MAcro CHAPTER 4.3:

CHAPTER SUMMARY

"Money" is a more complex concept than it might seem. In economics, we say that there are two types of money:

• Fiat money: Money whose only purpose is to be used as money, like US Dollars.

• Commodity money: Something that is used as money, but also has other purposes, like gold and silver.

To be considered money, something has to serve all three of the functions of money:

1. Medium of exchange: It can be used to buy goods and services, instead of having to trade one item for another.

2. Unit of account: It can be counted and used to measure the value of goods and services.

3. Store of value: It is durable, so people can save it for future consumption instead of spending it now.

For example, bananas would not be a good thing to use as money. Even though they could be a medium of exchange and a unit of account (1 cow = 300 bananas), they would not be a good store of value because they rot quickly.

We sort money into different categories, based on what function it serves and how liquid (easy to move/spend) it is:

• M0 / Monetary Base = Currency in circulation (actual bills & coins that people hold outside the banks) + Bank Reserves (the money banks are actually holding)

• M1 / Money Supply = Currency in circulation + Demand Deposits (money that people keep in a bank account, and can spend right away) + Savings Accounts (money that people put in a bank to earn interest, but can access easily)

• M2 = M1 + small (<$100k) time deposits, money market accounts

• M3 = M2 + large (>$100k) time deposits, less liquid accounts

While you won't really need to worry about M3, it is extremely important to understand the difference between M0, M1, and M2. M0 only counts actual cash, whether it is held by people or banks. M1 is money that I could spend today, with ease - things like cash or my checking account or savings account which are linked directly to a debit card. M2, however, might be less liquid, as I would need to first sell stocks or close out accounts at the bank before spending this money.

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