Ec. 132 Harold Petersen
Principles of Economics-Macro February 13, 2014
Lecture 8 Money: Meaning of and Demand for Money
It is time to turn to money, interest rates, banking, and monetary policy
as pursued through a central bank, in this country The Fed. First, what do we
mean by money? We all have a sense of this--dollar bills in the U.S., or Euros in
France, or yen in Japan--but let's be a bit more precise. By money, in economics,
we mean anything readily accepted as a means of payment. It may be some
commodity, such as gold or silver, or paper, or even an accounting entry.
Historically its most common form has been gold and silver, but olive oil,
wampum, and cigarettes have also served as money.
Money serves three purposes: 1) a medium of exchange --a means by
which I can trade what I have (economics lectures) for what I want (tennis balls
and chocolate donuts) much more easily than through barter, or direct exchange.
2) Money also serves as a store of value --a means of preserving purchasing
power for future needs or wants. (I give my lectures now but want an airline
ticket next summer. I hold money in the meantime.) 3) Finally, money serves as
a unit of account --a basis for comparing apples and oranges--for keeping
records as in total sales for a firm--for recording debts and collecting taxes--for
measuring GDP and charitable giving.
To serve these purposes well, money should be
1) durable (gold is durable but ice cream or fish are not)
2) divisible (to facilitate small purchases as well as large--thus
wheat might work but tractors would not)
3) limited in supply (so as to have high value per weight or
volume measure and thus not be cumbersome in use--thus sand
would not work well, even though it is durable and divisible).
Gold and silver worked quite well for years. They met all three of the
criteria above. But what do you suppose happened when vast amounts of gold
and silver were brought in to Europe from the New Word in the sixteenth century.
As money was suddenly much more abundant, prices rose rapidly. (This is shown
on a graph in your text on p. 326 (p. 610 in the hardcover version).)
At different times and places, tobacco, cigarettes, and wampum have all
served as money. In colonial Virginia the currency unit was a pound of tobacco
and tobacco was readily accepted as a means of payment. And then warehouse
receipts that provided an ownership claim to tobacco became accepted as a
means of payment. This was in effect paper money backed by tobacco. 2
Cigarettes were used in a P.O.W. camp in World War II. Think of that
great movie, Stalag 17, with William Holden (1953). Or if that doesn’t ring a bill,
think of reruns of Hogan’s Heroes. Shipments of goods would come in to the
prisoners, including soap, shoelaces, cans of peaches, cigarettes, candy bars.
Somehow they would be divided but then the prisoners would trade them among
themselves. And cigarettes become the medium of exchange. I would accept
ten cigarettes in exchange for a bar of soap, even if I didn’t smoke, and then
exchange four cigarettes for a tube of toothpaste.
And wampum was used by the American Colonists. Wampum were
colored shells, or beads, which were produced by Native Americans. They were
prized for their beauty and also had ceremonial value. They were pierced and
strung for wearing. But were they limited in supply? Weren’t they shells, and
couldn’t anyone pick them up on the beach. But they were pierced. And the art
of piercing was a delicate one--to pierce them without breaking them. So they
were limited in supply. Were they durable? Yes, so long as you didn’t step on
them too hard. The colonists began to trade goods with the Native Americans
for wampum and then trade the wampum amongst themselves for other goods.
Wampum became a means of payment in all of the original 13 colonies.
Today paper money is dominant--paper money printed and circulated by
government. It is accepted and retains value based on a faith that government
will exercise restraint in printing money.
The U.S. money supply as measured in December 2013 consisted of
Currency (outside banks) 1163 bill.
+ Checking Account Deposits 1485 bill.
= M1 (transactions money) 2648 bill.
Why do we include checking accounts in our measure of money?
Because they are spendable cash. Because so many payments are made by
check, or by debit cards, and because checks are readily accepted as a means of
payment. But if that is the reason, why not also include the credit limit (the part
unspent) on my credit cards? Isn’t that spendable cash? A good question.
We measure money because we see a link between money, or spendable
cash, and total spending. In the Keynesian model, spending drives the system,
and the availability of money impacts spending. We build models to explain the
link, and then we look to measurement to test the models. We look to measures
that help explain how the system works.
Demand for Money . Why do people hold money, as opposed to assets which
earn interest, as do bonds, or dividends, as do stocks, or land or antiques, which
might be expected to increase in value? Primarily for convenience in making
1) Transactions. Receipts and Expenditures are not perfectly synchronized
in time. We may get paid once a month and then make expenditures over the
course of the month. We are holding money on most days in anticipation of
expenditures to be made, to bridge a gap between receipts and expenditures.
2) Precautionary. We hold money to meet anticipated near-term
expenditures but also hold some in reserve for unanticipated needs. The car
might break down or guests may arrive unexpectedly.
3) Store of Wealth. We may hold part of our wealth as money in order to
be able to act immediately should an investment opportunity arise. The