15.1 Show Me the Money
3 min read•june 18, 2024
is the lifeblood of our economy, enabling transactions and storing value. It serves as a , , and , with key characteristics like and acceptability.
The U.S. money supply is categorized into , , and M3, encompassing various forms of and deposits. Factors like consumer demand, income levels, and alternative payment methods influence how much money circulates in the economy.
The Basics of Money
Characteristics and Functions
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- Money serves three primary functions in an economy:
- Medium of exchange facilitates transactions between buyers and sellers and eliminates the need for bartering (direct exchange of goods or services)
- Unit of account provides a standard measure of value allowing for consistent pricing of goods and services (dollars, euros, yen)
- Store of value retains purchasing power over time enabling wealth accumulation and future transactions
- Characteristics of effective money:
- Durability withstands wear and tear from frequent use (coins, plastic bills)
- easily carried and transported (lightweight, compact)
- can be divided into smaller units for precise payments (cents, pence)
- standardized units enable easy valuation (serial numbers, watermarks)
- scarcity maintains value and prevents
- Acceptability widely recognized and trusted by the public
Components of the U.S. Money Supply
M1, M2, and M3
- :
- Currency in circulation is physical cash held by the public (banknotes, coins)
- are checking accounts at banks
- Other are accounts that allow unlimited check-writing (NOW accounts)
- :
- Includes all components of M1, plus:
- are accounts that pay interest, with limited withdrawals
- Small are (CDs) under $100,000
- invest in short-term, low-risk securities (Treasury bills, commercial paper)
- Includes all components of M1, plus:
- M3 money supply (no longer published by the Federal Reserve):
- Includes all components of M2, plus:
- Large time deposits are CDs of $100,000 or more
- Institutional money market funds are used by large organizations and financial institutions
- Repurchase agreements are short-term loans collateralized by U.S. government securities
- Includes all components of M2, plus:
Factors Influencing Currency Circulation
Demand, Income, and Alternatives
- Consumer demand:
- Higher demand for goods and services increases currency circulation
- Economic growth and consumer confidence boost spending (GDP, consumer sentiment index)
- Income levels:
- Rising incomes lead to increased consumer spending
- Higher-income individuals tend to use more electronic payment methods (credit cards, mobile apps)
- Alternative payment methods:
- Credit and debit cards reduce the need for physical cash transactions
- Mobile payment apps enable digital transfers of funds (Venmo, PayPal)
- Cryptocurrencies are decentralized digital currencies competing with traditional money (Bitcoin, Ethereum)
- :
- Central bank decisions impact currency supply and circulation
- Interest rates: Lower rates encourage borrowing and spending
- Open market operations: Buying and selling government securities affects money supply
- Central bank decisions impact currency supply and circulation
- Seasonal factors:
- Holiday shopping seasons increase currency circulation (Christmas, Black Friday)
- Summer travel and tourism boost cash transactions
Key Terms to Review (32)
Certificates of Deposit: Certificates of deposit (CDs) are a type of savings account offered by banks and credit unions that pay a fixed interest rate in exchange for the customer agreeing to keep their money deposited for a specific period of time. CDs are considered a low-risk investment option and are commonly used by individuals to save and earn interest on their money.
Checkable Deposits: Checkable deposits, also known as demand deposits, are funds held in bank accounts that can be withdrawn on demand through the use of checks or electronic transfers. These types of deposits are highly liquid and serve as a convenient way for individuals and businesses to store and access their money.
Cost-push inflation: Cost-push inflation occurs when the overall prices in an economy rise due to increases in the costs of production, such as raw materials and wages. This type of inflation results not from increasing demand, but from rising costs that suppliers pass on to consumers.
Currency: Currency refers to the system of money in general use within a particular country or region. It serves as a medium of exchange, a unit of account, and a store of value, facilitating economic transactions and the flow of goods and services within a given economic system.
Demand deposits: Demand deposits are bank account balances that can be withdrawn at any time without prior notice. They form the basis of the money supply that is immediately accessible for transactions.
Divisibility: Divisibility refers to the property of a number being exactly divisible by another number, without leaving a remainder. It is an important concept in mathematics and finance, as it helps determine the factors and multiples of a given number, which can have practical applications in various contexts.
Durability: Durability refers to the ability of a product or service to withstand wear, tear, and other stresses over an extended period of time without losing its functionality or quality. It is a critical factor in determining the long-term value and reliability of a product or service.
In the context of the topic '15.1 Show Me the Money,' durability is an important consideration for businesses when evaluating the viability and profitability of their offerings. A durable product or service can provide a sustainable competitive advantage and contribute to customer satisfaction, repeat business, and long-term revenue streams.
Exchange Rate: The exchange rate is the price of one currency in terms of another currency. It represents the value of a country's currency relative to another currency and is a crucial factor in international trade and finance.
Federal Reserve System: The Federal Reserve System is the central banking system of the United States that plays a crucial role in macroeconomic policy, monetary policy, and the regulation of the country's financial institutions. It is responsible for managing the nation's money supply, setting interest rates, and overseeing the stability of the financial system.
Federal Reserve System (the Fed): The Federal Reserve System is the central bank of the United States, responsible for setting monetary policy, supervising and regulating banks, and providing financial services to depository institutions, the U.S. government, and foreign official institutions. It plays a key role in achieving macroeconomic goals such as controlling inflation, maximizing employment, and stabilizing financial markets.
Fiat Money: Fiat money is a type of currency that is not backed by a physical commodity, such as gold or silver, but is instead declared legal tender by a government. Its value is derived from the government's declaration that it is a valid form of payment, rather than from the intrinsic value of the currency itself.
Financial Statements: Financial statements are the primary means of communicating a company's financial information to both internal and external stakeholders. They provide a comprehensive overview of a business's financial health, performance, and cash flow over a specific period of time.
Inflation: Inflation is the sustained increase in the general price level of goods and services in an economy over time. It is a key economic concept that affects various aspects of business and financial decision-making, as well as the overall standard of living for consumers.
Limited Supply: Limited supply refers to a situation where the quantity of a good or resource available is constrained or restricted, often due to factors such as scarcity, production limitations, or high demand. This concept is fundamental in understanding the dynamics of supply and demand, as well as the economic principles that govern the allocation and pricing of scarce resources.
Liquidity: Liquidity measures how quickly and easily an asset can be converted into cash without significantly affecting its value. In the context of a balance sheet, it indicates a company's ability to meet short-term obligations with its most liquid assets.
Liquidity: Liquidity refers to the ease and speed with which an asset can be converted into cash without significant loss in value. It is a crucial concept in finance and accounting, as it measures a company's or individual's ability to meet short-term obligations and maintain financial flexibility.
M1: M1 is a category of the money supply that includes all physical currency and coin, demand deposits, traveler's checks, and other checkable deposits. It represents the most liquid forms of money that are readily available for spending.
M1 Money Supply: The M1 money supply is the most liquid measure of the money supply in an economy. It includes all physical currency in circulation, as well as demand deposits, traveler's checks, and other checkable deposits that can be easily converted into cash or used for immediate spending.
M2: M2 is a measure of the money supply that includes all elements of M1 (cash and checking deposits) plus savings deposits, money market securities, mutual funds, and other time deposits. It provides a broader understanding of the amount of money circulating in the economy and available for spending.
M2 Money Supply: The M2 money supply is a broader measure of the money supply that includes the M1 money supply (currency in circulation, traveler's checks, demand deposits, and other checkable deposits) plus savings deposits, small time deposits, and shares in retail money market mutual funds. It represents a larger pool of liquid assets that the public can readily use to make purchases or hold as short-term investments.
Medium of Exchange: A medium of exchange is a commonly accepted form of payment that facilitates the exchange of goods and services in an economy. It serves as an intermediary in transactions, allowing people to trade without the need for direct barter.
Monetary policy: Monetary policy is the process by which a central bank, like the Federal Reserve in the United States, controls the supply of money in an economy, primarily through interest rates and other measures, to achieve macroeconomic goals such as controlling inflation, managing employment rates, and stabilizing currency values. It plays a crucial role in influencing economic activity, consumer spending, and overall economic health.
Monetary Policy: Monetary policy refers to the actions taken by a country's central bank to influence the supply, availability, and cost of money and credit in order to achieve macroeconomic goals such as price stability, full employment, and economic growth. It is a critical tool used by governments to manage the overall economic conditions of a nation.
Money: Money is any item or verifiable record accepted as payment for goods and services and repayment of debts in a particular country or socio-economic context. It functions as a medium of exchange, a unit of account, a store of value, and sometimes, a standard of deferred payment.
Money Market Mutual Funds: Money market mutual funds are investment vehicles that pool together money from investors and invest in short-term, highly liquid, and low-risk securities such as government bills, certificates of deposit, and commercial paper. These funds aim to provide investors with a stable, low-risk way to earn a modest return on their cash holdings.
Portability: Portability refers to the ability of a product, service, or system to be easily transferred, accessed, or used across different platforms, devices, or environments. It is a crucial feature that allows users to seamlessly transition between various systems or locations without significant disruption or loss of functionality.
Savings Deposits: Savings deposits refer to funds that individuals or businesses hold in savings accounts at financial institutions, such as banks or credit unions. These deposits are typically held for the purpose of saving money, earning interest, and maintaining a reserve of funds for future use or emergencies.
Store of Value: A store of value is an asset that can be saved, retrieved, and exchanged at a later time without losing its purchasing power. It serves as a way to preserve wealth and maintain its value over time, even in the face of inflation or economic fluctuations.
Time deposits: Time deposits are savings accounts or certificates of deposit (CDs) in financial institutions that have a fixed term and typically offer higher interest rates than regular savings accounts. Withdrawals before the term ends may result in penalties.
Treasury’s Bureau of Engraving and Printing: The Bureau of Engraving and Printing is a government agency responsible for designing and producing United States currency, including paper money. It operates under the Department of the Treasury, ensuring the supply of safe and secure currency to meet the nation's financial demands.
Uniformity: Uniformity refers to the consistent and standardized application of policies, procedures, or practices within an organization or system. It ensures that operations, outputs, and experiences are similar across different contexts, locations, or time periods.
Unit of Account: A unit of account is a standard unit used to measure and account for economic value. It serves as a common denominator that allows the value of different goods, services, assets, liabilities, income, and expenses to be easily compared and recorded.