Slide.

2ème année de la Grande Ecole de l’Institut de Rabat

Semestre 3

Monetary and Financial Economic

Lecture 2: Money Defined & Measured

1st Term 2017-2018

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Plan for today

• Describe what money is
• List and summarize the functions of money
• Identify different types of payment systems
• Compare and contrast the M1 M2, and M3 money supplies

Monetary and Financial Economics

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What is Money ?
Economist’s Meaning of Money
Money : is anything that is generally accepted in payment for goods and
services or in repayment of debt.

Compare money with income and wealth?

• Money has three Characteristics :
– Medium of Exchange (or payment)
– Unit of Account
– Store of Value

Monetary and Financial Economics

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Functions of Money
• Medium of Exchange:
– Eliminates the trouble of finding a double coincidence of needs
(reduces transaction costs)
– Promotes specialization
• A medium of exchange must:
– be easily standardized
– be widely accepted
– be divisible
– be easy to carry
– not deteriorate quickly

Monetary and Financial Economics

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Functions of Money
• Unit of Account:
– Used to measure value in the economy
– Reduces transaction costs

Monetary and Financial Economics

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Functions of Money
• Store of Value:
– Used to save purchasing power over time.
– A means of payment has to be durable and capable of transferring
purchasing power from one day to the next.
– Paper currency does degrade, but is accepted at face value in
transactions.
– Other forms of wealth are also a store of value: stocks, bonds,
houses, etc.
– Money is the most liquid of all assets but loses value during inflation.
Liquidity is a measure of the ease with which an asset can be turned into a
means of payment.
– The more costly it is to convert an asset into money, the less liquid
it is.

Monetary and Financial Economics

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Evolution of the Payments System

• The payments system is a web of arrangements that allow for the
exchange of goods and services, as well as assets.
– It is critical this functions well.
• Money is at the heart of the payments system.
1. Commodity : valuable, easily standardized and divisible
commodities (e.g. precious metals, cigarettes)
2. Fiat Monies: paper money decreed by governments as legal tender
3. Checks : an instruction to your bank to transfer money from your
account
4. Electronic Payments

Monetary and Financial Economics

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Evolution of the Payments System

Commodity and Fiat Monies
• Commodity monies are things with intrinsic value.
– Included items like silk and salt.
• To be successful, must be:
– Usable by most people,
– Able to be made into standardized quantities,
– Durable,
– Easily transportable, and
– Divisible into smaller units.
• Gold has been the most common as it is valuable, easily standardized
and divisible.
• Gold coins and notes, backed by gold, were used until the 20th century.
• Today’s paper money is called fiat money, because its value comes from
government decree, or fiat.
• We are willing to accept these bills as payment because the government
stands behind its paper money. In the end, money is about trust.
Monetary and Financial Economics
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Evolution of the Payments System

• Checks: an instruction to your bank to transfer money from your

account
• Electronic Payment (e.g. online bill pay).
• E-Money (electronic money):
– Debit card
– Stored-value card (smart card)
– E-cash : A consumer gets e-cash by setting up an account with a
bank that has links to the Internet and then has the e-cash
transferred to her electronic device. When she wants to buy
something with e-cash, she surfs to a store on the Web and clicks
the ‘buy’ option for a particular item, whereupon the e-cash is
automatically transferred.

Monetary and Financial Economics

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Some lessons from the Crisis

• Market liquidity and funding liquidity are both needed to market financial
markets function smoothly.
• 2007-2009 financial crisis lead to a sudden loss of liquidity.
• Before the crisis
– Financial institutions relied on short-term borrowing to hold long-term
financial instruments.
• They believed funding liquidity would remain readily available.
– They also believed markets would also be liquid.
• They would always be able to sell the securities and loans they held.

Monetary and Financial Economics

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Evolution of the Payments System

• Although e-money might be more convenient and may be more

efficient than a payments system based on paper, several factors work
against the disappearance of the paper system.
• WHY?

Monetary and Financial Economics

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Evolution of the Payments System

Debit Card Vs. Credit Card
• When you shop, should you use a debit card or a credit card?
• A debit card works like a check only faster.
– Funds are immediately removed from your account.
• A credit card makes a deferred payment.
– If not paid fully on time, there is interest on the debt.
– But if you do pay on time and fully, it is an interest free loan for a
period of time.

Monetary and Financial Economics

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Evolution of the Payments System

Will Bitcoin Become the Money of the Future?
• Bitcoin is type of electronic money created in 2009.
• It is created by decentralized users when they use their computing
power to verify and process transactions.
• Although Bitcoin functions as a medium of exchange it performs less
well as a unit of account and a store of value.

Monetary and Financial Economics

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Measuring Money
• Changes in the quantity of money are related to
– Interest Rates
– Economic Growth
– Inflation
• Evidence suggests that money plays an important role in generating
business cycles.
• Recessions (unemployment) and expansions affect all of us.
• Monetary theory ties changes in the money supply to changes in
aggregate economic activity and the price level.

Monetary and Financial Economics

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Measuring Money
• Inflation:
– The process of prices rising.
• Inflation rate:
– The measurement of the process.
• With inflation, you need more money to buy the same basket of goods.
• The primary cause of inflation is too much money.
• A continual rise in the price level (inflation) affects all economic players
• Data shows a connection between the money supply and the price level.

Monetary and Financial Economics

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Aggregate Price Level and the Money Supply in the United States, 1950–2014

Source: Mishkin, 2016

Monetary and Financial Economics
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Aggregate Price Level and the Money Supply in Morocco, 2001–2010

Index 2005= 100

In billions of MAD
CPI M3
115 1000

900

110 800

700

105 600

500

100 400

300

95 200

100

90 0

Source: Data from BKAM and IMF

Monetary and Financial Economics
 Average Inflation Rate Versus Average Rate of Money
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Growth, Selected Countries, 2003-2013

Source: Mishkin, 2016

Monetary and Financial Economics
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Measuring Money
• The value of the means of payment depends on how much of it is
circulating.
– We therefore must be able to measure how much is circulating.
– Defining money means defining liquidity

Which particular assets can be called “money”?

Different definitions of money are based upon degree of liquidity.
Drawing the line in different places has led to several measure of
money called the money aggregates: M1, M2 and M3.

Monetary and Financial Economics

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Measuring Money
• Drawing the line in different places has led to several measure of
money called the money aggregates: M1, M2 and M3.

• Various definitions of monetary aggregates:

– Differences in what members of each society accept as a medium of exchange.
– Due to financial innovations, some assets are accepted as money in some
societies but not in others.
– Differences amongst institutions responsible for issuing monetary aggregates,
normally the central bank and depository institutions.

Monetary and Financial Economics

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Measuring Money
Monetary aggregates considerably differ from one country to another.

Mishkin (2013, p. 54)

Monetary and Financial Economics
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Measuring Money
• In Morocco :
– M1 (most liquid assets)
• Currency in the hand of the Public
• Demand deposits with Banks and the Treasury
– M2 (adds to M1 other assets that are not so liquid) :
• M1
• Savings deposits redeemable any time (comptes sur carnets)
– M3 (add to M2 other monetary assets)
• M2
• Other monetary assets Other monetary assets
• Time Deposits with banks
• Money Market Mutual Funds Shares/Un
• Deposits in foreign currencies with bank
• Repos
• Certificates of deposit (1)
(1):
• Time Deposits with the treasury
of a residual maturity of 2 years or less
(2) : Loans from other Financial Institutions. • Other deposits(2)
Monetary and Financial Economics
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Which Is The Most Accurate Aggregate?

Which measure should central banks consider when trying to affect
variables (e.g. inflation) in the economy?
• If the monetary aggregates move together, it does not matter much
• If they do not move together, then what one monetary aggregate tells
us is happening to the money supply might be quite different from
what another aggregate would tell us.
• M3 is less affected by substitution between various liquid asset
categories and is more stable than narrower definitions of money like
M1.

Monetary and Financial Economics

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-4,00%
-3,00%
-2,00%
-1,00%
0,00%
1,00%
2,00%
3,00%
4,00%

M1 2015
M2 2015
M3 2015
M4 2015
M5 2015
Growth rate in %

M6 2015
M7 2015
M8 2015
M9 2015
M10 2015
M11 2015
M12 2015
M1 2016
M2 2016
M3 2016
M4 2016
M5 2016
M3

Monetary and Financial Economics

M6 2016
M7 2016
M8 2016
M9 2016
M1
M1 and M3 in Morroco

M10 2016
M11 2016
M12 2016
M1 2017
M2 2017
M3 2017
Source: Data from BKAM

M4 2017
M5 2017
M6 2017
M7 2017
M8 2017
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M1 and M3 in Euro Area

Source: ECB
Monetary and Financial Economics
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Measuring Money

M1
M2

Currency in the
Savings deposits
hand of Public
redeemable any time
Demand Deposits

Other monetary assets M3

Monetary and Financial Economics

Slide.27
Measuring Money
Consider the following monetary instruments (in billions of MAD) . Compute M1, M2 and M3

N N+1
Bank notes and coins in circulation 205.9 215.7
Demand deposits with BAM 2.7 2.2
Demand deposits with banks 465.5 496.6
Banks' cash holdings 13.2 12.5
Demand deposits with the Treasury 46.2 49.8
Time Deposits with banks 171.0 163.3
Money Market Mutual Funds Shares/Units 62.5 60.7
Loans from other Financial Institutions 2.4 3.8
Deposits in foreign currencies with Banks 39.3 43.2
Repos 2.9 5.6
Certificates of deposit of a residual maturity of 2 years or less 18.5 20.0
Savings deposits redeemable any time 138.4 146.2
Time Deposits with the treasury 6.0 7.7

Source: BAM, 2016

Monetary and Financial Economics
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Measuring Money
N N+1
Currency in the hand of the Public 192.6 203.2
Bank notes and coins in circulation 205.9 215.7
Banks' cash holdings 13.2 12.5
Bank money 514.4 548.6
Demand deposits with BAM 2.7 2.2
Demand deposits with banks 465.5 496.6
Demand deposits with the Treasury 46.2 49.8
M1 707.1 751.9
Savings deposits redeemable any time 138.4 146.2
M2 845.5 898.1
Other monetary assets 302.6 304.3
Time Deposits with banks 171.0 163.3
Money Market Mutual Funds 62.5 60.7
Deposits in foreign currencies with Banks 39.3 43.2
Repos 2.9 5.6
Certificates of deposit of a residual maturity of 2 years or less 18.5 20.0
Time Deposits with the treasury 6.0 7.7
Loans from other Financial Institutions 2.4 3.8
M3 1 148.0 1 202.4

M2-M1=?
M3-M2 = ? Source: BKAM, 2016
Monetary and Financial Economics