3. What is Money? Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-1

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1 3. What is Money? Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-1

2 Meaning of Money Money (money supply) anything that is generally accepted in payment for goods or services or in the repayment of debts Wealth the total collection of pieces of property that serve to store value Wealth includes not only money but also other assets such as bonds, common stock, art, land, furniture,cars, and houses. Income flow of earnings per unit of time Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-2

3 Functions of Money Medium of Exchange it is used to pay for goods and services. promotes economic efficiency by minimizing the time spent in exchanging goods and services For a commodity to function effectively as money, it has to meet the following criteria: Must be easily standardized - making it simple to ascertain its value Must be widely accepted Must be divisible Must be easy to carry Must not deteriorate quickly Unit of Account used to measure value in the economy. Store of Value used to save purchasing power; most liquid of all assets but loses value during inflation Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-3

4 Evolution of the Payments System Payment system: the method of conducting transactions in the economy The payment system has evolved from commodity money to E-money Commodity Money Fiat Money Checks Electronic Payment E-Money Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-4

5 Commodity Money Money made up precious metal or another valuable commodity Commodity money functioned as the medium of exchange in all but the most primitive societies Problem: Very heavy and very hard to transport from one to another Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-5

6 Fiat Money Paper currency decreed by governments as legal tender Much lighter than coins or precious metals But can easily be stollen Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-6

7 Checks Instrument from a holder to a bank to transfer money from the holders account to somebody else s account No need to curry around large amounts of currency Takes time to make use of the funds Paper required to process checks is costly Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-7

8 Electronic payment Computers and internet now make it cheap to make payments electronically Saves time and effort Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-8

9 E-Money Money that exists in electronic form Debit card allows a holder to purchase goods and services by electronically transferring funds directly from their bank account to a merchant s account Store-value card another form of e-money and works like a prepaid phone card Smart card contains a computer chip, which allows it to be loaded with cash from the owners bank account whenever needed Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-9

10 Measuring Money The method by which central banks define money differs from one economy to another Money supply (monetary aggregates) differs depending on the norms of money holders, the innovation of financial instruments and the variety of issuers of money Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-10

11 Table 1 Measures of the Monetary Aggregates M1 = Currency + Traveler s checks + Demand deposits + Other checkable deposits M2 = M1 + Small-denomination time deposits and repurchase agreements + Savings deposits and money market deposit accounts + Money market mutual fund shares (noninstitutional) M3 = M2 + Large-denomination time deposits and repurchase agreements + Money market mutual fund shares (institutional) + Repurchase agreements + Eurodollars Total M 3 Source: Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-11

12 Monetary Aggregates in Namibia Narrow Money Supply (M1) is defined to include currency in circulation and transferable deposits of resident sectors, excluding Central Government and depository corporations. Broad Money Supply (M2) include currency outside depository corporations, transferable and other deposits in national currency of the resident sectors, excluding deposits of the Central Government and those of the depository corporation Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-12

13 How Reliable are the Money Data? Revisions are issued because: Small depository institutions report infrequently Adjustments must be made for seasonal variation We probably should not pay much attention to short-run movements in the money supply numbers, but should be concerned only with longer-run movements Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-13

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16 Review Questions If gold is used in the conduct of transactions, this is called: fiat money barter money cheque commodity money Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-16

17 Near money assets are: A. are physical assets not easily convertible to cash B. are wealth assets not easily convertible to cash C. are assets not easily convertible to cash D. are assets easily convertible to cash Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-17

18 Rank the following from most liquid to least liquid Cheque account deposits House Currency Washing Machine Savings deposit Common stock Copyright 2007 Pearson Addison-Wesley. All rights reserved. 3-18