Money

Assumption

Financial sector:

  • Primary sector - monetary authorities (central government and central bank)
  • Secondary sector - banking system
  • Tertiary sector - non-bank financial intermediaries and the markets where debt instruments are traded

Concept

Money is:

  1. Unit of account
    • Avoid unnecessary calculations of one good barter price in terms of another.
    • Allows preferences
    • Transmit economic information
    • Unit of contract (only need to estimate the future value of one good)
  2. Means of payment
    • Simplifies economic transactions
    • Replaces bilateral trading with multilateral trading.
    • Money increases the number of similar transactions, increasing competition.
  3. Store of value - liquidity (over other assets)
    • Marketability
    • Predictability
    • Reversibility
    • Divisibility

Evaluation

  • Where exactly money ends and other alternative assets begin may not be essential for economic analysis, and not needed for the practice or the comprehension of monetary policy.
  • Is money supply exogenous (determined by a monetary authority) or endogenous (expanding and contracting in line with variations in the volume of credit provided by financial intermediaries)?
  • Price of money? Monetarists says inverse of the price level, a Keynesian/Central banker the interest rate. However, also need to consider domestic goods market and the foreign exchange market
  • Key question is the neutrality of money - Classical view is money was neutral, Monetarist view is that money can have temporary short-run effects (due to nominal rigidities or mistaken expectations). Keynesian is that real economy adjusts to interest rate (which is a monetary phenonenom)