federal Reserve Notes are fiat money; they
have no intrinsic value.
Legal Tender
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Federal Reserve Notes are legal tender.
Legal tender means that paper currency must
be accepted in payment of a debt, or else the
creditor forfeits the privilege of charging
interest and the right to sue the debtor for
non-payment.
Coins and checks are not legal tender, yet
they are widely accepted.
MV=PQ
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M: the supply of money in the economy
V: the velocity of money, or the number of
times a year that the average dollar is spent
on final goods and services
P: the overall price level in the economy
Q: the quantity of all goods and services
produced; also known as real output
MV=PQ
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This is a simple model of a macro economy
during a time period.
MV represents the total amount spent by
buyers in the economy.
PQ represents the total amount received by
sellers.
Therefore MV should be roughly equal to PQ
MV=PQ
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If there is a change in one of the variables,
there must be a change in one of the other
variables to keep MV equal to PQ.
Money and Prices

There exists a negative relationship between
prices and the value of the dollar.
-- Higher prices lower the value of the dollar because
more dollars are needed to buy a particular amount of
goods, services, or resources
-- Lower prices tend to raise the value of the dollar
because fewer dollars are needed to buy a particular
amount of goods, services, or resources.
Money and Prices

Very high levels of inflation can result in:
-- A breakdown in money’s function as a medium of
exchange.
-- A breakdown in money’s function as a store of value.
-- A breakdown in money’s function as a unit of account.