ECON 001 Lecture Notes - Lecture 20: Market Liquidity, Money Supply, Federal Open Market Committee
Chapter 29 Monetary Policy
I. Money: anything that is accepted as payment for goods or services or as repayment of
debts
A. The Functions of Money
1. Medium of Exchange: A good that serves as a medium of exchange is a good that
buyers can give sellers (and sellers will accept) in exchange for another good or
service. Having a medium of exchange is much more efficient than the alternative of
bartering. Imagine that you wanted eggs for breakfast and are willing to trade 4
tomatoes for 4 eggs. Without money acting as a medium of exchange, you would have
to find someone with eggs that would also want the tomatoes that you are offering in
exchange. This is known as the problem of double coincidence of wants. Having a
medium of exchange eliminates the double coincidence of wants problem.
2. Unit of Account: One of the functions of money is that it must serve as a way to
measure the value of goods and services. Money should serve as a consistent way of
quoting prices. How is the price of an apple quoted? Apple prices are quoted in
dollars, but suppose we lived in a world without money. In that case stores would
have thousands of relative prices for apple (the price of apples quoted in terms of
different goods that could be traded for apples). For example an apple could be
quoted as 1.5 oranges, or 3 bananas or ā
of an oil change, etc... There are thousands of
ways we could have measured the price of apples. Having a standard unit of account
makes it easier to quote prices and measure the worth of a good.
3. Store of Value: Money also serves as a store of valueāmoney can be used to
transport purchasing power from one time period to another. In other words,
someone can hold on to money for a period of time and use the money to make
purchase at a later period. This property would mean that perishable goods such as
bananas could never be considered money because they would not have the store of
value property.
B. Liquidity
1. Money is not the only store of value for individuals. Many transfer their purchasing
power into the future by holding non-monetary assets such as stocks, bonds, real
estate, etc... When we talk about wealth we are referring to both money and
non-money asset. One method to classify assets is by its liquidity.
Definition: Liquidity refers to the ease one can convert an asset into the accepted medium of
exchange. Since money is by definition a medium of exchange, money is the most liquid
asset available. Checking accounts and savings accounts are also very liquid. Stocks and
bonds are relatively liquid, as it is somewhat easy to sell those assets for money. Other assets
such as houses and rare paintings are less liquid as it takes a long time to sell those assets.
C. Types of Money
1. Commodity Money: Money that has intrinsic value. Would have value even if not
used for money. Like gold, silver, cigarettes
2. Fiat Money: money that has no intrinsic value (has value because some authority it
has value). Like paper currency.
D. Measuring Money
1. MI: Narrow Definition of Money: currency, demand accounts (checking accounts),
travelerās checks
2. M2: Broader Definition of Money: everything in M1, savings deposits, small
denomination (under $100,000), time deposits (certificate of deposits CDs), money
market accounts (money market refers to bonds that have maturity of < 1 yr)
II. Federal Reserve
āCentral bank of the US
āCreated in 1913 as a result of severe banking panic in 1907
Two Main Functions
1. Regulate Banking System- act as lender of last resort
2. Controls nationās money supply
Structure of Federal Reserve (3 Entities)
1. Federal Reserve Banks; 12 Regional banks located throughout the country; each bank
has president; report on local economic conditions and physically print money
2. Board of Governors; 7 members appointed by the President- confirmed by Senate;
serve single term of 14 years; one of the governors serves as chair chosen by the
President and serve 4 year term (can be reappointed); in charge of Board Meetings,
testify before Congress; Current Chair: Janet Yellen
3. Federal Open Market Committee (FOMC): 12 members comprised of following: 7
board of governors; President of NY Fed; 4 other presidents of regional fed banks
(serve on routine basis); Responsible for determining monetary policy
Document Summary
Having a medium of exchange is much more efficient than the alternative of bartering. Imagine that you wanted eggs for breakfast and are willing to trade 4 tomatoes for 4 eggs. Without money acting as a medium of exchange, you would have to find someone with eggs that would also want the tomatoes that you are offering in exchange. This is known as the problem of double coincidence of wants. Having a medium of exchange eliminates the double coincidence of wants problem: unit of account: one of the functions of money is that it must serve as a way to measure the value of goods and services. Money should serve as a consistent way of quoting prices. Apple prices are quoted in dollars, but suppose we lived in a world without money. In that case stores would have thousands of relative prices for apple (the price of apples quoted in terms of different goods that could be traded for apples).
