FUNDAMENTALS OF BUSINESS ECONOMICS

E.  Monetary Aggregates:  Measuring Money

• Money - makes economic transactions more efficient

• Fiat money - not backed fully by a commodity

- Given value by government (legal tender)

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1.  Money supply and the macroeconomy

• Keynesian theory - money supply indirectly affects expenditures through changes in interest rates

• Monetarist theory - money supply directly affects expenditures

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2.  Measures of the money supply

• Based on liquidity - ability to convert an asset into cash quickly and without substantial loss of value

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a.  M1

• Currency in circulation - bills, coins

• Demand deposits - deposits in checking accounts

• Negotiable orders of withdrawal (NOW) - interest-earning checking accounts

• Automatic transfer service (ATS) accounts - automatic transfers from savings to checking accounts

• Credit union share drafts - checking accounts at credit unions

• Travelers' checks - can be used as cash

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b.  M2 = M1 plus near money:

• Savings accounts - interest bearing accounts with no check-writing privileges

• Small time deposits - accounts of less than $100,000 with fixed maturities and penalties for early withdrawal

• Money market mutual funds - shares of funds that invest in short-term financial assets and have limited check-writing privileges

• Money market deposit accounts - money market accounts at banks

• Overnight repurchase agreements - banks sell government securities and repurchase the next day at a higher price

• Overnight eurodollars - one-day dollar-denominated deposits in foreign depository institutions

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c.  Total reserves

• Cash in vaults of financial intermediaries and deposits at the central bank

• Affects banking system's ability to lend money

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d.  Monetary base (high-powered money)

• Currency in circulation plus reserves held by financial institutions

• Controlled by central bank

• Changes in monetary base cause changes in M1 and M2

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Data on monetary aggregates