Transcript money affects real gdp - Choose your book for Principles of

Chapter 25
Money
© 2002 South-Western
Economic Principles
• Barter Exchange
• The Characteristics of Money
• Gold-Backed and Fiat Money
• Liquidity
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Economic Principles
• The Equation of Exchange
• The Quantity Theory of Money
• The Classical View of Money
• The Keynesian View of Money
• Monetarism
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Introduction
Barter
The exchange of one good for
another, without the use of
money.
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Introduction
1. What is the key problem with
barter exchange?
• To function effectively, barter requires a
double coincidence of each party to the
exchange wanting precisely what the other
has to offer. A double coincidence of wants
is difficult to achieve.
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The Invention of Money
Money
Any commonly accepted good
that acts as a medium of
exchange, a measure of value,
and a store of value.
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The Invention of Money
Money must be durable,
portable, divisible, homogeneous,
and supplies must be stable.
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The Invention of Money
Which of the following is most
likely to serve as money:
a. Strawberries.
b. Cows.
c. Gold.
d. Water.
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The Invention of Money
Which of the following is most
likely to serve as money:
c. Gold.
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The Invention of Money
Which of the following is most
likely to serve as money:
Strawberries are not durable,
cows are not easily divisible, and
most of the time the supply of
water is too abundant and
difficult to control.
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The Invention of Money
Gold makes a good type of money
because:
a. Gold supplies are fairly stable.
b. Gold is homogeneous.
c. Gold is durable.
d. Gold is divisible.
e. Gold is portable.
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The Invention of Money
Fiat money
Paper money that is not backed
by or convertible into any good.
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Fluffy Rabbits and
Gresham’s Law
Suppose that more valuable silver
quarters and less valuable copper-nickel
quarters freely circulate together in the
economy. What would happen over time?
• People would keep the more valuable
silver quarters, and eventually only the
less valuable copper-nickel quarters
would freely circulate.
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Fluffy Rabbits and
Gresham’s Law
Suppose that more valuable silver
quarters and less valuable copper-nickel
quarters freely circulate together in the
economy. What would happen over time?
• Sir Thomas Gresham, a 16th century
merchant to the English crown, observed
that bad money drives out good.
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Money in a Modern
Economy
Currency
Coins and paper money.
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Money in a Modern
Economy
Liquidity
The degree to which an asset can
easily be exchanged for money.
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Money in a Modern
Economy
Liquidity is what distinguishes
money from any other asset form.
• Some assets are relatively
liquid, and can serve as money.
• Most assets are highly illiquid
and thus far removed from
serving as money.
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Money in a Modern
Economy
Money supply
Typically, M1 money. The supply
of currency, demand deposits,
and traveler’s checks used in
transactions.
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Money in a Modern
Economy
M1 Money supply
The supply of the most immediate
form of money. It includes
currency, demand deposits, and
traveler’s checks.
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Money in a Modern
Economy
M2 Money supply
M1 money plus less-immediate forms of
money, such as savings accounts, money
market mutual fund accounts, money
market deposit accounts, repurchase
agreements, and small-denomination time
deposits.
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Money in a Modern
Economy
M3 Money supply
M2 money plus largedenomination time deposits and
large-denomination repurchase
agreements.
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Explaining the Impressive
Growth of M2 Money
What caused the impressive
growth of M2 money?
• Deregulation of the banking industry led
to a large increase in money market
accounts (mutual funds and deposit
accounts), and increased the liquidity of
savings accounts.
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Money in a Modern
Economy
The dividing line between money
and non-money assets is blurry.
Most any asset is potential
money.
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Money in a Modern
Economy
Are credit cards a form of
money?
• No. They may be accepted as readily as
money by stores, but credit cards are loans
that must be repaid.
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EXHIBIT 1
U.S. MONEY SUPPLY: 2000 ($ BILLIONS)
Source: Federal Reserve Bulletin (Washington, D.C.: Federal Reserve, December 2000), p. A13, table 1.21.
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Exhibit 1: U.S. Money
Supply: 2000 ($Billions)
1. True or false: The largest
component of M1 is demand
deposits.
• False. In 2000 currency was over $523
billion of the $1,095 billion supply of M1
money.
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Exhibit 1: U.S. Money
Supply: 2000 ($Billions)
2. True or false: The largest
component of M2 is M1.
• False. In 2000 M1 was $1,094.9 billion,
but savings deposits and money market
accounts made up $1,839.4 of the $4,860.9
billion supply of M2 money.
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Exhibit 1: U.S. Money
Supply: 2000 ($Billions)
3. True or false: The largest
component of M3 is made up of
Eurodollars.
• False. In 2000 the largest component of
M3 was M2. Eurodollars were only a
minor part of M3.
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EXHIBIT 2
GR
OWTH OF THE
MONEY
SUPPLY:
1970
–2000
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Exhibit 2: Growth of the
Money Supply: 1970-2000
1. True or false: M1 grew more
slowly than M2 and M3 between
1970 and 2000.
• True. Deregulation of the banking
industry increased elements of M2, which
in turn increased M3.
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Exhibit 2: Growth of the
Money Supply: 1970-2000
1. True or false: By 1992, M2
became larger than M3.
• False. That cannot occur because M3
includes M2 plus other types of money.
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Money Challenge Quiz
1. What is the largest denomination of
currency printed today?
a. $10,000.
b. $1,000.
c. $500.
d. $100.
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Money Challenge Quiz
1. What is the largest denomination of
currency printed today?
d. $100.
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Money Challenge Quiz
2. What agency actually prints currency?
a. The Federal Reserve System.
b. The Bureau of Engraving and Printing.
c. The Internal Revenue System.
d. The U.S. Mint.
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Money Challenge Quiz
2. What agency actually prints currency?
b. The Bureau of Engraving and Printing.
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Money Challenge Quiz
3. All of the U.S. coins currently minted
portray…
a. past U.S. presidents.
b. national parks.
c. national monuments.
d. various universities founded before
1900.
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Money Challenge Quiz
3. All of the U.S. coins currently minted
portray…
a. past U.S. presidents.
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Money Challenge Quiz
4. The average life of a $1 bill is…
a. 3-6 months.
b. 6-9 months.
c. 12-18 months.
d. 3 years.
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Money Challenge Quiz
4. The average life of a $1 bill is…
c. 12-18 months.
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Money Challenge Quiz
5. The average life of a $100 bill is…
a. 3-4 years.
b. 5-6 years.
c. 7-8 years.
d. 8-9 years.
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Money Challenge Quiz
5. The average life of a $100 bill is…
d. 8-9 years.
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Money Challenge Quiz
6. Some features of U.S. currency that
deter counterfeiters include…
a. tiny red and blue fibers in the paper.
b. a polyester strip embedded vertically in
the paper.
c. special inks.
d. all of the above.
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Money Challenge Quiz
6. Some features of U.S. currency that
deter counterfeiters include…
d. all of the above.
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Money Challenge Quiz
7. The former U.S. President or statesman
featured on the $5 bill is…
a. George Washington.
b. Andrew Jackson.
c. Ulysses S. Grant.
d. Abraham Lincoln.
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Money Challenge Quiz
7. The former U.S. President or statesman
featured on the $5 bill is…
d. Abraham Lincoln.
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Money Challenge Quiz
8. The former U.S. President or statesman
featured on the $50 bill is…
a. George Washington.
b. Andrew Jackson.
c. Ulysses S. Grant.
d. Abraham Lincoln.
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Money Challenge Quiz
8. The former U.S. President or statesman
featured on the $50 bill is…
c. Ulysses S. Grant.
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Money Challenge Quiz
9. The emblem or monument printed on
the back of the $50 bill is…
a. the Great Seal of the United States.
b. the White House.
c. the U.S. Capitol.
d. independence Hall.
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Money Challenge Quiz
9. The emblem or monument printed on
the back of the $50 bill is…
c. the U.S. Capitol.
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Money Challenge Quiz
10. Currency printed after 1929 is…
a. 6.14’’ by 2.61’’.
b. 6.00’’ by 3.00’’.
c. 5.25’’ by 3.36’’.
d. 5.00’’ by 3.00’’.
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Money Challenge Quiz
10. Currency printed after 1929 is…
a. 6.14’’ by 2.61’’.
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The Quantity Theory of
Money
Velocity of money
The average number of times per
year each dollar is used to
transact an exchange.
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The Quantity Theory of
Money
Equation of exchange
MV = PQ. The quantity of money
times its velocity equals the
quantity of goods and services
produced times their prices.
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The Quantity Theory of
Money
The classical view:
• Real GDP (Q in the equation of
exchange) depends on the amount of
resources in the economy, which are fixed.
• Prices are flexible.
• Velocity is fixed.
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The Quantity Theory of
Money
The classical view:
Since Q and V are fixed, while P
is flexible, the classical view holds
that there is a direct relationship
between M and P.
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The Quantity Theory of
Money
Quantity theory of money
P = MV/Q. The equation
specifying the direct relationship
between the money supply and
prices.
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The Quantity Theory of
Money
Monetarists attempted to rescue the
classical view from evidence showing that
M1 velocity is not constant. They argue
that if velocity is stable and predictable,
and if Q is at full-employment GDP, then
the direct relationship between M and P
remains intact.
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EXHIBIT 3
HISTORICAL RECORD OF MONEY VELOCITY
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Exhibit 3: Historical Record
of Money Velocity
How might the use of credit cards have
explained the change in M1 velocity from
the 1950s to the 1980s?
• Increased use of credit cards during this
period allowed people to buy more goods
and services with less cash and lower
demand deposit balances relative to
nominal GDP.
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The Quantity Theory of
Money
Keynesians reject the monetarist’s idea
that V is either stable or predictable, and
that Q always reflects full-employment
GDP. In this case, changes in M will affect
more than just P—they may also change
Q.
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The Demand for Money
Transactions demand for money
The quantity of money demanded
by households and businesses to
transact their buying and selling
of goods and services.
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The Demand for Money
The classical view is that the
transactions demand for money is
the only motive for demanding
money. If P or Q rises, the
transactions demand for money
will also rise.
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The Demand for Money
The Keynesian view is that in
addition to the transactions
demand for money, there is also a
precautionary motive and a
speculative motive for demanding
money.
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EXHIBIT 4
THE SPECULATIVE DEMAND FOR MONEY
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Exhibit 4: The Speculative
Demand for Money
According to the speculative motive, why
does the quantity of money demanded
increase as interest rates decrease?
• People shift out of interest-paying
accounts into holding money because the
opportunity cost of holding money has
fallen.
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Exhibit 4: The Speculative
Demand for Money
According to the speculative motive, why
does the quantity of money demanded
increase as interest rates decrease?
• This reduces the cost of speculatively
having money immediately available to
take advantage of unforeseen good
purchasing opportunities that may
suddenly arise.
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EXHIBIT 5A MONEY AFFECTS REAL GDP
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EXHIBIT 5B MONEY AFFECTS REAL GDP
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EXHIBIT 5C MONEY AFFECTS REAL GDP
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Exhibit 5: Money Affects
Real GDP
According to the Keynesian view, how
does a change in the money supply affect
real GDP?
• An increase in the money supply reduces
interest rates.
• Lower interest rates increase investment
spending.
• Increased investment spending increases
aggregate demand.
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The Demand for Money
What is the shape of the aggregate supply
curve when a change in the money supply
affects real GDP but not the price level?
• The segment of the aggregate supply
curve over which aggregate demand shifts
is horizontal.
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The Demand for Money
How do classical economists and
monetarists see the shape of the aggregate
supply curve?
• The segment of the aggregate supply
curve over which aggregate demand shifts
is vertical, and occurs at the fullemployment level of real GDP. Thus only
prices change, not real GDP.
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