For money to do its work, almost everyone must believe that if they accept money from you in return for handing over their good or service, then they will be able to use the money to buy something else in turn. In other words, they must trust that others will accept your money as payment. Governments and banks usually provide this trust. But the Irish bank closure shows that, when there is sufficient trust among households and businesses, money can function in the absence of banks.
NM3 (Broad Money)
At point F, her discount rate, ρ, exceeds r, the interest rate, so she would like to bring consumption forward in time. Similar reasoning eliminates all points on the feasible frontier except E. Julia wishes to get to the highest indifference curve but is limited by her feasible frontier.
Comment on whether a rise in the interest rate would be expected to reduce consumption expenditure in an economy in which a proportion of households are like Julia, and a proportion are like Marco. To see the effect of a lower interest rate on consumption spending, we return to Julia, who has no wealth, but expects to receive $100 one year from now. Use the analysis in Figure 10.18 to see how the interest rate affects her decision over how much to spend now.
Defined monetary aggregates are M1, M3 and Broad Money (BM). Defined monetary aggregates are M1, M2 and M3. Anything that can serve as a medium of exchange, a unit of account, a store of value, and be used for repayment of debt can be called Money.
Broad Money and Narrow Money
Figure 10.2 Borrowing, the interest rate, and the feasible set. The flow through the drain is called consumption expenditure, and it reduces wealth just as net income increases it. Not everyone passes the trustworthiness tests set by pub owners and moneylenders, of course. And, in Chambar and New York, some of those who do pay much higher interest rates than others.
The highest feasible indifference curve when the interest rate is 10% will be the one that is tangent to the feasible frontier, shown as point E broad money refers to in Figure 10.4. The gradations are presented in decreasing order of fluidity. M1 has the highest liquidity and is the easiest to deal with, whilst M4 has the least. The most often used money supply statistic is M3. Another name for it is aggregate monetary resources.
2 Borrowing: Bringing consumption forward in time
What you own (including what you are owed by others) is called your assets, and what you owe others is called your liabilities (to be liable means to be responsible for something, in this case to repay your debts to others). The difference between your assets and your liabilities is called your net worth. The relationship between assets, liabilities, and net worth is shown in Figure 10.11. Like Julia, Marco will find the amount of storage that gets him to the highest feasible indifference curve by finding the point of tangency between the indifference curve and the feasible frontier. This is point H, so he will eat $68 of the grain now, and consume $26 of it later (mice ate $6 of the grain). At point H, Marco has equated his MRS between consumption now and in the future to the MRT, which is the cost of moving goods from the present to the future.
There are various types of money such as Commodity Money, Metallic Money, Paper Money, etc. Thus, NM3 captures the complete balance sheet of the banking sector. Plastic money is a term that is used predominantly in reference to the hard plastic cards in place of actual bank notes. They can come in many different forms such as cash cards, credit cards, debit cards, etc.
The word ‘cross-section’ refers to currencies, currency areas or economic areas. Narrow money growth rates are prone to outliers. Credible inflation-targeting countries have posted similar ranges of expansion since the 1990s. The name is derived from the fact that M0 and M1 are the narrowest or most restrictive forms of money that are the basis for the medium of exchange within an economy. This category of money is considered to be the most readily available for transactions and commerce.
- Holders of M3 are households, private businesses, and OFCs.
- It includes all the items in M4, plus foreign currency deposits in banks and building societies.
- Defined monetary aggregates are M1, M2, liquidity aggregate of financial institutions (LF), and liquidity aggregate (L).
- This income for the bank increases its accumulated profits and therefore its net worth by $10.
- In emerging economies this gap can be quite large, owing to the uncertain economic environment.
- The relationship between the lender and the borrower is a principal–agent problem.
In other words, it had been passed on from one person to another exactly as if it were money. V.3.5 Foreign currency deposits are included only in M4. V.2.8. Monetary aggregates (M, NM, and NM include only the liabilities of the banking system; while liquidity aggregates (L, L, and L also include the liabilities of FIs and NBFCs. V.1.5. Foreign currency denominated deposits are excluded from each aggregate.
- Owing to the nature of bank deposits, especially time-restricted savings account deposits, M4 represents the most illiquid measure of money.
- Some cheques circulated many times, endorsed on the back by the pub or shop owner, just like a bank note.
- Abacus Bank’s balance sheet gains $100 of base money as an asset, and a liability of $100 that is payable on demand to Marco, as shown in Figure 10.13a.
- Generally, broad money refers to M2 and M3 money.
Figure 10.6 Smoothing consumption by storing and lending. Use the analysis in Figure 10.4 to see how Julia will choose consumption when the interest rate is 10% and when it is 78%. In that case she would have $23 to spend next year. Another possible combination is to borrow and spend just $30 now, which would leave Julia with $67 to spend next year, after repaying her loan. You can think of the interest rate as the price of bringing some buying power forward in time. If, instead of 10%, the interest rate is 78%, Julia can only borrow a maximum of $56 now.
Nonetheless, savings deposits and most time deposits are generally included in M2. Money holders usually consist of the private non-bank (or non-depository) residents, except Korea and Turkey. In Korea, currency and deposits held by its central government and its central bank are included in each of its monetary aggregates.
This is why taking out the loan has no effect on her current net worth—the liability and the asset are equal to one another, so her net worth remains unchanged at zero. In Figure 10.12 this is recorded in her balance sheet under the heading ‘Now (before consuming)’. In the bathtub analogy, the water in the bathtub represents wealth as accumulated savings, and is the same as net worth. As we saw, net worth or wealth increases with income, and declines with consumption and depreciation. For a household, income increases bank deposits, while consumption is paid with bank deposits.