Chapter 3 - What Is Money

Mishkin/Serletis
The Economics
of Money, Banking,
and Financial Markets
Fifth Canadian Edition
Chapter 3
WHAT IS MONEY?
Copyright © 2014 Pearson Canada Inc.

Learning Objectives
1. Describe the meaning of the word money

2. Distinguish among the three primary functions of
money
3. Illustrate how information technology has paved the
way for e-money, e-banking, and e-commerce
4. Explain money measurement matters
Copyright © 2014 Pearson Canada Inc. 3-2

Meaning of Money
• What is it?
• Money (or the “money supply”): anything that is
generally accepted in payment for goods or services or
in the repayment of debts.
• A broad definition

Meaning of Money (cont’d)
• Money (a stock concept) is different from:

– Wealth
• the total collection of pieces of property that serve to store value
– Income
• flow of earnings per unit of time
• a flow concept

Functions of Money: Medium of Exchange
• 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

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

Functions of Money: Store of Value
• Store of Value:
– used to save purchasing power over time.
– other assets also serve this function
– money is the most liquid of all assets but loses value during
inflation
– hyperinflation is when the inflation rate exceeds 50% per
month

Evolution of the Payments System
• Commodity Money
– valuable, easily standardized and divisible commodities
– e.g. precious metals, cigarettes
• Fiat Money
– paper money decreed by governments as legal tender

Evolution of the Payments System (cont’d)
• Cheques
– 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

FYI Are We Headed for a Cashless Society?
• Predictions of a cashless society have been around for

decades
• E-money might be more convenient and efficient than
a payments system based on paper
• Several factors work against the disappearance of the
paper system
• The use of e-money will likely still increase in the future

Measuring Money
• How do we measure money? Which particular assets

can be called “money”?
• Construct monetary aggregates using the concept of
liquidity
• M1+
– the narrowest definition is called M1+
– includes: currency in circulation + chequable deposits at
chartered banks, TMLs, and CUCPs
– these assets are all extremely liquid

Measuring Money (cont’d)
• M2
– Currency in circulation + personal deposits at chartered banks
+ non-personal demand and notice deposits at chartered
banks + fixed term deposits

Measures of Monetary Aggregates

Growth Rates of Monetary Aggregates
• Does it matter which measure of money is considered?

• Aggregates can move in different directions in the short
run (see figure 3-2)
• Conclusion: the choice of monetary aggregate is
important for policymakers

Growth Rates of M2, M1++, M2++

FYI: Where Are All the Dollars?
• The more than $1500 of currency held per person in

the Canada is a surprisingly large number
• Where are all these dollars and who is holding them?
– criminals
– foreigners

Money as a Weighted Aggregate
• The Bank of Canada’s money supply measures are

‘simple-sum’ indices, the index
M = x1 + x2 + … + xn ,
where xj is one of the n monetary components of the

monetary aggregate M
• Weighted monetary aggregates seem to predict inflation

and the business cycle somewhat better than the
conventional measures
How Reliable are the Money Data?
• Revisions are issued because:

– small depository institutions report infrequently
– adjustments must be made for seasonal variation
• We probably should not pay much attention to short-
run movements in the money supply numbers but
should be concerned only with longer-run movements

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Mishkin/Serletis

Copyright © 2014 Pearson Canada Inc.

1. Describe the meaning of the word money

Copyright © 2014 Pearson Canada Inc. 3-2

Copyright © 2014 Pearson Canada Inc. 3-3

• Money (a stock concept) is different from:

Copyright © 2014 Pearson Canada Inc. 3-4

Copyright © 2014 Pearson Canada Inc. 3-5

Copyright © 2014 Pearson Canada Inc. 3-6

Copyright © 2014 Pearson Canada Inc. 3-7

Copyright © 2014 Pearson Canada Inc. 3-8

Copyright © 2014 Pearson Canada Inc. 3-9

• Predictions of a cashless society have been around for

Copyright © 2014 Pearson Canada Inc. 3-10

• How do we measure money? Which particular assets

Copyright © 2014 Pearson Canada Inc. 3-11

Copyright © 2014 Pearson Canada Inc. 3-12

Copyright © 2014 Pearson Canada Inc. 3-13

• Does it matter which measure of money is considered?

Copyright © 2014 Pearson Canada Inc. 3-14

Copyright © 2014 Pearson Canada Inc. 3-15

• The more than $1500 of currency held per person in

Copyright © 2014 Pearson Canada Inc. 3-16

• The Bank of Canada’s money supply measures are

where xj is one of the n monetary components of the

• Weighted monetary aggregates seem to predict inflation

• Revisions are issued because:

Copyright © 2014 Pearson Canada Inc. 3-18

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