Deck 3: What Is Money

Question 1

Why is simply counting currency an inadequate measure of money?

Answer 1

Money is medium of exchange it is not a currency. It acts as medium of exchange to buy goods and services. By counting currency you are missing out on "anything that can be used to buy goods or services."
Counting currency is usually referring to paper money and coins, but money is anything that is accepted as payment for purchases. Money includes checks, e-cash, deposits, and many other forms of payment that surpass the paper and coin form. Therefore, simply counting currency is an inadequate measure because it only constitutes a small portion of money.

Question 2

Assume that you are interested in earning some return on the idle balances you usually keep in your checking account and decide to buy some money market mutual funds shares by writing a check. Comment on the effect of your action (with everything else the same) on M1 and M2.

Answer 2

The M1 money supply consists of currency, traveler's checks, demand deposits, and other checkable deposits; the M2 money supply consists of M1, small-denomination time deposits, money market mutual fund shares, and savings deposits and money market deposit accounts.
Suppose you decide to buy some money market mutual funds shares by writing a check. This causes the idle balance in your checking account to move out of the account (M1) and into these shares (M2). This because your checkable deposit, a component of M1, is reduced. However, the aggregate amount of money in , only its composition since M1 is part of M2. M1 would be reduced by the amount that you write on the check, but M2 would increase by that same amount because money market mutual fund shares serve as a component of M2.

Question 3

Go to http://www.federalreserve.gov/releases/h6/Current/.
a. What have been the growth rates of M1 and M2 over the past twelve months?
b. From what you know about the state of the economy, do these growth rates seem expansionary or restrictive?

Answer 3

The M1 and M2 are the main base of money supply in the economy:
- Since from past 12 months , it has been observed that the M1 has increased by 8.9% and M2 has increased by 5.4%.
- Seasonally adjusted money supply shows a constant increase from time to time. There has been an expansionary policy in the economy in recent time to boost the economy after major financial crisis.

Question 4

Suppose a researcher discovers that a measure of the total amount of debt in the U.S. economy over the past twenty years was a better predictor of inflation and the business cycle than M1 or M2. Does Lhis discovery mean that we should define money as equal to the total amount of debt in the economy?

Question 5

In prison, cigarettes are sometimes used among inmates as a form of payment. How is it possible for cigarettes to solve the "double coincidence of wants" problem, even if a prisoner does not smoke?

Question 6

Three goods are produced in an economy by three individuals: If the orchard owner likes only bananas, the banana grower likes only chocolate, and the chocolatier likes only apples, will any trade between these three persons take place in a barter economy? How will introducing money into the economy benefit these three producers?

Question 7

Why did cavemen not need money?

Question 8

Most of the time it is quite difficult to separate the three functions of money. Money performs its three functions at all times, but sometimes we can stress one in particular. For each of the following situations, identify which function of money is emphasized.
a. Brooke accepts money in exchange for performing her daily tasks at her office, since she knows she can use that money to buy goods and services.
b. Tim wants to calculate the relative value of oranges and apples, and therefore checks the price per pound of each of these goods as quoted in currency units.
c. Maria is currently pregnant. She expects her expenditures to increase in the future and decides to increase the balance in her savings account.

Question 9

In Brazil, a country that underwent a rapid inflation before 1994, many transactions were conducted in dollars rather than in reals, the domestic currency. Why?

Question 10

Was money a better store of value in the United States in the 1950s than in the 1970s? Why or why not? In which period would you have been more willing to hold money?

Question 11

Why have some economists described money during a hyperinflation as a "hot potato" that is quickly passed from one person to another?

Question 12

Why were people in the United States in the nineteenth century sometimes willing to be paid by check rather than with gold, even though they knew there was a possibility that the check might bounce?

Question 13

In ancient Greece, why was gold a more likely candidate for use as money than wine?

Question 14

If you use an online payment system such as PayPal to purchase goods or services on the Internet, does this affect the M1 money supply, the M2 money supply, both, or neither? Explain.

Question 15

Rank the following assets from most liquid to least liquid:
a. Checking account deposits
b. Houses
c. Currency
d. Automobiles
e. Savings deposits
f. Common stock

Question 16

Which of the Federal Reserve's measures of the monetary aggregates-Ml or M2-is composed of the most liquid assets? Which is the larger measure?

Question 17

It is not unusual to find a business that displays a sign saying "no personal checks, please." On the basis of this observation, comment on the relative degree of liquidity of a checking account versus currency.

Question 18

For each of the following assets, indicate which of the monetary aggregates (Ml and M2) includes them:
a. Currency
b. Money market mutual funds
c. Small-denomination time deposits
d. Checkable deposits