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Summary Monetary Economics (full)
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Summary Monetary Economics, year , includes all lections and in-class interactions.
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Monetary Economics SummaryWEEK 1 – MISHKIN CHAPTER 1 (WHY STUDY MONEY? …) AND
CHAPTER 3 (WHAT IS MONEY?)
- Why study money and monetary economics?
1. Evidence suggests that money, defined as anything that is generally accepted as
payment for goods or services or in the repayment of debts, plays an important role
in generating business cycles.
2. Recessions (unemployment) and expansions affect all of us.
3. Monetary theory ties changes in the money supply to changes in aggregate
economic activity and the price level.
Money Supply Growth in the UK
(Shaded areas represent recessions)
As we can see from the above graph the rate of money growth has declined before most of
recessions, however it did not decline before the recent crisis in 2007 which means that not
every decline in the rate of money growth is followed by a recession. This graph suggests that
money might play a role in generating business cycles.
è The aggregate price level is the average price of goods and services in an economy.
è A continual rise in the price level (inflation) affects all economic players.
è Data show a connection between the money supply and the price as we can see in
the graph below.
,Price Level and Money Supply in the UK
Inflation and Money Growth across Countries
The graph of inflation and money growth across countries suggests that the countries with the
highest inflation rate are generally the ones with the highest money growth rates.
, - Money and Interest Rates:
1. Interest rates are the price of money.
2. Prior to 1980 the rate of money growth and the interest rate on long term Treasury
bonds were closely tied.
3. Since then, the relationship is less clear, but the rate of money growth is still an
important determinant of interest rates as we can see from the graph below.
Money Growth and Long-Term Interest Rate in UK
In the graph above we can see that the relation becomes weaker in the recent times.
è In this chapter, we develop precise definitions by exploring the functions of money,
looking at why and how it promotes economic efficiency, tracing how its forms have
evolved over time, and examining how money is currently measured.
Money (money supply) – is anything that is generally accepted as payment for goods or
services or in the repayment of debts. This a broad definition.
- Money is different from:
1. wealth which is the total collection of pieces of property that serve to store value.
2. Income which is the flow of earnings per unit of time (a flow concept) but money is a
stock concept not flow concept.
- Functions of money:
1. Medium of exchange – eliminates the trouble of finding a double coincidence of
need (reduces transaction costs) and promotes specialization. A medium of
exchange must:
• Be easily standardized
• Be widely accepted
• Be divisible
• Be easy to carry
• Not deteriorate quickly.
, 2. Unit of account:
• Used to measure value in the economy
• Reduce transaction costs
3. 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
- Evolution of the payment system:
1. Commodity money – valuable, easily standardized, and divisible commodities (e.g.,
precious metals, cigarettes)
2. Fiat money – Paper money decreed by governments as legal tender. The only
difference between money and a simple paper is that we believe that one has more
value than the other.
3. Cheques – An instruction to your bank to transfer money from your account.
4. Electronic Payment – electronic money like debit card, smart card, mobile payment
services, e-cash, and cryptocurrencies.
- Are we headed for a cashless society?
1. Predictions of a cashless society have been around for decades, but they have not
come to fruition.
2. Although e-money might be more convenient and efficient than a payments system
based on paper, several factors work against the disappearance of the paper system.
3. However, the use of e-money will likely still increase in the future.
- How do we measure money? Which assets can be called “money”? Different
definition in Euro Area, UK, and US. Construct monetary aggregates using the
concept of liquidity:
1. M1 (contains the most liquid assets) = Currency + demand deposits + other
checkable deposits
2. M2 (adds to M1 other assets that are less liquid) = M1 + time deposits (2-year
maturity) + deposits redeemable at notice of up to three months.
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