Chapter 3 What Is Money?

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Meaning of Money
What is it?

Money (or the money supply): anything that is generally accepted in payment for goods or services or in the repayment of debts. A rather broad definition
Money (a stock concept) is different from:
Wealth: the total collection of pieces of property that serve to store value Income: flow of earnings per unit of time (a flow concept)

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Functions of Money
Medium of Exchange:
Eliminates the trouble of finding a double coincidence of needs (reduces transaction costs) Promotes specialization

A medium of exchange must

be easily standardized be widely accepted be divisible be easy to carry not deteriorate quickly

Unit of Account:
used to measure value in the economy reduces transaction costs

Store of Value:
used to save purchasing power over time. other assets also serve this function Money is the most liquid of all assets but loses value during inflation
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Evolution of the Payments System

Commodity Money: valuable, easily standardized and divisible commodities (e.g. precious metals, cigarettes). Fiat Money: paper money decreed by governments as legal tender. Checks: an instruction to your bank to transfer money from your account Electronic Payment (e.g. online bill pay). E-Money (electronic money):
Debit card Stored-value card (smart card) E-cash

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Measuring Money
How do we measure money? Which particular assets can be called money? Construct monetary aggregates using the concept of liquidity: Narrow money: M1 (most liquid assets) = currency + travelers checks + demand deposits + other checkable deposits. Broad money: M2 (adds to M1 other assets that are not so liquid) = M1 + small denomination time deposits + savings deposits and money market deposit accounts + money market mutual fund shares.
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Measures of the Monetary Aggregates US system

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Monetary Aggregates
M1 (4) M2 (4+3)

Currency Travelers Checks Demand Deposits Other Check. Dep

Small Den. Dep. Savings and MM Money Market Mutual Funds Shares

M3 (4+3+4)
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Definition of money
Indonesian system

Mo = C + Rb

where Mo = monetary base (high-powered money) ; C = Currency (bank notes); Rb = Bank reserves (banks account at the central bank + cash in vault) where DD = Demand deposits (checking accounts, giro accounts) where TD = Saving and Time deposits

M1 = C + DD

M2 = C + DD + TD M3 = M2 +

(not available in Indonesia)

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Balance sheets of Monetary Authority and Monetary System (Monetary survey)

N er a c a O t o r ita s M o n e te r A k tiv a A k tiv a L u a r N e g e ri B e rsih A k tiv a D alam N e g e ri B e rsih - T a g iha n b e rsih p a d a p em e rinta h p us at - T a g iha n p a da se k to r sw a sta d o m es tik - T a g iha n p a da b a n k um um A k tiv a L a in n y a B e r sih U a n g k a r ta l - d i m a sy a ra k a t - d i ba n k um um S a ld o g iro - m ilik b an k um um - m ilik m a sy a ra k a t P a s iv a ( u a n g k a rta l ) (c a d a n g a n b a n k )

- --- ------ -- ------ --- --- U a n g P rim e r (M 0)

Neraca Sistem Moneter

Aktiva 1. Aktiva Luar Negeri Bersih 2. Tagihan Bersih pada Pemerintah Pusat 3. Tagihan pada Lembaga dan Perusahaan Pemerintah 4. Tagihan pada Perusahaan dan Perorangan 5. Lainnya Bersih Keterangan: format standar penyusunan neraca analitis ini adalah seperti yang dipublikasikan kepada masyarakat dalam Statistik Ekonomi dan Keuangan Indonesia Pasiva Uang Beredar (M2)/ Likuiditas Perekonomian 1. M1 - Uang Kartal - Uang Giral 2. Uang Kuasi

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M1 vs. M2, and Mo

Does it matter which measure of money is considered? M1 and M2 can move in different directions in the short run but should be parallel over the longer-run period. Conclusion: the choice of monetary aggregate is important for policymakers. Mo (Monetary Base) is the central bank money used mostly as indicator for monetary operation Mo = Currency + Banks reserves

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