Chapter 2 - The role of money in the macroeconomy. In this chapter you will learn to understand the role of money in an economy, comprehend the different measurements of money used in the United States, see how the money supply drives inflation and economic expansion. | Chapter 2 The Role of Money in the Macroeconomy Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Learning Objectives • Understand the role of money in an economy • Comprehend the different measurements of money used in the United States • See how the money supply drives inflation and economic expansion Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 2-2 Introduction • Recurrent theme—What is the proper amount of money for the economy? • Sir William Petty (1623–87) wrote in 1651 • “To which I say that there is a certain measure and proportion of money requisite to drive the trade of a nation, more or less than which would prejudice the same” – Too much money will lead to inflation – Too little money will result in an inefficient economy Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 2-3 1 Introducing Money • Uses of Money – Medium of exchange—means of payment – A store of wealth—retains its value over time – Standard of value—unit of account used to compare prices and relative values • Liquid Asset – Something that can be turned into a generally acceptable medium of exchange, without loss of value – Liquidity is a continuum from very liquid to illiquid – Currency and checking accounts are most liquid assets Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 2-4 Primary Definition of Money (M1) • Currency outside banks plus checking accounts (demand deposits) • Currency held by banks is not part of money supply • Checking accounts are not legal tender, but commonly accepted as payment • Other definitions of money (M2) start with M1 and add progressively less liquid financial assets • Refer to following page for basic composition of the money supply (M1 and M2) • Most economists prefer the narrow definition of money supply (M1) since it is generally acceptable as a means of payment Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 2-5 Composition of the Money Supply • M1 – Currency outside
