Households, firms, and policymakers are all interested in measuring money because, as we will see, changes in the quantity of money are associated with changes in interest rates, prices, production, and employment. Recall that one of the functions that money provides is to serve as a medium of exchange. If this were the only function of money, then money should include only currency, checking account deposits, and traveler’s checks because households and firms can easily use these assets to buy goods and services.
But including just these three assets would result in too narrow a measure of the money supply in the real world. Many other assets can be used as a medium of exchange, even though they are not as liquid as cash or a checking account deposit. For example, you can easily convert your savings account at a bank into cash. Likewise, if you own shares in a money market mutual fund which is a mutual fund that invests exclusively in short-term bonds, such as Treasury bills you can write checks against the value of your shares. So, assets such as savings accounts and money market mutual fund shares can plausibly be considered part of the medium of exchange.
Measuring Monetary Aggregates
As part of its responsibility to regulate the quantity of money in the United States, the Federal Reserve currently publishes data on two different definitions of the money supply. Figure 2.1 illustrates these definitions referred to as monetary aggregates graphically
But including just these three assets would result in too narrow a measure of the money supply in the real world. Many other assets can be used as a medium of exchange, even though they are not as liquid as cash or a checking account deposit. For example, you can easily convert your savings account at a bank into cash. Likewise, if you own shares in a money market mutual fund which is a mutual fund that invests exclusively in short-term bonds, such as Treasury bills you can write checks against the value of your shares. So, assets such as savings accounts and money market mutual fund shares can plausibly be considered part of the medium of exchange.
Measuring Monetary Aggregates
As part of its responsibility to regulate the quantity of money in the United States, the Federal Reserve currently publishes data on two different definitions of the money supply. Figure 2.1 illustrates these definitions referred to as monetary aggregates graphically
M1 Aggregate The narrower definition of the money supply is M1. As panel (a) in Figure 2.1 shows, M1 measures money as the traditional medium of exchange: currency, checking account deposits, and traveler’s checks. Through the early 1980s, government regulations did not allow banks to pay interest on checking accounts, which made them close substitutes for currency. Since then, financial innovation in the banking industry and government deregulation in the 1970s, 1980s, and 1990s have made more types of accounts close substitutes for traditional bank checking accounts. These new accounts include checking accounts at savings institutions and credit unions, as well as interest-bearing checking accounts at commercial banks.Measures of M1 now include these other deposits against which checks may be written, along with non-interestbearing checking account deposits called demand deposits, traveler’s checks, and currency.
M2 Aggregate M2 is a broader measure of the money supply than M1 and includes accounts that many households treat as short-term investments. These accounts can be converted into currency, although not as easily as the components of M1. As shown in panel (b) of Figure 2.1, in addition to the assets included in M1, M2 includes:
● Time deposits with a value of less than $100,000, primarily certificates of deposits in banks.
● Savings accounts.
● Money market deposit accounts at banks.
● Noninstitutional money market mutual fund shares. “Noninstitutional” means that the money market fund shares are owned by individual investors rather than by institutional investors, such as pension funds. Noninstitutional is also sometimes referred to as “retail.”
Panel (a) of Figure 2.1 shows that in July 2010, the total value of U.S. currency was $886.5 billion. The value for currency included in M1 is technically “currency outstanding,” which includes all paper currency and coins outside the banking system. That total represents more than $2,800 for every person in the United States. Even given that some of the currency is held by firms rather than by individuals, $2,800 still seems like far more currency than the typical individual holds.Most people hold most of the funds that they want to easily access in their checking accounts rather than as cash. The figure below shows for the years from 1959 to 2010 the ratio of currency to checking account deposits, a ratio that helps us to understand how over time people have balanced their holdings of currency relative to their holdings of checking account deposits.
M2 Aggregate M2 is a broader measure of the money supply than M1 and includes accounts that many households treat as short-term investments. These accounts can be converted into currency, although not as easily as the components of M1. As shown in panel (b) of Figure 2.1, in addition to the assets included in M1, M2 includes:
● Time deposits with a value of less than $100,000, primarily certificates of deposits in banks.
● Savings accounts.
● Money market deposit accounts at banks.
● Noninstitutional money market mutual fund shares. “Noninstitutional” means that the money market fund shares are owned by individual investors rather than by institutional investors, such as pension funds. Noninstitutional is also sometimes referred to as “retail.”
Panel (a) of Figure 2.1 shows that in July 2010, the total value of U.S. currency was $886.5 billion. The value for currency included in M1 is technically “currency outstanding,” which includes all paper currency and coins outside the banking system. That total represents more than $2,800 for every person in the United States. Even given that some of the currency is held by firms rather than by individuals, $2,800 still seems like far more currency than the typical individual holds.Most people hold most of the funds that they want to easily access in their checking accounts rather than as cash. The figure below shows for the years from 1959 to 2010 the ratio of currency to checking account deposits, a ratio that helps us to understand how over time people have balanced their holdings of currency relative to their holdings of checking account deposits.
Note that the ratio starts to rise in the mid-1990s and reaches very high levels during the financial crisis that began in 2007, before declining somewhat as the financial crisis eased during 2009. Why have people over the past 15 to 20 years apparently increased their desire to keep their money in cash rather in the bank? The answer seems to be that most of the people who have increased their demand for U.S. currency since the mid-1990s are outside the United States. In fact, the Federal Reserve estimates that as much as two-thirds of the $886.5 billion in currency outstanding in July 2010 was held outside the United States. During the 1990s, a number of economies in Asia,Latin America, and Eastern Europe experienced high rates of inflation or other problems with their currencies. In these countries, many households and firms switched to conducting transactions in U.S. dollars rather than in their domestic currencies. Even the leaders of foreign governments often squirrel away private hoards of U.S. currency When the United States invaded Iraq in 2003, U.S. troops discovered hundreds of millionsof dollars in cash that members of Saddam Hussein’s family had hidden away. Even though the U.S. dollar is not legal tender in most other countries, it still can be used as a medium of exchange, as long as most households and firms are willing to accept it. Some countries, including Panama, El Salvador, and Ecuador, use the U.S. dollar as their official currency. As we saw in the chapter opener, in early 2009, thegovernment of Zimbabwe abandoned its own currency in favor of the dollar
Finally, note in the figure that demand for U.S. currency spiked in late 2008, during the worst period of the financial crisis, before declining again during 2009 as the crisis eased. Although some of this increase may have been due to consumers in the United States converting their checking accounts into currency because of fears of bank failures, most of the increase came once again from households and firms in other countries, which saw the dollar as a safe haven during a time when they doubted the stability of their own currencies.
Finally, note in the figure that demand for U.S. currency spiked in late 2008, during the worst period of the financial crisis, before declining again during 2009 as the crisis eased. Although some of this increase may have been due to consumers in the United States converting their checking accounts into currency because of fears of bank failures, most of the increase came once again from households and firms in other countries, which saw the dollar as a safe haven during a time when they doubted the stability of their own currencies.
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