Functions of Money

1. Medium of Exchange: One of the functions of money is that it can be used to buy things and can be received when selling things.
  • Money is readily acceptable as money.
  • Money is a social invention with which resource suppliers and producers can be paidand that can be used to buy any of the full range of items available in the market place.
  • It allows society to escape the complications of barter.
2. Unit of Account: A second function of money is that it acts as a measure or "unit". One can measure the value of products with money.
  • With money as an acceptable unit of account the price of each item need be stated inky in terms of the monetary unit.
  • It aids rational decision making by enabling buyers and sellers to easily compare the the prices of various goods, services, and resources.
  • It permits us to define debt obligations, determine taxes owed, and calculate the nations GDP.
3. Store of Value: Money will keeps its value over time (not accounting for inflation) and therefore also serves as a store of value for the future.
  • In order to buy things later people store some of theur wealth as money.
  • Money is often the preferred store of value for short periods because it is the most liquid of all assets,
  • Example: If a farmer grows a large crop of potatoes, he would have to trade all of those potatoes shortly after he harvests them since they would quickly spoil. He probably would not get very good deals, since people would know that he has to trade all of the potatoes. He also would not get a chance to trade for everything that he wants. However, with money, he can simply sell all of the potatoes for money, which will not spoil.

Money Definitions

  • M1: This is the most limited definition of money. It includes the all the currency in possession of the public and all checkable deposits.
    • Currency: The paper money and coins used in an economy.
    • Most countries use token money, meaning that there is no intrinsic value of the currency.
    • Paper money in the U.S. is referred to as Federal Reserve Notes. These notes are released through the Federal Reserve system after the approval of Congress.
    • Checkable deposits constitute a large portion of M1.
    • Checkable deposits are the funds stored at a financial institution, such as a commercial bank or thrift institution, on which checks may be written. Checks can be written to withdraw funds from the financial institution, or to transfer ownership of the funds to someone else
    • Commercial banks are the main source used for the storage of funds. The money banks receive is used to make loans to households and businesses.Thrift institutions include Savings and Loan associations, mutual savings banks, and credit unions.
  • M2 takes into account both M1 and specific types of near monies.
    • Near monies are not usable as a medium of exchange, but they can be converted, without difficulty, into the money defined under M1. They are, therefore, liquid assets.
  • The following include near-monies considered under M2.
    • Savings deposits: The funds held in a savings account can be moved to either a checking account, or can be removed from the account at the discretion of the holder of the funds. Also included under savings deposits are money market deposit accounts, which accrue interest on the funds deposited. These accounts restrict the number of times funds can be withdrawn.
    • Money market deposit account (MMDA): an interest-bearing bank account where individual deposits are pooled to buy interest-bearing short-term securities (McConnell and Brue 235).
  • Fiat Currency: currency backed only by the declaration of the government
    • No intrinsic value
    • Not backed by gold as in the past, and cannot be exchanged for gold (McConnell)
  • M3: includes large time deposits, often owned by businesses as certificates of deposit (McConnell and Brue 235).
    • Businesses often use these large time deposits for saving, and not for money itself.
    • M3 doesn't really exist nowadays, and has mostly collapsed down to M2.

The Demand for Money
The public wants to have money to either make purchases or to have assets mainly (McConnell and Brue 238)
  • Transactions Demand, Dt
    • demand for money to pay for things like labor materials, power, or other inputs (McConnell and Brue 238)
  • Asset Demand Da
    • demand for money for stocks, private or government bonds, or other monies (McConnell and Brue 238)
  • Total Money Demand (Dm)
    • Total demand for money: The sum of the transactions demand for money and the asset demand for money. (McConnell and Brue)
    • The slope that represents the total money demand, shows the amount of money the public wants to old, both for transactions and assets. It shows this at every possible interest rate. (McConnell and Brue)
    • A change in nominal GDP affects the total money demand curve:
      • An increase in nominal GDP means the public wants to hold more money for transactions, shifting the curve to the right.
      • A decrease in nominal GDP means the curve will shift to the left.

The Federal Reserve and the Banking System

  • In the U.S we have something known as the FED or the Federal Reserve System. Its function is t control the lending activity of the nation’s banks and thrift institutions. The Fed is also referred to as the " monetary authorities".
  • There are 12 Federal Reserve Banks in America.
  • FED was started in 1913 with the Federal Reserve Act due to Congress wishes to help rough economic problems.
  • Of the FED we have the Board of Governors which is the central authority of the U.S money and banking system. The president appoints the seven board members; senate must confirm them.
  • Each member has a term of 14 years and one member is replaced every two years.
    • The long term appointments provide the Board with experience and separation from political pressures that could result in inflation
  • Federal Open Market Committee (FOMC): aids the Board of Governors in conducting monetary policy; 12 individuals:
    • 7 members of the Board of Governor
    • The president of the NY Federal Reserve Bank.
    • 4 of the remaining presidents of Federal Reserve Banks on a 1-year rotating basis.
  • Quasi-Public Banks: 12 Federal Reserve Banks are quasi-public banks, which blend private ownership and public control (each owned by the private commercial bank in its district).
  • Bankers' Banks: The Federal Reserve Banks are the "bankers' bank" meaning the the central banks accept the deposits of and make loans to banks and thrifts.
  • They issue currency when they are directed to do so by the Federal Reserve Board.


Fed Functions and the Money Supply
  • The Federal Reserve Bank issues paper currency to be used.
  • The Fed sets reserve requirements and how much a bank has to hold.
  • The Fed also lends money to banks and thrifts with an interest rate (discount rate).

Fed Functions and the Money Supply
  • The Federal Reserve System serves a means for collecting checks. When an individual deposits a check they received from someone else, the ‘Fed’ adjusts the reserves between the two banks (McConnell and Brue, 245).
  • The Federal Reserve System acts a supervisor to banks. It overlooks their activities, making sure none are committing fraud and confirming how much profit the bank is bringing in (McConnell and Brue, 245).
  • The currency that we use and hold in banks, is issued by the Federal Reserve System (McConnell and Brue, 244).
  • The Federal Reserve system can lend money to the U.S. banking industry to help out in times of financial need (McConnell and Brue, 244).

The Relative Decline of Banks and Thrifts
  • Financial services industry- includes firms that deal with the management, investment, transfer, and lending of money.
  • The declining shares of banks and thrifts went to pensions funds, insurance firms, securities firms, and mutual fund companies (McConnell and Brue, 245).
  • Banks and thrifts didn't offer as much as other institutions which had higher rates of return so as a result households and buisinesses put more of their savings out of banks and thrifts.
Convergence of Services provided by finical institutions
  • Financial Services Modernization Act of 1999- Allows companies working in an industries to help each other and invest in each other.
  • Many Large banks and pension funds now provide mutual funds, including money markets funds that pay relatively high interest. (McConnell and Brue, 246)
Globalization of Financial Markets
  • Globalization of markets is the increasing integration of world financial markets. This has been a significant banking development. Institutions from abroad now do some of their business in the United States, and American businesses also do business abroad.
  • Visa, MasterCard, and American Express is a form of globalization of financial markets which has the capabillity to do buisness abroad.
  • Since computers and the Internet are quickly becoming more advanced, these advancements are likely to facilitate the growth of globalization of financial markets.
Electronic Transactions
The rapid advance of the Internet has brought on the advance of electronic transactions, or using the internet to buy and sell anything with the help of credit cards, transfer bank funds, and pay bills. Electronic transactions can involve online "stores" that connect buyers and sellers, such as eBay, or purchases from companies that have online websites set up. Some experts believe that in the future, electronic money will be widely used, and account holders might even be able to insert stored-value cards into slots in their computers to load electronic money onto the card. Some day, we might make nearly all payments through the internet or with smart cards. Currently, smart cards called credit cards and debit cards exist and are most widely used in the United States but are less common in European countries.