Chapter 1
Money—
An Introduction
PowerPoint Presentation by Charlie Cook
Copyright © 2004 South-Western. All rights reserved.
Fundamental Issues
1. How have financial globalization and cyber
technologies acted together to alter the
economic roles of banking institutions and
money?
2. What functions does money perform?
3. How has money evolved?
4. What are monetary aggregates, and how are
they constructed?
5. How do changes in payments technologies
affect our definitions of money?
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1–2
Money and Banking in the Digital Age
• Cybertechnologies:
 Technologies that connect savers, investors,
traders, producers, and governments via computer
linkages.
• Electronic money (e-money):
 Money that people can transfer directly via
electronic impulses.
• Wire transfers:
 Payments made via telephone lines or through
fiber-optic cables.
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1–3
Money
• Money:
 Anything that functions as a medium of exchange,
store of value, unit of account, and standard of
deferred payment.
• Purchasing power of money:
 The value of money in terms of the amount of real
goods and services it buys.
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1–4
Money
• Barter:
 The direct exchange of goods, services, and
financial assets.
• Double coincidence of wants:
 The situation when two individuals are
simultaneously willing and able to make a trade; a
requirement for barter.
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1–5
Money’s Functions
• Medium of exchange:
 A means of payment.
• Store of value:
 Held for future use without loss of value in the
meantime.
• Unit of account:
 A measure of the value of goods, services, and
financial assets.
• Standard of deferred payment:
 A means of valuing future receipts in loan contracts.
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1–6
The Evolution of Money
• Commodity money:
 A good with a nonmonetary value that is also used
as money.
• Commodity standard:
 A money unit whose value is fully or partially
backed by the value of some other physical good
such as gold or silver.
• Fiat money:
 A token that has value only because it is accepted
as money.
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1–7
Different Types of Money
Iron
Corn
Whale teeth
Round stones with
Copper
Salt
Boar tusks
centers removed
Brass
Crystal salt bars
Red woodpecker scalps
Knives
Gold
Horses
Feathers
Pots
Silver
Sheep
Leather
Boats
Wine
Goats
Pitch
Slaves
Rum
Cows
Glass
Paper
Molasses
Tortoise shells
Polished beads
Playing cards
Tobacco
Snail shells
(wampum)
Cigarettes
Rice
Porpoise teeth
Agricultural implements
Table 1–1
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1–8
Commodity Standards
• Gold standard:
 A monetary system in which the value of money is
linked to the value of gold.
• Gold bullion:
 Within a gold standard, the amount of gold used as
money.
• Bimetallic standard:
 A monetary system in which the value of money
depends on the values of two precious metals,
such as gold and silver.
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1–9
Commodity Standards
• Monetary base:
 A “base” amount of money that serves as the
foundation for a nation’s monetary system.
 Under a gold standard, the amount of gold bullion
 In a fiat money system, the sum of currency in
circulation plus reserves of banks and other
depository institutions.
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1–10
The Use Of Coins
• Seigniorage:
 The difference between the market value of money
and the cost of its production, which is gained by
the government that produces and issues the
money.
• Debasement:
 A reduction in the amount of precious metal in a
coin that the government issues as money.
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1–11
Money in Circulation
• Liquidity:
 The ease with which an asset can be sold or
redeemed for a known amount of cash at short
notice and at low risk of loss of nominal value.
• Monetary aggregate:
 A grouping of assets sufficiently liquid to be defined
as a measure of money.
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1–12
The Monetary Base
• Currency:
 Coins and paper money.
• Depository financial institutions:
 Financial institutions that issue checking and
savings deposits that are included in measures of
money and that legally must hold reserves on
deposit with Federal Reserve banks or in their
vaults.
• Reserves:
 Cash held by depository institutions in their vaults
or on deposit with the Federal Reserve System.
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1–13
M1: A Basic Definition of “Cash”
• M1:
 Currency plus transactions deposits.
• Transactions deposits (checking accounts):
 Demand deposits:

Non-interest-bearing checking accounts.
 Negotiable-order-of-withdrawal (NOW) accounts:

Interest-bearing checking deposits.
 Automated-transfer-system (ATS) account:

An interest-bearing savings account and non-interestbearing checking account.
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1–14
Components of the Monetary Base and M1 ($ Billions)
SOURCE: Board of Governors of the Federal Reserve
System,H.6(508) Statistical Release, August 1,2002.
Copyright © 2004 South-Western. All rights reserved.
Figure 1–1
1–15
M2: Cash Plus Other Liquid Assets
• M2:
 M1 plus savings and small-denomination time
deposits and balances of individual and brokerdealer money market mutual funds.
 Savings deposits:

Interest-bearing savings accounts without set
maturities.
 Money market deposit accounts:

Savings accounts with limited checking privileges.
 Small-denomination time deposits:

Deposits with set maturities and denominations of
less than $100,000.
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1–16
M2: …Other Liquid Assets
• Money market mutual funds:
 Pools of funds from savers that managing firms use
to purchase short-term financial assets such as
Treasury bills and commercial paper.
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1–17
The Components of M2 ($ Billions)
M1
Small-denomination time deposits
Savings deposits and
money market deposits
Individual and broker-dealer
money market mutual funds
M2
SOURCE: Board of Governors of the Federal Reserve
System,H.6(508) Statistical Release, August 1,2002.
Copyright © 2004 South-Western. All rights reserved.
$1,187.3
924.9
2,511.4
944.6
$5,568.2
Table 1–2
1–18
Comparing the
Monetary Base,
M1,and M2
($ Billions)
SOURCES: Board of Governors of the Federal
Reserve System,H.6(508) Statistical Release and
H.3(502) Statistical Release, August 1, 2002.
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Figure 1–2
1–19
M3: The Broadest Monetary Aggregate
• M3:
 M2 plus large-denomination time deposits,
Eurodollars and repurchase agreements, and
institution-only money market mutual funds.
 Large-denomination time deposits:

Deposits with set maturities and denominations
greater than or equal to $100,000.
 Repurchase agreements:

Contracts to sell financial assets with a promise to
repurchase them at a later time.
 Eurodollars:

Dollar-denominated deposits located outside the U.S.
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1–20
The Components of M3 ($ Billions)
M2
$5,568.2
Large-denomination time deposits
810.6
Repurchase agreements
and Eurodollar deposits
594.0
Institution-only money market mutual funds
M3
SOURCE: Board of Governors of the Federal Reserve
System,H.6(508) Statistical Release, August 1,2002.
Copyright © 2004 South-Western. All rights reserved.
1,180.8
$8,153.6
Table 1–3
1–21
Annual Growth Rates of M1 and M2.
SOURCES: 2002 Economic Report of the President, Economic Indicators, various issues.
Copyright © 2004 South-Western. All rights reserved.
Figure 1–3
1–22
Money in the Digital Economy
• Electronic Payments
 Automated clearinghouses:

Institutions that process payments electronically on
behalf of senders and receivers of those payments.
 Point-of-sale (POS) transfer:

Electronic transfer of funds from a buyer’s account to
the firm from which a good or service is purchased at
the time the sale is made.
 Automated bill payment:

Direct payment of bills by depository institutions on
behalf of their customers.
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1–23
Electronic versus Nonelectronic Payments
SOURCES: Authors’ estimates.
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Figure 1–4
1–24