Principles of Macroeconomics: History of Money, Fractional Reserve Banking and Monetary Policy

What is Money?

money is Medium of Exchange

• the Good in which all other goods are price in and traded for

• Common denominator

• Standard of measurement

• Not all Media is a Money

• Greatest invention of man-kind(according to economic historians)

• Money is the most misunderstood of all economic goods

• is the only good that if it malfunctions, can cause economy-wide harm, no one unaffected

what are the characteristics necessary for a good to become money?

• Acceptable

• Divisible

• Durable

• Relatively Scarce (high value to weight)

• Portable

• Fungible

What is Commodity Money?

• Commodity money consists of objects that had value in use before they had value in exchange

• Pretty shells could serve as commodity money

• Gold jewelry can serve as commodity money

• Among prisoners, cigarettes often serve as commodity money

What is Specie Money?

• Commodity Money problem, high transaction costs; to transact business, everything must be weighed

• Humans are ingenious creatures. Create “Specie” money to overcome Commodity Money problem

• Specie (latin) = “to coin” (precious metals)

-People would mint metals into coins of equal weight and fineness in order to transact business quicker and cut down on transaction cost (time)

What is Money substitutes?

• Specie money is heavy. Humans transition again.

• Money Certificates/Warehouse receipts

• 100% backed by specie money

• Fiduciary Media

-Less than 100% backed by specie money

-Fiduciary is from the Latin “fiduca” = monetary contract

What is “Fiat” money

is something that has no intrinsic value, but which the government declares “by fiat” to be money

• is money that has value only because of government regulation or law

• The term derives from the Latin “fiat, meaning “let it be done”, as such money is established by government decree

• “Trusted” money

What is M0: Monetary Base?

often called “high-powered money” this includes all physical currency in circulation plus commercial bank reserves held at the central bank

Function: it is the base from which other forms of money are created

What is M1: Narrow Money

often redefined in some regions (like the U.S) to exclude bank reserves and focus on “narrow money”. It covers currency in circulation, demand deposits (checking accounts), and travelers checks

-represents money currently used for purchases, having the highest liquidity

What is M2: Broad Money

Includes all of M1 (M1 now includes savings and deposits in the U.S as of 2020 plus “close substitutes for M1

-savings accounts, small-denominations time deposits (certificates of deposit/CDs), and retail money market mutual funds

-low liquidity

What are the functions of money?

• Medium of exchange

• Store of value

• Unit of value

• Standard of deferred payment

“legal tender” or words meaning “offer”

What is Money Supply (M)?

is equal to the sum of various monetary aggregates

example

• demand/checkable deposits

• currency in circulation

• money market accounts

• CD’s and saving (time deposits)

M1 = Demand deposits (D) + Currency in Circulation (C)

M2 = M1 + Savings Deposits + Small Time Deposits (CD’s < 100k) + MMA + retail MMMF

What is the Central Bank (the Fed) influences the supply of money through the monetary base (MB)?

MB = Reserves (R) + Currency in Circulation (C)

What is in the commercial bank balance sheet for assets?

• reserves: equal to the level of vault cash and deposits at the Fed. Used to meet depositors needs

• loans: bank loans to individuals and business

• securities: represents other non-loan debt held by the banks (s)

• property: represents buildings, land, supplies, etc.

What is in the commercial bank sheets for liabilities?

• demand deposits = checking accounts

• time deposits = savings and CD accounts

• discount loans Due to Fed: are loans of reserves a bank has borrowed

• owners equity: represents book value of the company; residual of A-L

What is the Fed’s Balance Sheet for Assets?

• The Fed purchases securities (mostly those issued by the U.S Treasury) from private banks and the non-bank public

• The Fed makes discount loans to private banks that are repaid at the discount interest rate

• The Fed is responsible for the gold holdings of the U.S government

What is the Fed’s Balance Sheet for Liabilities?

• Currency in circulation is currency held by the public

• Bank Deposits refer to “currency” held by private banks in their own vaults or at the Fed

• Treasury deposits refers to the Government’s checking account(s)

How to calculate “The Labor Force Participation Rate for the U.S”?

Labor Force = Employed + Unemployed

Calculating the labor force participation rate: (Labor Force/Total Population)/ * 100

How to calculate “The unemployment rate in the U.S is”?

Find the number of unemployed: Number of employed workers - Civilian labor force

Calculate the unemployment rate: Number of unemployed/Civilian labor force * 100

-express answer as a percentage