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Most people define money as cash and coin in pocket. However this is a rare definition of money. It can also include more than currency, for example a checking account.
Also known as demand deposit
- Functions of Money
- 1.Medium of exchange- Allows specialization in endeavors in which we
- have comparative advantage by facilitating payments to others for the
- goods and services they provide.
- 2. Unit of accounting- A basis with which we can compare the relative
- value of goods & services in the economy (GNP & GDP)
- 3. Store of value Holds Value in the form of an asset (Store of wealth),
- Compared to gold, cattle, real estate stocks
- Money is liquid in comparison to all others
3 types of measures of money
M1- Currency and demand deposits
the most liquid form of money, (until the 1980's only banks could offer demand deposits)
Assets taht are almost money or can be converted to money quickly with no loss in value. Examples include time deposits (CD'S), savings accounts, shares in money market funds. All of these assets are liquid but not as liquiad as cash or checks
M2=M1 + Near Monies- so M2 is M1 plus assets that are slightly less liquid, also includes certain overnight assets
M3=M2 + CD's (100.000 value or more). SO M3 is M2 plus assets that are NOT very liquid. I mean, Imagine the difficulty you would have trying to qickly sell a CD with a face value of 100,000
Why Money is worth something?
Monetary economies like the US works because of what is called a fiduciary monetary system.
3 reasons why it works
Fiduciary monetary system
is value of currency issued by gov't based on the public's faith that currency can be exchanged for goods and services. In other words currency is worth something be cause we believe it is
- Money is acceptable by others when purchasing goods and services
- Demand deposits and currency have been designated legal tender for all debts public and private
- Money is predictable in nominal terms.
The Federal Reserve System is also known as the fed. It was first passed into law on Dec 23, 1914.
Goals are to Encourage economic growth and combat inflationary and recessionary tendencies. It does this by regulating the quantity and cost of credit in the economy
- Organized around a board of governers based in washington D.C.
- 7 full time members are appointed by the president and approved by the senate.
- 12 district banks are located around the US
- 25 branches of the main 12 districts
The Fed's responsibilities include
Determining reserve requirements ( the amount of money a bank must have on hand at all times)
Reviews and determines the discount rate (rate the fed charges banks to borrow from it)
Determines margin requirements on stock market credit.
Used to determine ceilings on yeilds paid out by banks
- Each governor serves one 14 year terms
- Cannot be associated with banking in any way during their term
- No two governors may come from the same district
- Board has a chairman and Vice Chairman both appointed by the president
- Officers may be reappointed during their 14 year term
Money Demand- why do people hold money
Transactions demand for money- Demand to hold money to pay for expected expenditures
Precautionary Demand For money- Demand to hold moeny to pay for unexpected expenditures that arise
Speculative Demand For money- Demand to hold money as an asset in expectation that other asset prices will fall
- Federal Budget- A statement of the Fed Gov't receipts and expenditures for the year Total of 70% spending
- Total spending by the fed Includes
- Social Security 22.5%
- National Defense 17.7%
- Income security 14.6%
- Interest on public debt 15.2 %
- The sum of social security and income security payments,, national
- defense expenditures, medicare expenditures, interest on the national
- debt, and the costs of others fed gov't programs during the year.
Federal receipts-Total of 100% of revenues
Personal income taxes 44.6%
Social Security Payments 35.6%
Corporate Income taxes 11.7%
Licenses, fees 8.1%
The sum of personal and corporate income taxes, social security taxes and contribution and other sources of revenue received by the fed gov't.
The annual shortfall of federal receipts relative to federal expenditures
Funding for the fed gov't is based on a fiscal year, starting October 1st
Deficits are funded by the issuance and sale of gov't securities (SOMA)
- National Debt
- The sum of outstanding fed gov't securities upon which interest and principal payments must be made
Debt-Should we worry?
Yes and no- if you look at just the size of the debt, or per capita debt, its a scary pic. But if you look at the size of the National Debt compared to the GDP its roughly the same ration as it was post- WW2
If we look at the interest payments compared to GDP, they are still relatively small percentage of GDP but are growing.
A fourth of the debt is covered by fed agencies and the reserve. Three/Fourth is owned by state and local gov't individuals, commercial banks and life insurance companies. Payments to US citizens are basically payments to ourselves
- Arent we burdening future generations?You dont want a company paying off debt at once because we want the corporation to be a continuing inuity. we want them to be able to service its obligations yearly while managing debt
- However the growing debt does damage future gen in certain ways because direct crowding out is when gov't activity supplants private business activity on a dollar for dollar basis. Example: Amtrak and yellowstone could be privately owned.
Indirect crowding out
US treasury sells new gov't bonds to finance federal budget deficints, which leads to higher interest rates in money marketrs and reduces scheduled private investments expenditures.
Govt can raise taxes or print more money if they really wanted to.
- Fiscal Policy- Act of changing gov't spending and or taxes to achieve specific policy goals such as promoting economic growth and stability. Controlled by the president and congress.
- Automatic Fiscal Policy- policies that take effect without an explicit action by the president or congress
- Discretionary Fiscal Policy-Policies that require the legislative and executive branches of gov't to take explicit policy actions that would not occur otherwise
Automatic Fiscal Policy- Waters down the punch when the economy gets roaring and spikes it when the economy is tanking. Example is our current progressive tax system, Our unemployment compensation system is another.
Progressive Tax System- When a boom is occurings taxable income goes up and the marginal tax rate also does. When economy tanks taxable income goes down and so does marginal tax rate.
Unemployment Compensation- Same thing. economy goes up fewer ppl are unemployed. In a recession more ppl are unemplyed so compensation is greater the key is balance over time. take the good take the bad
- Discretionary Fiscal Policy- Economic recovery tax Act (ERTA) of 1981 is an example. Required passage by the congress and signing by the president, Reworked and lowered the tax rates Americans were paying.
- Expansionary Fiscal Policy- Designed to make the economy grow at a faster rate. All things politicians love to do. Higher income taxes(Less for taxpayers to spend) and lower gov't spending(lower for citizens to spend).
- Contractionary Fiscal Policy- Designed to make the economy grow slower. What politicians have to do. Higher income taxes, (less for taxpayers to spend) and Lower gov't spending( Less for citizens to spend)
- Progressive tax rate- Marginal tax rate increases as income increases
- Regressive tax rate- Marginal tax rate decreases as income decreases
- Flat tax rate- Flat % of income paid as taxes