The role of money

Question 1

What is a liquid asset?

Answer 1

something that can be turned into an acceptable medium of exchange without loss of value

Question 2

What is the definitions of money? (M1)

Answer 2

1. Currency outside banks plus checking accounts (demand deposits; allowing withdrawals and deposits of money)
2. Currency held by banks is not part of money supply
3. Checking accounts are not legal tender, but commonly accepted as payment

4.Other definitions of M2; starts with M1and adds progressively less liquid financial

Question 3

What is the definitions of money? (M2)

Answer 3

1. Small denominated time deposits (CD’s) (fixed return and set of maturity)
2. Money market deposits
3. Saving deposits: can’t transfer money directly from this account to other people.
4. Retail money market mutual funds: offers high liquidity at lower risk.

Question 4

Who determines our money supply?

Answer 4

1. The central bank (federal reserve system) responsible for execution of national monetary policies.
   - The fed influences the total money supply
   - Fed implements monetary policies

Question 5

What is the difference between barter and money?

Answer 5

• Direct exchange of goods and services for other goods and services versus any commodity accepted as medium of exchange can be used as money
• Very inefficient and limited economy + No medium of exchange or unit of account versus certainty of exchange
• Requires double coincidence of wants versus frees people from need to barter
• Items must have about the same value versus permits specialisation of labour: sell one’s labour to the market in exchange for money to purchase goods and services
• Need to determine exchange rate between difference goods and services

Question 6

What is required for an economy to grow?

Answer 6

1. Has to forgo present consumption (save) and invest into new capital assets
2. Money hence contributes to the economic development and growth by stimulating savings and investments
3. Money separates the act of saving and investing; savers expect interest rate payment and investors expect to earn a return over the cost of borrowing
4. Financial institutions and markets act as intermediaries between savers and borrowers

Question 7

What is the relationship between bank reserves and the money supply?

Answer 7

1. Demand deposits (money) are created when banks extend loans through the issuance of credit.
2. Banks are required to hold reserves in form of vault cash, or on deposits with the fed against checking account liabilities (demand deposits).
3. Money is created by banks by making loans with excess reserves, those above the feds required level of reserves.
4. Increase in money supply alters public’s liquidity and influences spending through portfolio adjustment.

Question 8

What is the impact of money supply on society?

Answer 8

• Direct impact: excess liquidity is spent on goods and services
• Indirect impact: purchase financial assets which lowers interest rates
• However: change in liquidity may alter demand for money and not influence GDP as people hoard the additional money.

Question 9

What is inflation? versus deflation?

Answer 9

persistent rise of prices (it is a monetary phenomenon that can only increase with money supply, this is however not a sufficient condition)

Deflation: falling prices, usually during severe recessions or depressions