Transcript Money

Paper Money
Prof. Dariusz Filar
Fiat money
Fiat means „let there be” in Latin, and hence by
„decree”. During the period of twenty years between
the two world wars (1918-1939), almost all the
countries of the world abandoned the gold standard;
their currencies were thus no longer convertible into
gold. Paper money (fiat money) that is not
convertible into anything valuable derives its value
from its acceptability in exchange.
Richard G.Lipsey
K. Alec Chrystal
Fiat money, sometimes called token money
Most people take the ability to use money for granted. People
simply take it for granted that they can walk into practically
any store or restaurant or boutique or gas station and buy
whatever they want , as long as they have enough little pieces
of paper. But stop and ask yourself: „How is it that a shop
owner is willing to part with a loaf of bread that I can eat in
exchange for some pieces of paper that are intrinsically
worthless?” The actual value of a one-, a ten-, or a fifty-dollar
bill itself is basically zero. Why would anyone agree to use
worthless scraps of paper as money?
Karl E. Case
Ray C. Fair
Paper currency, fiat money
The contemporary monetary systems are based entirely on
inconvertible paper currency, or fiat money. Fiat money is a
medium of exchange or store of value that cannot be
redeemed for anything other than a replica of itself. A fiat
dollar can be exchanged only for another dollar. The general
acceptability of paper currency does not depend on either its
intrinsic market value (as, for example, was the case with rock
salt in parts of the ancient Roman Empire), or its redemption
value (as was the case with gold certificates). It depends
entirely on people’s confidence in its continued usefulness in
trade.
Dennis Placone
Money is a contract
Money is a contract – the freest, most gorgeous
of them all. Money is somebody else’s
promise to pay, to give me what I want, when
I want it. (…) Modern money is a contract with
(1) parties unknown for the (2) future delivery
of (3) pleasures undecided upon.
David Bazelon
The Value of Money
Why does money have value? Dollars in bank accounts cannot
have intrinsic value – they are just figures on paper.
Furthermore, the dollar’s value is not based on some kind of
„gold backing” – there is no such thing. Contrary to popular
belief, the government no longer holds gold in Fort Knox to
back the dollar. Only until 1971, the government was required
to hold $ 0.25 in gold for every dollar outstanding. Although it
may seem a little like magic, confidence in its general
acceptability is the stuff money is made of. Hence the value of
money ultimately depends on an unwritten social agreement
that it is valuable.
Richard B. McKenzie
Functions of Money
• Money as a Medium of Exchange, or Means of
Payment
• Money as a Unit of Account
• Money as a Store of Value
Money as a Medium of Exchange,
or Means of Payment
• Under a monetary system, money is exchanged
for goods and services when people want to buy
things
• Goods and services are exchanged for money
when people sell things
• No one ever has to trade goods for other goods
directly (barter)
• Money is a lubricant in the functioning of a
market economy – it facilitates trade and
contributes to national production
Money as a Unit of Account
• All prices are quoted in monetary units; a
standard unit of account is extremely useful
when quoting and comparing prices
• Money is a kind of common denominator in
which the relative values of other goods and
services can be expressed
• No one has to posses money physically to
compare prices of various goods and services
Money as a Store of Value
• Money could be used to „transport” purchasing
power from one period of time to another
• One could keep some of his/her earnings in the
form of money until such time as he/she wants to
spend it
• Money is very easy to exchange for goods and
services; economists call this the liquidity
property of money. Other stores of value
(diamonds or antique paintings for example) are
characterised by „stickness” (it is not so easy to
exchange them for something else)
The overall demand for money
• The overall demand for money in the
economy is the sum of all individual demands
for money by the people in the economy.
• People decide how much money to hold in
currency and how much in bank deposits
• The overall demand for money (Md) is equal
to the sum of currency plus deposits
The Demand for Money
• Transaction demand for money: the desire to hold
money balances in order to carry out anticipated
purchases of goods and services
• Precautionary demand for money: the desire to hold
money balances in order to finance unexpected or
emergency purchases of goods and services
• Speculative demand for money: the desire to hold
money balances in anticipation of a decrease in the
price of other assets and in anticipation of future
profits
Determining the Supply of Money
• There are two types of money:
CURRENCY – or cash in circulation - coins and
bills that could be used for transactions
DEPOSITS – funds hold at accounts in
commercial banks
• Commercial banks keep as RESERVES some of
the funds they receive in the form of deposits
• Money Supply is cash in circulation plus
deposits
Central Bank – the high-powered money,
or the monetary base
• The central bank money is sometimes called
high-powered money (Hd) or the monetary
base.
• The high-powered money consists of issued
currency (total amount of bills and coins) and
of deposits held by commercial banks with the
Central Bank
• To the Central Bank the high-powered money
is a liability
The Balance Sheet of Central Bank
• Assets
• Government Bonds
(mainly FX bonds)
• Other securities
• Liabilities
• Currency (all bills and
coins in circulation)
• Required reserves of
commercial banks
• Own capital
High-powered money and the economic system
The Central Bank gets high-powered money into
the economic system simply by buying
securities. It pays for these purchases of
securities with newly issued currency. Hence,
in creating additional high-powered money,
the Central Bank is expanding both sides of its
own balance sheet. At the same time as it
increases its liabilities, it purchases assets of
equal value.
Money multiplier
• The overall supply of money depends on the
amount of central bank money (high-powered
money; monetary base)
• Increases in Hd lead to more than one-for-one
increases in the overall money supply
• The overall supply of money is, therefore,
equal to central bank money times the money
multiplier
Understanding the money multiplier
(1)
• Suppose central bank buys 100 units worth
bonds.
• To pay the seller (call him Seller 1), central
bank creates 100 units in central bank money.
• Seller 1 (if he doesn’t want to hold any
currency) deposits the 100 units in a deposit
at his bank – call it Bank A. This leads to an
increase in deposits of 100 units.
Understanding the money multiplier
(2)
• Here is the beginning of the work of the
Money Multiplier:
• Bank A keeps 100 units x 0,1 (reserves ratio) =
10 units in reserves and buys bonds with the
rest (100 – 10 = 90) from the Seller 2
• Seller 2 deposits 90 units in a deposit at her
bank – call it Bank B. This leads to an increase
in deposits of additional 90 units.
Understanding the money multiplier
(3)
• Bank B keeps 90 units x 0,1 = 9 units in
reserves and buys bonds with the rest (90 – 9
= 81). It pays 81 units to the seller of those
bonds – call him Seller 3
• Seller 3 deposits his 81 units at a account in
his bank – call it Bank C. This leads to an
increase in deposits of 81 units.
• And so on …