Slide 4

Let me define money. Money is the set of assets in an economy that

people regularly use to buy goods and services from other people. The key word
here is asset. So what is an asset? It is a resource with economic value that an
individual, corporation or country owns or controls with the expectation that it
will provide future benefit.
Slide 5
What are the functions of money? It includes medium of exchange, unit of
account, store of value, and liquidity. Let us deal on each of this function.
Medium of exchange is an item that buyers give to sellers when they want
to purchase goods and services. To put it simply, money is a medium of
exchange in the sense that people all agree to accept it in making transactions.
Unit of account is the yardstick people use to post prices and record debts.
To elaborate the unit of account refers to the fact that the prices of different
goods are expressed in common monetary unit. For example, a candy is P2/pc
while a biscuit is P6/pc. Without unit of account, we say that the price of candy is
1/3 of the price of biscuit. Isnt it quite complicated?
Store of value is an item that people can use to transfer purchasing power
from the present to the future. An example of a store of value is currency, which
can be exchanged for goods and services. If the value of currency becomes
unpredictable, such as in times of hyperinflation, investors and consumers will
shift to alternative stores of value, such as gold, silver, precious stones and real
estate.
Slide 6
Liquidity is the ease with which an asset can be converted into the
economys medium of exchange. It means how quickly you can get your hands
on your cash. Being able to come up with liquidity quickly can help you make an
immediate profitable buy at the right time. When your asset is in liquid form you
can easily use it to buy or pay any goods and services at an instant.
Slide 7
What are the kinds of money? Commodity money takes the form of a
commodity with intrinsic value. By intrinsic, we mean that the item would have
value even if it were not used as money. Commodity money derives its value
from the commodity out of which the good/money is made from. So if a gold
coin was made, the value of the coin would be its value in terms of gold rather
than the face value of the coin. Commodity money developed as a more
convenient form of trade because it is superior to barter. However, commodity
money is prone to huge fluctuations in price.
Imagine the commodity chosen was gold, and a new gold deposit is found.
Those who held lots of gold (think modern day banks) will lose a lot of their

wealth. Also, if food (such as dried beans) are used, what happens during a
drought or a famine? All the money is used for consumption so trade becomes
more difficult.
Fiat money is money without intrinsic value
that is used as money
because of government decree. Fiat money was first introduced as a more
convenient form of money. Instead of having to carry around
gold/silver/cigarettes we could carry paper backed by the government. Over
time governments have been less willing to back up their fiat currency with gold
or other commodities so fiat money has essentially become faith based in your
government who issues it. Most governments require that their currency be
accepted to pay debts. Fiat money is worthless without a guarantee from a
government (notice on US currency it says people MUST accept this for all
debts).
Slide 8
Money in the U.S. Economy is either currency or demand deposits.
Currency is the paper bills and coins in the hands of the public while demand
deposits are balances in bank accounts that depositors can access on demand by
writing a check.
Slide 9
Money stock is the quantity of money circulating in the economy. The
important point is that the money stock for the U.S. economy includes both the
currency and deposits in banks and other financial institutions that can be readily
accessed and used to buy goods and services.
Slide 10
This figure shows U.S. Money in Billions of Dollars as indicated in the Yaxis. In the X-axis are the two classifications of U.S. Money, the M1 and M2. The
M1 covers only about $ 1,179 billion including both the demand deposits and
currency. The M2, on the other hand, includes everything in M1 plus additional
deposits such as savings and small time, mutual funds and others. M2 therefore
reach up to $ 4,276 billion.

Slide 20
Banks and the Money Supply. Banks can influence the quantity of demand
deposits in the economy and the money supply. It is the simple case of 100percent-reserve banking and money creation with fractional-reserve banking.
Slide 21
Reserves are deposits that banks have received but have not loaned out.
Slide 22

Assets for Reserves and Liabilities for Deposits. Both $100.00

Slide 23
100% Reserve Bank
Example: You have $6000 left from your monthly allowance and you
decided to put it in the bank for safe keeping. The moment you gave your money
to the bank, the $6000 will be their asset and as well as their liability to you.
Slide 24
Notice that the assets and liabilities are exactly balance. Each deposit in
the bank reduces currency and raises demand deposits by exactly the same
amount, leaving the money supply unchanged. Thus, if banks hold all deposits in
reserve, banks do not influence the supply of money.
Slide 37
The Money Multiplier. The creation of money does not stop with Forever
National Bank. Suppose the borrower from Forever National uses the $90 to buy
something from someone who then deposits the currency in Sea-Side National
Bank. Here is the T-account for Sea-Side National Bank:
Slide 38
The Money Multiplier. Both the Forever National Bank and Sea-Side
National Bank have shown the same reserve ratio of !0% despite difference in
the amount of assets and Liabilities. Note that the sum of reserves plus loans is
equal to liabilities.
Side 39.
The same is true with Beach Front National Bank and Resorts World
National Bank.
Slide 40
The Money Multiplier can be defined as the amount of money the banking
system generates with each dollar of reserves. It is the reciprocal of the reserve
ratio as: M = 1/R, meaning for every increase in each dollar of reserves, the
money multiplier decreases or for every decrease in each dollar of reserves, the
money multiplier increases.
Slide 41
To illustrate, it is shown in this slide that given 10% reserve ratio, the
multiplier is 10 while when reserve ratio is 20%, the multiplier decrease to 5.
Slide 42
Further in this slide, when reserve ratio becomes 25%, the multiplier is 4.
However, when reserve ratio was increased to 50%, the multiplier became 2.

Slide 43
Note therefore, that the higher the reserve ratio, the less of each deposit
banks loan out, and the smaller the money multiplier. In the special case of 100percent-reserve banking, the reserve ratio is 1, the money multiplier is 1, and
banks do not make loans or create money.
Slide 50
Problems in controlling money supply. The Feds control of the money
supply is not precise. The Fed must wrestle with two problems that arise due to
fractional-reserve banking. The Fed does not control the amount of money that
households choose to hold as deposits in banks. The Fed does not control the
amount of money that bankers choose to lend.
Slide 51
In Summary, The term money refers to assets that people regularly use to
buy goods and services. Money serves three functions in an economy: as a
medium of exchange, a unit of account, and a store of value. Commodity money
is money that has intrinsic value. Fiat money is money without intrinsic value.
Slide 52
In addition, the Federal Reserve, the central bank of the United States,
regulates the U.S. monetary system. It controls the money supply through openmarket operations or by changing reserve requirements or the discount rate.
Slide 53
Lastly, when banks loan out their deposits, they increase the quantity of money
in the economy. Because the Fed cannot control the amount bankers choose to
lend or the amount households choose to deposit in banks, the Feds control of
the money supply is imperfect.