Chapter 3: What is Money?

Summary
1. To economists, the word money has different meaning from income or wealth. Money is anything that is generally accepted as payment for goods or services or in the repayment of debts.

2. Money serves three primary functions: as a medium of exchange, as a unit of account, and as a store of value. Money as a medium of exchange avoids the problem of double coincidence of wants that arises in a barter economy, and thus lowers transaction costs and encouraging specialization and the division of labor. Money as a unit of account reduces the number of prices needed in the economy, which also reduces transaction costs. Money also functions as a store of value, but performs this role poorly if it is rapidly losing value due to inflation.

3. The payments system has evolved over time. Until several hundred years ago, the payments system in all but the most primitive societies was based primarily on precious metals. The introduction of paper currency lowered the cost of transporting money. The enxt major advance was the introductino of checks, which lowered transcation costs still further. We are currently moving toward an electronic payments system in which paper is eliminated and all transactions are handled by computers. Despite the potential efficiency of such a system, obstacles are slowing the movement to the checkless society and the development of new forms of electronic money.

4. The Federal Reserve System has defined two different measures of the money sypply - M1 and M2. These measures are not equivalent and do not always move together, so they cannot be used interchangeably by policymakers. Obtaining the precise, correct measure of money does seem to matter and has implications for the conduct of monetary policy.

5. Another problem in the measurement of money is that the data are not always as accurate as we would like. Substantial revisions in the data do occur; they indicate that initially released money data are not a reliable guide to short-run movements in the money supply, although they are more reliable over longer periods of time, such as a year.

Meaning of money
1. Economists define money as anything that is generally accepted in payment for goods or services or in the repayment of debts.
2. Currency, paper money and coins, is one type of money.
3. Wealth, income and money are different things. Income is a flow of earnings and money is a stock.

Functions of money
I). Medium of exchange
1. used to pay for goods and services
2. barter economic: goods and services are exchanged directly for other goods and services.
- has transaction cost: high because people have to satisfy a "double coincidence of wants"
3. money lower transaction cost and encourage specialization and the division of labor.
4. effective money: easily standardized, making it simple to ascertain its value; widely accepted; divisible, so to "make change"; easy to carry; not deteriorate quickly.

II). Unit of Account
1. unit of account: used to measure value in the economy

III). Store of Value
1. used to save purchasing power from the time income is received until the time it is spent.
2. money not unique to store of value; any asset can be used to store wealth.
3. other assets have more benefits than money as store of value but we still use money because it is extremely liquid.
4. money is the most liquid asset because it is the medium of exchange; other assets have transaction costs when converting into money.
5. how good money is as a store of value depends on the price level.

Evolution of the payments system
1. functions of money and the forms it has taken over time
2. payments system: method of conduction transactions in the economy.

I). Commodity money
1. commodity money: money made up of precious metals or valuable items
2. hard to transport

II). Fiat money
1. paper currency: backed by governments but not convertible into precious metals.
2. easy to carry but only works if there is trust in government
3. can be easily stolen --> invention of checks.

III). Checks
1. an instruction from you to your bank to transfer money from your account to another account.
2. reduces transaction costs; loss from theft reduced
3. takes time and money to process checks

IV). Electronic payments
1. substitutes checks

V). E-money
1. substitutes cash: debit card, smart card(computer chip loaded with digital cash from bank account), e-cash(used on internet to buy goods).

Measuring Money
1. money defined by people's behavior

I). The Fed's Monetary Aggregates
1. Monetary aggregates: measures of the money supply
2. M1: currency, traveler's checks, demand deposits, other checkable deposits
3. M2: M1, small-denomination time deposits, savings deposits and money market deposit accounts, money market mutual fund shares

How reliable are the money data?
1. should not pay much attention to short-run movements in the money supply numbers, but should be concerned only with longer-run movements.