The Nature and Measurement of Money Flashcards
What is money?
“Any generally accepted medium of exchange”
Transportable
Must be durable to act as a store of value
Must be divisible (unit of account)
Value must not change sharply, otherwise it loses its purpose of absorbing changes
Money is any asset acceptable in exchange for goods and services
Why does money exist?
Solution to the problem of ‘double coincidence of wants’
Monetary exchange develops due to lack of information on credit worthiness (i.e. can’t trust people with IOUs)
Origin of the word “credit”=”credo” in Latin=”I believe”
Government accepts money as a payment of taxes, therefore we trust money
Money facilitates exchange which encourages division of labour and specialisation
Which assets constitute money?
Notes and coins
Instant access bank deposits (e.g. current accounts)
Savings accounts
Why do people hold more money than needed for current expenditure despite the loss of interest?
To fund consumption due to ‘unpredicted’ needs
Fear of bank failure
What causes innovations such as ATMs?
Banks are profit-making businesses, therefore ATMs reduce the cost of paying wages to employees. More profit
What effect do such innovations have on the demand for particular monetary aggregates?
M0 (money base) - unchanged
NIBM1 (notes and coins in circulation) - increases
M2 (deposits with banks/building societies) - decreases?
Why can it be argued that the divisia index is superior to simple-sum money aggregates?
Simple-sum adds the components together to measure M4, as it assumes each component is as money-like as each other. E.g. assumes CDs are money. But this is invalid if some components are less money-like than others.
Divisia attempts to measure the amount of money available for transactions purposes by weighting each component to the extent they provide transaction services. The divisia index is superior due to internalising switches between components (e.g. withdrawing cash from account)
Explain why the BoE ceased to publish data for M0, NIBM1, M1
M0 - stopped in 2006 due to BoE starting to pay interest on bank’s reserves balances
NIBM1 - irrelevant as interest-bearing sight deposits spread
M1 - discontinued in July 1989 as people used building society accounts, excluded from M1, for transactions
Explain why M4 is likely to be a better measure of the money stock than M1
M4 includes a larger variety of components in the money stock than M1
Main advantages of money as unit of account
Money greatly reduces the information cost of trade (different goods and services expressed in a common unit; only need to know the price of something to know how much money to give up)
No numeraire=huge amount of price ratios (prices are all quoted relative to money; 0.5n(n-1) price ratios)
Using unit of account greatly reduces number of price ratios, and cost of exchange
Financial innovation’s impact on the usefulness of monetary aggregates
Monetary aggregates change due to financial innovation, they are not constant over time (e.g. no data for M0, NIBM1 and M1 anymore)
Financial innovation increases the range of money-like instruments, making some assets more liquid. Liquidity of assets changes due to innovation, but for some assets liquidity is not immutable.
Financial innovation makes defining and measuring money difficult
Is credit money?
- If money is defined as means of financial settlement, then credit is not money (passing on your debt to someone else, not settling it)
+ Credit increases money as ‘spending resources’
+ Credit is money because it is how money is created (through loans)
Define financial innovation
Financial innovation = the act of creating and then popularising new financial instruments, technologies, institutions and markets
Define M0
Notes and coins outside of BoE + banks operational deposits at BoE
MONEY BASE
Define NIBM1
Notes and coins in circulation + NBPS holdings of NIB sight deposits
