1- Intro Flashcards
What are the 4 main frictions that make money essential?
-Lack of double coincidence of wants
-Lack of commitment
-Imperfect enforcement
-Anonymity
Why is Lack of double coincidence of wants a friction?
Rarely two agents will want exactly what each is offering
Why is Lack of commitment a friction?
If people can commit they can promise to repay debts and there is no need for a medium of exchange
Why is Imperfect enforcement a friction?
If people cannot record and punish defaulters, then they will get away with not paying back IOUs
Why is Anonymity a friction?
If agents do not know who you are, they cannot deduce your credibility in an exchange
What is the main difference between bank deposits and currency?
Bank deposits are the liability of the issuing commercial bank whereas currency is the liability of the central bank
What are the 3 main functions of money?
-Unit of account
-Medium of exchange
-Store of value
How does money help as a unit of account?
We can use a single reference point to price goods; we don’t have to quote them in terms of other goods.
What main economic information can money transmit?
An increase in a good’s price implies an increase in its relative demand
How can inflation distort the economic information money transmits?
When there is an increase in the general price level, not all firms change at the same time so broad-based rises may appear to be relative changes
What 2 inefficiencies of bartering does a medium of exchange eliminate?
-Eliminates needing double coincidence of wants
-Promotes specialisation as agents do not have to worry about satisfying many coincidences
What is a medium of exchange?
Something that people hold because they want to swap it for something else, not because they want to directly derive utility from the medium itself
What are 3 main features a medium of exchange must have?
-Homogenous & verifiable
-Widely accepted
-Predictable value
Why must a medium of exchange be Homogenous & verifiable?
Agents won’t be willing to accept something they cannot tell is legitimate
Why must a medium of exchange be Widely accepted?
The fewer people that accept it the less value it has because you can’t get anything with it
Why must a medium of exchange have Predictable value?
If what money can buy vastly changes from day to day, agents will be more hesitant to accept it
What 2 ways does money as a store of value save purchasing power over time?
-Protects against liquidity shocks
-Money’s divisibility allows consumption smoothing; don’t have to swap loads of goods at once
What is the Rate of return equality assumption?
All assets are perfect substitutes, so agents will only hold 2 if they offer the same return
Why do people hold money if it returns less than other assets violating return equality assumption?
Because money offers benefits that other assets do not
What are the 3 components of the market value of any monetary unit?
-Intrinsic value
-Promise of payment
-Liquidity premium
What is Intrinsic value of a monetary unit?
You can derive utility from consuming it or you can use it as a factor of production e.g. Gold
What is the Promise of payment value of a monetary unit?
No risk with currency, but bank deposits are an IOU from the bank to depositor
What is the Liquidity premium of a monetary unit?
No need for asset conversion, can directly exchange money for goods
What is the value of fiat money based on?
Expectations regarding its future acceptance and marketability- has no fundamental value
Why is an infinite time horizon important for fiat money to be valued?
Agents won’t accept worthless asset in last period of time, same for second last period, domino effect no one will accept
What is the value of money in monetary models (vₜ)?
The inverse of the price level i.e. how many goods a unit of money can buy: vₜ = 1/pₜ
What 2 types of money do central banks issue?
-Currency (fiat money): to everyone
-Reserves (digital money): to banks
What is the monetary base?
Money issued by the central bank
What are Reserves?
Overnight balances eligible financial institutions hold in an account at the central bank
What is the System of scarce reserves?
Monetary policy stance implemented through operations in local money markets (changing the supply of money)
What is the System of abundant reserves?
Monetary policy stance implemented through interest rate paid on reserves (remuneration of the money supply)
How does the rate paid on Reserves by the central bank affect prevailing interest rates?
Reserve rate effectively sets a floor on rates offered because it’s the benchmark liquid risk-free rate
What are the 2 main reasons Fiat money coexists with assets which yield a higher return?
-Risk level
-Liquidity
