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Lecture (Monetary Theory & Policy)

1) Money plays a key role in the economy by facilitating transactions and is the mechanism central banks use to influence aggregate economic activity like growth, employment, and inflation. 2) Money includes currency, coins, and demand deposits like checking accounts, and more broadly the monetary system that allows transactions. 3) There is an optimal amount of money needed to efficiently drive economic activity, with too much leading to inflation and too little hindering the economy.

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77 views12 pages

Lecture (Monetary Theory & Policy)

1) Money plays a key role in the economy by facilitating transactions and is the mechanism central banks use to influence aggregate economic activity like growth, employment, and inflation. 2) Money includes currency, coins, and demand deposits like checking accounts, and more broadly the monetary system that allows transactions. 3) There is an optimal amount of money needed to efficiently drive economic activity, with too much leading to inflation and too little hindering the economy.

Uploaded by

simra
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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MONETARY THEORY & POLICY

Introduction of Concepts (Cont.)


• Money
– “Lubricant that greases the wheels of economic
activity”
– Not just limited to currency (bills and coins)—also
includes demand deposits (checking accounts)
issued by banks
– Plays a key role in influencing the behavior of the
economy as a whole and the performance of
financial institutions and markets

2
Introduction of Concepts (Cont.)

• Money (Cont.)
– More broadly the monetary economy
• Facilitates transactions within the economy
• Principal mechanism through which central
banks attempt to influence aggregate economic
activity
– Economic Growth
– Employment
– Inflation

3
The Role of Money in the Macro
economy
Introduction
• Recurrent theme—What is the proper amount of
money for the economy?
• Sir William Petty (1623–87) wrote in 1651
“To which I say that there is a certain measure and
proportion of money requisite to drive the trade of a
nation, more or less than which would prejudice the
same”
– Too much money will lead to inflation
– Too little money will result in an inefficient economy

5
Introducing Money
• Uses of Money
 Standard of value: or unit of account for all the
goods and services we might wish to trade.
 Medium of exchange: it is the only financial
asset that virtually every business, household,
and unit of government will accept in payment of
goods and services.
 Store of value: reserve of future purchasing
power.
6
Introducing Money
• Liquid Asset
– Something that can be turned into a
generally acceptable medium of exchange,
without loss of value
– Currency and checking accounts are most
liquid assets

7
Primary Definition of Money (M1)

• Currency outside banks plus checking


accounts (demand deposits)

• Other definitions of money (M2 and M3)


start with M1 and add progressively less
liquid financial assets
8
Composition of the Money Supply (Money
Aggregates)
M1 consists of coins and currency in circulation, checking accounts
(A checking account is a deposit account with a bank or other financial firm
that allows the holder to make deposits and withdrawals).

M2 is a more broad definition of money than M1. M2 = M1 + small savings


accounts, money market funds(money market funds include cash, cash
equivalent securities, and high-credit-rating, debt-based securities with a
short-term maturity. Money market funds are intended to offer investors high
liquidity with a very low level of risk. Money market funds are also called
money market mutual funds.) and small time deposits(Time deposits are an
extremely safe investment but they have a low rate of return).

M3 is even more broad and includes M2 + large time deposits, large money
market funds.
9
Who Determines Our Money Supply?

• Gold does not determine the money supply—


this link was abolished in 1968.

• Central Bank is responsible for execution of


national monetary policy
Who Determines Our Money Supply? (Cont.)

• Central Bank influences the total money


supply, but not the fraction of money
between currency and demand deposits
which is determined by public preferences
• Central Bank implements monetary policy
by altering the money supply and
influencing bank behavior

11
The Importance of Money:
Money Versus Barter

• Barter—direct exchange of goods/services for


other goods/services
– Very inefficient and limited economy
– No medium of exchange or unit of account
– Requires double coincidence of wants—”I have
something you want and you have something I
want”
– Items must have approximate equal value
– Need to determine the “exchange rate” between
different goods/services
12

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