money assignment economics

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24.1 What Is Money?

Learning objectives.

• Define money and discuss its three basic functions.
• Distinguish between commodity money and fiat money, giving examples of each.
• Define what is meant by the money supply and tell what is included in the Federal Reserve System’s two definitions of it (M1 and M2).

If cigarettes and mackerel can be used as money, then just what is money? Money is anything that serves as a medium of exchange. A medium of exchange is anything that is widely accepted as a means of payment. In Romania under Communist Party rule in the 1980s, for example, Kent cigarettes served as a medium of exchange; the fact that they could be exchanged for other goods and services made them money.

Money, ultimately, is defined by people and what they do. When people use something as a medium of exchange, it becomes money. If people were to begin accepting basketballs as payment for most goods and services, basketballs would be money. We will learn in this chapter that changes in the way people use money have created new types of money and changed the way money is measured in recent decades.

The Functions of Money

Money serves three basic functions. By definition, it is a medium of exchange. It also serves as a unit of account and as a store of value—as the “mack” did in Lompoc.

A Medium of Exchange

The exchange of goods and services in markets is among the most universal activities of human life. To facilitate these exchanges, people settle on something that will serve as a medium of exchange—they select something to be money.

We can understand the significance of a medium of exchange by considering its absence. Barter occurs when goods are exchanged directly for other goods. Because no one item serves as a medium of exchange in a barter economy, potential buyers must find things that individual sellers will accept. A buyer might find a seller who will trade a pair of shoes for two chickens. Another seller might be willing to provide a haircut in exchange for a garden hose. Suppose you were visiting a grocery store in a barter economy. You would need to load up a truckful of items the grocer might accept in exchange for groceries. That would be an uncertain affair; you could not know when you headed for the store which items the grocer might agree to trade. Indeed, the complexity—and cost—of a visit to a grocery store in a barter economy would be so great that there probably would not be any grocery stores! A moment’s contemplation of the difficulty of life in a barter economy will demonstrate why human societies invariably select something—sometimes more than one thing—to serve as a medium of exchange, just as prisoners in federal penitentiaries accepted mackerel.

A Unit of Account

Ask someone in the United States what he or she paid for something, and that person will respond by quoting a price stated in dollars: “I paid $75 for this radio,” or “I paid $15 for this pizza.” People do not say, “I paid five pizzas for this radio.” That statement might, of course, be literally true in the sense of the opportunity cost of the transaction, but we do not report prices that way for two reasons. One is that people do not arrive at places like Radio Shack with five pizzas and expect to purchase a radio. The other is that the information would not be very useful. Other people may not think of values in pizza terms, so they might not know what we meant. Instead, we report the value of things in terms of money.

Money serves as a unit of account , which is a consistent means of measuring the value of things. We use money in this fashion because it is also a medium of exchange. When we report the value of a good or service in units of money, we are reporting what another person is likely to have to pay to obtain that good or service.

A Store of Value

The third function of money is to serve as a store of value , that is, an item that holds value over time. Consider a $20 bill that you accidentally left in a coat pocket a year ago. When you find it, you will be pleased. That is because you know the bill still has value. Value has, in effect, been “stored” in that little piece of paper.

Money, of course, is not the only thing that stores value. Houses, office buildings, land, works of art, and many other commodities serve as a means of storing wealth and value. Money differs from these other stores of value by being readily exchangeable for other commodities. Its role as a medium of exchange makes it a convenient store of value.

Because money acts as a store of value, it can be used as a standard for future payments. When you borrow money, for example, you typically sign a contract pledging to make a series of future payments to settle the debt. These payments will be made using money, because money acts as a store of value.

Money is not a risk-free store of value, however. We saw in the chapter that introduced the concept of inflation that inflation reduces the value of money. In periods of rapid inflation, people may not want to rely on money as a store of value, and they may turn to commodities such as land or gold instead.

Types of Money

Although money can take an extraordinary variety of forms, there are really only two types of money: money that has intrinsic value and money that does not have intrinsic value.

Commodity money is money that has value apart from its use as money. Mackerel in federal prisons is an example of commodity money. Mackerel could be used to buy services from other prisoners; they could also be eaten.

Gold and silver are the most widely used forms of commodity money. Gold and silver can be used as jewelry and for some industrial and medicinal purposes, so they have value apart from their use as money. The first known use of gold and silver coins was in the Greek city-state of Lydia in the beginning of the seventh century B.C. The coins were fashioned from electrum, a natural mixture of gold and silver.

One disadvantage of commodity money is that its quantity can fluctuate erratically. Gold, for example, was one form of money in the United States in the 19th century. Gold discoveries in California and later in Alaska sent the quantity of money soaring. Some of this nation’s worst bouts of inflation were set off by increases in the quantity of gold in circulation during the 19th century. A much greater problem exists with commodity money that can be produced. In the southern part of colonial America, for example, tobacco served as money. There was a continuing problem of farmers increasing the quantity of money by growing more tobacco. The problem was sufficiently serious that vigilante squads were organized. They roamed the countryside burning tobacco fields in an effort to keep the quantity of tobacco, hence money, under control. (Remarkably, these squads sought to control the money supply by burning tobacco grown by other farmers.)

Another problem is that commodity money may vary in quality. Given that variability, there is a tendency for lower-quality commodities to drive higher-quality commodities out of circulation. Horses, for example, served as money in colonial New England. It was common for loan obligations to be stated in terms of a quantity of horses to be paid back. Given such obligations, there was a tendency to use lower-quality horses to pay back debts; higher-quality horses were kept out of circulation for other uses. Laws were passed forbidding the use of lame horses in the payment of debts. This is an example of Gresham’s law: the tendency for a lower-quality commodity (bad money) to drive a higher-quality commodity (good money) out of circulation. Unless a means can be found to control the quality of commodity money, the tendency for that quality to decline can threaten its acceptability as a medium of exchange.

But something need not have intrinsic value to serve as money. Fiat money is money that some authority, generally a government, has ordered to be accepted as a medium of exchange. The currency —paper money and coins—used in the United States today is fiat money; it has no value other than its use as money. You will notice that statement printed on each bill: “This note is legal tender for all debts, public and private.”

Checkable deposits , which are balances in checking accounts, and traveler’s checks are other forms of money that have no intrinsic value. They can be converted to currency, but generally they are not; they simply serve as a medium of exchange. If you want to buy something, you can often pay with a check or a debit card. A check is a written order to a bank to transfer ownership of a checkable deposit. A debit card is the electronic equivalent of a check. Suppose, for example, that you have $100 in your checking account and you write a check to your campus bookstore for $30 or instruct the clerk to swipe your debit card and “charge” it $30. In either case, $30 will be transferred from your checking account to the bookstore’s checking account. Notice that it is the checkable deposit, not the check or debit card, that is money . The check or debit card just tells a bank to transfer money, in this case checkable deposits, from one account to another.

What makes something money is really found in its acceptability, not in whether or not it has intrinsic value or whether or not a government has declared it as such. For example, fiat money tends to be accepted so long as too much of it is not printed too quickly. When that happens, as it did in Russia in the 1990s, people tend to look for other items to serve as money. In the case of Russia, the U.S. dollar became a popular form of money, even though the Russian government still declared the ruble to be its fiat money.

The term money , as used by economists and throughout this book, has the very specific definition given in the text. People can hold assets in a variety of forms, from works of art to stock certificates to currency or checking account balances. Even though individuals may be very wealthy, only when they are holding their assets in a form that serves as a medium of exchange do they, according to the precise meaning of the term, have “money.” To qualify as “money,” something must be widely accepted as a medium of exchange.

Measuring Money

The total quantity of money in the economy at any one time is called the money supply . Economists measure the money supply because it affects economic activity. What should be included in the money supply? We want to include as part of the money supply those things that serve as media of exchange. However, the items that provide this function have varied over time.

Before 1980, the basic money supply was measured as the sum of currency in circulation, traveler’s checks, and checkable deposits. Currency serves the medium-of-exchange function very nicely but denies people any interest earnings. (Checking accounts did not earn interest before 1980.)

Over the last few decades, especially as a result of high interest rates and high inflation in the late 1970s, people sought and found ways of holding their financial assets in ways that earn interest and that can easily be converted to money. For example, it is now possible to transfer money from your savings account to your checking account using an automated teller machine (ATM), and then to withdraw cash from your checking account. Thus, many types of savings accounts are easily converted into currency.

Economists refer to the ease with which an asset can be converted into currency as the asset’s liquidity . Currency itself is perfectly liquid; you can always change two $5 bills for a $10 bill. Checkable deposits are almost perfectly liquid; you can easily cash a check or visit an ATM. An office building, however, is highly illiquid. It can be converted to money only by selling it, a time-consuming and costly process.

As financial assets other than checkable deposits have become more liquid, economists have had to develop broader measures of money that would correspond to economic activity. In the United States, the final arbiter of what is and what is not measured as money is the Federal Reserve System. Because it is difficult to determine what (and what not) to measure as money, the Fed reports several different measures of money, including M1 and M2.

M1 is the narrowest of the Fed’s money supply definitions. It includes currency in circulation, checkable deposits, and traveler’s checks. M2 is a broader measure of the money supply than M1. It includes M1 and other deposits such as small savings accounts (less than $100,000), as well as accounts such as money market mutual funds (MMMFs) that place limits on the number or the amounts of the checks that can be written in a certain period.

M2 is sometimes called the broadly defined money supply, while M1 is the narrowly defined money supply. The assets in M1 may be regarded as perfectly liquid; the assets in M2 are highly liquid, but somewhat less liquid than the assets in M1. Even broader measures of the money supply include large time-deposits, money market mutual funds held by institutions, and other assets that are somewhat less liquid than those in M2. Figure 24.1 “The Two Ms: October 2010” shows the composition of M1 and M2 in October 2010.

Figure 24.1 The Two Ms: October 2010

M1, the narrowest definition of the money supply, includes assets that are perfectly liquid. M2 provides a broader measure of the money supply and includes somewhat less liquid assets. Amounts represent money supply data in billions of dollars for October 2010, seasonally adjusted.

Source : Federal Reserve Statistical Release H.6, Tables 3 and 4 (December 2, 2010). Amounts are in billions of dollars for October 2010, seasonally adjusted.

Credit cards are not money. A credit card identifies you as a person who has a special arrangement with the card issuer in which the issuer will lend you money and transfer the proceeds to another party whenever you want. Thus, if you present a MasterCard to a jeweler as payment for a $500 ring, the firm that issued you the card will lend you the $500 and send that money, less a service charge, to the jeweler. You, of course, will be required to repay the loan later. But a card that says you have such a relationship is not money, just as your debit card is not money.

With all the operational definitions of money available, which one should we use? Economists generally answer that question by asking another: Which measure of money is most closely related to real GDP and the price level? As that changes, so must the definition of money.

In 1980, the Fed decided that changes in the ways people were managing their money made M1 useless for policy choices. Indeed, the Fed now pays little attention to M2 either. It has largely given up tracking a particular measure of the money supply. The choice of what to measure as money remains the subject of continuing research and considerable debate.

Key Takeaways

• Money is anything that serves as a medium of exchange. Other functions of money are to serve as a unit of account and as a store of value.
• Money may or may not have intrinsic value. Commodity money has intrinsic value because it has other uses besides being a medium of exchange. Fiat money serves only as a medium of exchange, because its use as such is authorized by the government; it has no intrinsic value.
• The Fed reports several different measures of money, including M1 and M2.

Which of the following are money in the United States today and which are not? Explain your reasoning in terms of the functions of money.

• A Van Gogh painting

Case in Point: Fiat-less Money

Figure 24.2

Michael Mandiberg – 1 million iraqi dinar – CC BY-SA 2.0.

“We don’t have a currency of our own,” proclaimed Nerchivan Barzani, the Kurdish regional government’s prime minister in a news interview in 2003. But, even without official recognition by the government, the so-called “Swiss” dinar certainly seemed to function as a fiat money. Here is how the Kurdish area of northern Iraq, during the period between the Gulf War in 1991 and the fall of Saddam Hussein in 2003, came to have its own currency, despite the pronouncement of its prime minister to the contrary.

After the Gulf War, the northern, mostly Kurdish area of Iraq was separated from the rest of Iraq though the enforcement of the no-fly-zone. Because of United Nations sanctions that barred the Saddam Hussein regime in the south from continuing to import currency from Switzerland, the central bank of Iraq announced it would replace the “Swiss” dinars, so named because they had been printed in Switzerland, with locally printed currency, which became known as “Saddam” dinars. Iraqi citizens in southern Iraq were given three weeks to exchange their old dinars for the new ones. In the northern part of Iraq, citizens could not exchange their notes and so they simply continued to use the old ones.

And so it was that the “Swiss” dinar for a period of about 10 years, even without government backing or any law establishing it as legal tender, served as northern Iraq’s fiat money. Economists use the word “ fiat ,” which in Latin means “let it be done,” to describe money that has no intrinsic value. Such forms of money usually get their value because a government or authority has declared them to be legal tender, but, as this story shows, it does not really require much “fiat” for a convenient, in-and-of-itself worthless, medium of exchange to evolve.

What happened to both the “Swiss” and “Saddam” dinars? After the Coalition Provisional Authority (CPA) assumed control of all of Iraq, Paul Bremer, then head of the CPA, announced that a new Iraqi dinar would be exchanged for both of the existing currencies over a three-month period ending in January 2004 at a rate that implied that one “Swiss” dinar was valued at 150 “Saddam” dinars. Because Saddam Hussein’s regime had printed many more “Saddam” dinars over the 10-year period, while no “Swiss” dinars had been printed, and because the cheap printing of the “Saddam” dinars made them easy to counterfeit, over the decade the “Swiss” dinars became relatively more valuable and the exchange rate that Bremer offered about equalized the purchasing power of the two currencies. For example, it took about 133 times as many “Saddam” dinars as “Swiss” dinars to buy a man’s suit in Iraq at the time. The new notes, sometimes called “Bremer” dinars, were printed in Britain and elsewhere and flown into Iraq on 22 flights using Boeing 747s and other large aircraft. In both the northern and southern parts of Iraq, citizens turned in their old dinars for the new ones, suggesting at least more confidence at that moment in the “Bremer” dinar than in either the “Saddam” or “Swiss” dinars.

Sources : Mervyn A. King, “The Institutions of Monetary Policy” (lecture, American Economics Association Annual Meeting, San Diego, January 4, 2004), available at http://www.bankofengland.co.uk/speeches/speech208.pdf . Hal R. Varian, “Paper Currency Can Have Value without Government Backing, but Such Backing Adds Substantially to Its Value,” New York Times , January 15, 2004, p. C2.

Answer to Try It! Problem

• Gold is not money because it is not used as a medium of exchange. In addition, it does not serve as a unit of account. It may, however, serve as a store of value.
• A Van Gogh painting is not money. It serves as a store of value. It is highly illiquid but could eventually be converted to money. It is neither a medium of exchange nor a unit of account.
• A dime is money and serves all three functions of money. It is, of course, perfectly liquid.

Principles of Economics Copyright © 2016 by University of Minnesota is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License , except where otherwise noted.

Lesson 9: Money and Inflation

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Introduction

In this lesson students learn that anything that performs the functions of money can be money (even macaroni!).  As they use their macaroni to bid on items during an auction, they learn that the value of money depends on the quantity of money relative to the quantity of goods and services they can buy with that money.   Historical and contemporary examples as well as video clips help students understand the role that banks and the Federal Reserve  play in expanding and contracting the money supply.

MINI ACTIVITY

• Inflation Auction

At the end of this lesson students will be able to:

• Identify the three functions of money.
• Explain how banks create money through fractional reserve banking.
• Give examples of how the Federal Reserve uses their tools to increase or decrease the money supply.
• Explain the cause of inflation.
• Provide examples of the costs of inflation

Economic Concepts

National Content Standards Addressed

Standard 11: role of money.

Money makes it easier to trade, borrow, save, invest, and compare the value of goods and services.

• Money is anything widely accepted as final payment for goods and services.
• Money encourages specialization by decreasing the costs of exchange.
• The basic money supply in the United States consists of currency, coins, and checking account deposits.
• In many economies, when banks make loans, the money supply increases; when loans are paid off, the money supply decreases.

Standard 12: Role of Interest Rates

Interest rates, adjusted for inflation, rise and fall to balance the amount saved with the amount borrowed, which affects the allocation of scarce resources between present and future uses.

• An interest rate is the price of money that is borrowed or saved.
• Like other prices, interest rates are determined by the forces of supply and demand.
• The real interest rate is the nominal or current market interest rate minus the expected rate of inflation.

Standard 19: Unemployment and Inflation

Unemployment imposes costs on individuals and nations. Unexpected inflation imposes costs on many people and benefits some others because it arbitrarily redistributes purchasing power. Inflation can reduce the rate of growth of national living standards because individuals and organizations use resources to protect themselves against the uncertainty of future prices.

• Inflation is an increase in most prices; deflation is a decrease in most prices.
• Inflation reduces the value of money
• When people’s incomes increase more slowly than the inflation rate, their purchasing power declines.
• The costs of inflation are different for different groups of people. Unexpected inflation hurts savers and people on fixed incomes; it helps people who have borrowed money at a fixed rate of interest.
• Inflation imposes costs on people beyond its effects on wealth distribution because people devote resources to protect themselves from expected inflation.

Standard 20: Monetary and Fiscal Policy

Federal government budgetary policy and the Federal Reserve System’s monetary policy influence the overall levels of employment, output, and prices.

• Monetary policies are decision by the Federal Reserve System that lead to changes in the supply of money and the availability of credit. Changes in the money supply can influence overall levels of spending, employment, and prices in the economy by inducing changes in interest rates charged for credit and by affecting the levels of personal and business investment spending.

Download full lesson guide for procedures and teaching tips.

• Voluntary trade creates wealth.
• Institutions that facilitate trade help to increase wealth and raise standards of living.

2. Money enhances voluntary trade by reducing transaction costs.

• Money is anything generally accepted in exchange for goods and services.
• Money is a store of value
• Money is a standard of value.
• Money is a medium of exchange.

3. The interest rate is the opportunity cost of holding money, because instead of holding money, people could hold interest-earning assets (such as Certificates of Deposit or bonds) instead.

4. Interest rates are determined by the interaction of lenders who supply funds, and borrowers, who demand funds.

• Savers supply funds to be loaned and are paid interest for waiting to consume at a later date.
• Demanders of these funds are the borrowers, who pay interest in order to have the right to spend now instead of waiting for future income. This spending might be on consumption or on investment goods (such as plant and equipment).
• Interest rates vary with the type of market. Rates change within a market in response to changes in supply and demand for loanable funds.

5. The money supply is a measure of the total amount of money in an economy.

• The money supply changes through activities of the commercial banking system.
• The Federal Reserve uses open market operations to alter the amount of currency and bank reserves, generally signaling its intentions to do so through changes in its target value for the Federal Funds rate and changes in the Discount rate.
• The Federal Fund rate is the rate of interest at which U.S. banks lend to one another their excess reserves held on deposit by Federal Reserve banks.
• The Discount rate is the rate at which member banks may borrow short term funds directly from a Federal Reserve Bank.
• Other policy vehicles available to the Fed include: reserve requirements, margin requirements on stock loans, credit controls on lending quality, and changes in eligible “collateral” for direct loans to member banks and other commercial institutions (e.g., investment banks).

6. Inflation is a general increase in the level of prices throughout the economy.

• The most commonly used measure of inflation is the Consumer Price Index, (or CPI). The GDP Deflator is another important measure of inflation. Changes in these price indices indicate changes in the purchasing power of the U.S. dollar.
• Inflation encourages more debt and faster spending as buyers and sellers try to avoid rising prices.
• Inflation creates uncertainty and makes future planning more difficult.
• Unanticipated inflation erodes the purchasing power of nominal assets, including money, bonds, and savings accounts. Individuals with fixed incomes also lose.
• The extremely high cost of using money during hyperinflations forces people to resort to barter, which is an inefficient means of transacting.
• A high average rate of inflation is always accompanied by much uncertainty about the future inflation rate, which makes many contracts more risky. Greater levels of risk increase the value of the “option to wait,” which delays many consumption and investment decisions, and thereby slows economic growth.

7. Inflation is a monetary phenomenon, and almost always occurs because increases in the stock of money exceed growth in output of goods and services.

• A frequent problem in developing nations is that governments without stable or consistent tax collections often resort to printing money to finance government spending.
• Intended to halt rising prices, price controls instead disguise inflation and disrupt the allocation of goods and services.

Ideas To Take Away From This Lesson

• Money is an innovation that significantly improved the operation of markets.
• Banks facilitate the operation of markets by expanding the quantity of money in circulation.
• Inflation is a consequence of the money supply growing faster than production.
• The Fed manages price and interest rate levels by changing the money supply.
• Inflation creates disruptions and losses in the overall economy as buyers and sellers act to avoid its effects.

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Money and Banking

(7 reviews)

Robert E. Wright, NYU

Copyright Year: 2012

ISBN 13: 9780982043080

Publisher: Saylor Foundation

Language: English

Formats Available

Conditions of use.

Learn more about reviews.

Reviewed by Nabila Rahman Biju, Assistant Professor of Economics, Berea College on 11/14/23

I really liked the fact that the first few chapters started with very basic ideas which makes it easier for the beginners to start in this field. And I like the think-boxes. read more

Comprehensiveness rating: 5 see less

I really liked the fact that the first few chapters started with very basic ideas which makes it easier for the beginners to start in this field. And I like the think-boxes.

Content Accuracy rating: 4

The discussion of moral hazard and the so called 'evil practice' is a good way to introduce students about the financial system's drawbacks. They should realize that this current system is not the best we could do so far. Rather, it the accumulation of historical accidents and there is plenty of room for improvements in this current system. So yes, I think the content was pretty unbiased.

Relevance/Longevity rating: 5

With all the detailed examples, I found it to be quite relevant. I am teaching Money and Banking class currently, and I can find most of my important topics in this book as well. So, yes, I will say this book is relevant.

Clarity rating: 5

The language of the book is really reader-friendly and as I mentioned before, I felt a non-Econ or non-Business background student also can easily understand.

Consistency rating: 4

The content and topics of each consequent chapters flow well.

Modularity rating: 5

It's already way too divided into sub-topics at least in my opinion. No need to break it down further.

Organization/Structure/Flow rating: 3

Although it is not an e-book and only a pdf, still, putting in a list of contents could be done. I strongly recommend to have a list of contents with hyperlinks linking to each chapter as it really helps. Especially when a person is re-reading, its really annoying to keep scrolling.

Interface rating: 2

Would be nice to have hyperlinks.

Grammatical Errors rating: 5

Good writing

Cultural Relevance rating: 4

I would expect more discussion of other countries also the ancient times. But it's still very relevant.

I liked it quite a bit. Only adding a list of content is the only thing I would ask for. Thanks!

Reviewed by Ulmaskhon Kalandarova, Instructor, Colorado State University on 1/2/21

Although the book covers majority of concepts in money and banking, but unfortunately it seems that all data is outdated and sometime the fundamental legislative laws like Dodd-Frank act not even mentioned. Also, more discussion of bank regulating... read more

Comprehensiveness rating: 3 see less

Although the book covers majority of concepts in money and banking, but unfortunately it seems that all data is outdated and sometime the fundamental legislative laws like Dodd-Frank act not even mentioned. Also, more discussion of bank regulating system is recommended - it is very brief in chapter-11. The revised and more comprehensive version of this book is recommended. For example, this book could compare its' contents with Cecetti's Money and Banking book, which is widely used in teaching this course.

Fundamental concepts seem to be discussed very well, but the demonstration data seems to be a bit loose.

Relevance/Longevity rating: 4

The text is written in clear prose. I did not have any difficulty with its understanding.

Consistency rating: 5

Text is consistent with terminology, however the modern terminology could be also included - like bitcoins, hi tech , mobile banking issues

Modularity rating: 3

Modularity needs to be revised and added more parts for practice, brief summaries, real-life examples.

Structure is outdated - need to include at least some practice problems and explanation of their solutions for some of them in the text. Also, real life examples section would be a plus. Also, brief summary of chapter's main points could improve this book.

Interface rating: 3

I think the book should be revised due to very outdated display features - it seems very old and comparing for example to Cecetti's book in money and banking - I would not choose this book for teaching - because it does not have many different informative, practice, learn sections as other books have.

I didn't find any grammatical errors in the text.

Cultural Relevance rating: 5

I would recommend to add more data from developing nations banking system for informative and comparison/analysis purposes. This could give a brief explanation of different factors that effect developing countries banking systems, and their special characteristics.

Reviewed by Peter Mikek, Associate Professor, Wabash College on 12/22/19

This is a great book for any student that is exposed to questions of money and banking for the first time.The book is certainly comprehensive in covering most of the money and banking topics, reaching a bit into macroeconomics and international... read more

This is a great book for any student that is exposed to questions of money and banking for the first time.The book is certainly comprehensive in covering most of the money and banking topics, reaching a bit into macroeconomics and international finance. The 26 chapters provide overview and numerous examples of standard Money and Banking courses/textbooks and, very likely, include more material than can be thoroughly covered in a semester course. The three chapters devoted totally to banking are complemented with standard coverage of monetary policy and well placed within macroeconomic framework. It is delightful that the focus on banks within financial sector is maintained through most of the text. The text includes a chapter on financial crisis, international finance, and several chapters reviewing and scaffolding a broader context for money and banking. I was puzzled by the fact that I could not locate the chapter of Financial Derivatives. However, I suspect that this was probably some error preparing the online PDF file. While the work is very broad in its scope the text in each sections is super focused and relatively short. While I am a fan of concise textbooks, I found it occasionally too limited (for example there is a chapter with only 6 pages of text that includes several unnecessary excursions into methodology and history).

Overall, I find the book very accurate and unbiased. In some sense the text strikes me as not completely polished but still great text. The remaining typos are not crucial for understanding and can be easily identified.Let me give you some examples: in an example of a balance sheet ,the author claim that liabilities are "things owNed," they place transaction deposits on one T account among bank's assets, in a scheme of a transmission mechanism they have an arrow turned the wrong way (EMP, net worth down), "nominal rates on risky securities had in fact soared in 1930-1933" should actually talk about the real rates, etc. Again, these are small remaining errors and a reader will be able to fix them easily as they go. I am convinced that the next iteration of the text will get rid of the remaining typos.

This is definitely one of the very strong attributes of this interesting text. The examples are definitely up-to-date as it includes examples from the recent financial crises and developments in international finance. But not only that, the author uses rich historical background artfully to place the more recent examples in historical context. This contributes to richer text and better understanding of several provided examples. I believe that the text will need relatively little in terms of updating it.

Clarity rating: 4

This is a fantastically clear presentation of ideas and concepts. The authors use Stop and Think boxes to expand upon the basic ideas with examples, Key Takeaways boxes to reiterate the most important points, Exercise boxes to provide hands-on opportunities. Each section starts with clearly spelled learning objectives. Super concise text leaves the reader with clear message. But maybe the most enjoyable feature of the text is vivacious, playful, and rich language. I am REALLY impressed with the rich vocabulary and engaging, occasionally truly erudite, nicely varied language ("if not insane, at least inane,” “Asymmetric information (that horrible three-headed hound from Hades),” “if you wrap your car around a tree,” etc.). The authors try to engage the average reader also with a number of colloquial expressions that are less to my taste ("those smakers," "kinda funny that," "darn high") but I guess that is just my taste.

The authors are consistent across the chapters, they use standard field specific vocabulary. I think they score high on this point.

This is another strong quality of the text. While some parts are absolutely essential in every Money and Banking text, such as time value of money or chapter on banking and one on monetary policy, there are parts that can easily be added or dropped based on preferences of the instructor. Chapters devoted to exchange rates or international monetary arrangements can easily be postponed to later courses. Similarly, students that already had a decent intermediate macroeconomics will not need chapters focused on macro. So, the text both allows for various arrangements of the building blocks in a variety of ways.

Organization/Structure/Flow rating: 5

The textbook follows a standard order in presentation of the material. Not only the sequencing but also parsing the material into logical units was done with the due care. This is actually essential for good learning success and they did if perfectly. Additionally, I already mentioned that each section has clearly spelled learning objective and Key Takeaways that contribute to transparent structure of the text. Finally, progression from one topic to the next is seamless and easy to follow.

Interface rating: 5

Navigation is easy and clear, the figures, excercises, Stop And Think boxes are clearly marked. The text consistently uses several different colors to indicate parts of the text or to emphasize this or that (such as tables). The interface is not only easy to use, it is also nicely appealing for the reader.

I found no issues with the grammar. Furthermore, I wish to emphasize again that the use charming and vivacious language.

I found the book to follow the usual standards regarding the cultural sensitivity and non-offensive language. Despite the fact that the book is devoted to functioning of a financial system in developed capitalist economy the text includes ample examples from across the globe - in particular in chapters on international finance. German reunification, Chinese high foreign reserves and exchange rate system, Argentine currency crises are just three of numerous examples that cross the cultural and geographical borders with ease and clarity.

This is an absolutely delightful text that uses fresh, clear, and playful language in the field that can be perceived as rather dry. The book will be best suited for beginners with first encounters with money and banking. For others, a skillful instructor can easy point out on what they should focus (and where are few remaining typos). The text is comprehensive and set in a way that will serve broad set of instructor's preferences; from those that wish to focus on international finance to those that wish to include some review of macroeconomics. One of the best attributes of the book is the fact that the author never loses its focus on banks and/or monetary policy. Overall, I find the text great.

Reviewed by Partha Gangopadhyay, Professor, St. Cloud State University on 6/10/19

The text provides a comprehensive coverage of Money and Banking topics. If anything, there is too much material in the book's 26 chapters for one course. Most colleges do not have more than one Money and Banking course. The book has enough... read more

The text provides a comprehensive coverage of Money and Banking topics. If anything, there is too much material in the book's 26 chapters for one course. Most colleges do not have more than one Money and Banking course. The book has enough material for at least two such courses. I did not see an index or a glossary of terms.

Content Accuracy rating: 5

I have not detected any error in the text. I checked out some of the hyperlinks to outside resources. The links seem to work just fine. I would like to see the sources of the tables and figures listed below the tables/figures in the book.

Relevance/Longevity rating: 2

The text needs to be revised and updated. The tables and figures in the book provide information up to 2007-2008. This applies to many of the tables/figures in chapters 9, 10, 11, 15, 16, 18, 19, 20, and 21. There is a brief discussion of banking regulation in chapter 11. However, I did not see even a mention of the Gramm-Leach-Bliley Act of 1999, or the Dodd-Frank Act of 2010, or the Basle 111 capital requirements. The discussion in the books seems to end with the Riegle-Neal Act of 1995, and the Basle 11 requirements. Also, the suggested readings at the end of the chapters need to include more current articles and other resources. The fundamental concepts of money and banking have not materially changed over time. The book does a good job of explaining these concepts. However, the banking laws and data and statistics have changed over time. These need to be updated. The book was written in 2012. It is time for a newer edition. The updates can be easily implemented.

The book is written in clear and concise language. Beginning students should not have any difficulty in reading and understanding the concepts. Students will also be able to personally relate to many of the examples and anecdotes that are spread throughout the book.

The writing style is consistent throughout the book. I also like the consistent layout of the chapters. Each chapter and section begin with a set of learning objectives, and ends with 'Key Takeaways', and a list of suggested readings. I also like the 'Stop and Think' boxes in each chapter.

I may be able to cover 10 or 11 chapters from the book in a sixteen-week semester. As I mentioned elsewhere, there is enough material in the book for at least two 'Money and Banking' courses. It will be easy to pick 10-12 chapters from the book to cover in a 'Money and Banking' class. The text is not overly self-referential, and most chapters can stand on their own. The text can be easily divided into smaller sub-units that can be incorporated in different courses.

The text and the individual chapters are logically organized. The order of the chapters is clear, and the concepts are presented in a coherent and logical manner.

Interface rating: 4

I did not detect any issues with interface. I suggest numbering the equations in chapters 4-7, 9, 14, 15, 17, 18, 20, and 21. Also, the sources of the various tables/figures should be listed below the tables or figures. Several exercises are included in chapters 4-7, 9, 15, 17, 18, and 21. I am assuming that the solutions to these exercises will be made available to the instructors in supplementary materials in the book's website. However, I suggest that the answers to at least some of these exercises should be provided in an Appendix at the end of the book. It will also be helpful if a section of conceptual questions and/or numerical exercises is added at the end of each chapter. I also suggest adding a section in chapter 4 (and in other chapters) showing how to calculate the time value of money (and bond prices) using a financial calculator.

I have not seen any grammatical errors in the book.

I did not notice any cultural insensitivity in the book.

The book is comprehensive in the coverage of Money and Banking topics. However, the book is very outdated. A new edition of the book with up-to-date discussion of the banking regulatory framework, and well as current data and statistics is needed at this point. The concepts are easy to understand, and the book is well-written.

Reviewed by Laura Carolevschi, Assistant Professor, Winona State University on 6/20/17

In its 26 chapters, the textbook covers a wide array of money and banking topics, as well as macroeconomics topics with monetary policy applications. The treatment of the subjects is clear, easy to follow and relevant with applied examples. No... read more

In its 26 chapters, the textbook covers a wide array of money and banking topics, as well as macroeconomics topics with monetary policy applications. The treatment of the subjects is clear, easy to follow and relevant with applied examples. No index or glossary was provided with the version that was reviewed.

The content is accurate, error-free and unbiased, at least in the sections I chose to review.

The theories discussed in the textbook are up-to-date, and will stand the test of time for a while. However, some of the data will need to be updated. I'm reviewing this book in 2017, and many of the graphs have data until 2007-2008.

The author uses a story-telling format that is easy to read and accessible to both beginners and advanced learners. The book has many examples that students might be able to relate to due to personal experience.

All chapters are using the same format. The terminology and concepts are used consistently throughout the text.

While the textbook covers a variety of topics, it is easily divisible into smaller sections. Each chapter is divided into several topics, and each sub-chapter is clearly organized around a single topic, while still easily integrating within the larger subject matter of each chapter. During a regular semester I am usually unable to cover an entire textbook, and I select some chapters to cover first, with a couple of chapters as "maybe", if we still have time at the end of the semester. This textbook can be easily organized in such a way.

The topics in the text are presented in a logical and clear fashion. The organization/structure/flow are consistent throughout the text. All chapters are organized in the same format, making the text easy to read and follow.

The text is free of any interface issues. Most images/tables/graphs were clear and easy to read. However, I encountered a couple of images that were unclear - on page 258, I could only read the names of the countries, but not the text in each box even after zooming in; the table on page 304 seems to not be visible in its entirety. Another thing that would make the book easier to navigate would be a table of contents with hyperlinks to each chapter. The .pdf version that I'm reviewing does not have it.

I could not find any grammar errors. (However, I found some typos - in a few instances, it seems that the space between the words is missing, likethis.)

The treatments of topics in this textbook is respectful of different cultures.

The book provides a comprehensive yet approachable coverage of several monetary policy issues. The format of the book make it versatile to several uses - as a standalone text in money and banking classes, or as supplementary reading in introductory or intermediary macroeconomics classes.

Reviewed by Wendy Usrey, Faculty Instructor, Colorado State University on 12/5/16

This book is fantastic in terms of the breadth of finance, money and banking topics. I have found that most money and banking texts have some of the topics I want to cover in my classes, but I have seen very few that contain all of the material I... read more

This book is fantastic in terms of the breadth of finance, money and banking topics. I have found that most money and banking texts have some of the topics I want to cover in my classes, but I have seen very few that contain all of the material I am looking for in one, easily digestible textbook. With 26 chapters covering everything from how money and banking applies to our everyday lives, to the theory of rational expectations and its implications for monetary policy, this book is so comprehensive I can easily see myself using it in several different finance classes as well as in various economics courses.

I have not seen any errors in terms of content or examples/problems in the text. However, some of the hyperlinks to outside resources are no longer working.

1. I was very excited to see all of the hyperlinks to external content (new stories, other texts, etc), but as mentioned above, quite a few of the hyperlinks are no longer working. Depending on the link this could be a relatively easy fix, but some of these sources may no longer exist and may need to be removed. While not particularly difficult, if the text refers to the content referenced by the link, portions of the text will need to be rewritten if the links are removed. I also noted a few places where the text is already in need of some updating, for example, the book does a good job of explaining the 2007-2008 Financial Crisis, along with concepts such as the “Lender of Last Resort” and monetary policy, but does not contain any discussion on quantitative easing. This was a very critical and important (as well as controversial) component of the Federal Reserve's response the Financial Crisis, so it should have been included in the text or added in an update.

Overall the text is written in a very accessible manner without sacrificing academic rigor. Concepts are explained fully but in such a way that students from a variety of backgrounds should be able to understand the content. As another reviewer mentioned, a glossary or index at the end of the text would be very useful for helping to navigate the text and find definitions of key terms quickly.

Terminology, writing style and framework remain consistent throughout the text.

Despite the amount of material, this text is very well organized. The content is broken up into manageable chunks with very clear learning objectives stated at the beginning and key takeaways at the end of each section. This format makes a big difference in terms of helping the reader stay oriented so they do not get lost in the world of financial jargon and concepts. I particularly liked how each chapter was organized with so many additional resources and references. I particularly like the clear chapter objectives, followed by learning objectives for each sub-section. The "suggested reading" at the end of each chapter, as well as the "stop and think" boxes make the text very approachable for students and give the instructor a lot of great ideas for incorporating outside content and examples into the class.

The order in which the topics are presented is also very good with progression between concepts fluid and intuitive, but hyperlinks referring to other parts of the text make it very easy for an instructor to teach the topics in an order that suits their individual class structure without the worry of having students end up "lost in the text."

The interface of the book is very easy to navigate. Content displays as expected and does not seem to be affected by the format (I reviewed both the web interface as well as the downloaded PDF version). One thing that would make navigation easier would be to add hyperlinks from the table of contents to the chapters in the downloadable PDF version. This feature is available when viewing on the web, but did not appear as an option once I downloaded the PDF.

No grammar or spelling errors were found during my review.

As expected from an academic text, there are no insensitive or offensive references in the text. Additionally, the information is easy to understand regardless of cultural background and can easily be used in diverse classes with little to no adaptation.

Overall I think this is a solid, well written text that contains a lot of relevant and useful information. The world of finance can be intimidating and the author does a wonderful job of helping make the subject matter approachable and interesting, particularly with the use of humor and clever chapter titles. I intend to use this text in several of my own classes that range from introductory up to intermediate level classes.

Reviewed by Mahmoud Al-Odeh, Assistant Professor, Bemidji State University on 6/10/15

This is a good textbook that covers a wide range of topics in the economic analysis theory and application. The book consists of 24 chapters that cover current topics related such as Interest Rates, Inflation, Rate of Return, Future and Current... read more

This is a good textbook that covers a wide range of topics in the economic analysis theory and application. The book consists of 24 chapters that cover current topics related such as Interest Rates, Inflation, Rate of Return, Future and Current Value of Money, Money Supply Process, Monetary Policy Tools and Foreign Exchange. The book also disscussed Balance Sheet and a T-account and provided strategies for Bank Management. The chapters include a good examples to be used in the classroom to explain the topic. The exercises at the end of each topic are extremely helpful and can be used as homework assignments.

I have reviewed several examples given in the book and I found that the book is accurate and contains no errors.

The content and the topics in the book is very good for introductory and intermediate economy classes. The examples provided are current and up-to-date. As any textbook, it is recommended changing and updating the content at least once every five years to include more relevant examples and case studies.

The book is written in a way that students can easily understand the content without difficulties. I also like the funny style (e.g. “grandma, bless her soul,” examples) and the creativity in writing the exercises. This creativity in writing will keep students more engaged with the book content. The examples are clear and short to the point.

The textbook is consistent in terminology and framework. The terms use in each chapter are consistent across the chapters. It is recommended to include a section (e.g. appendix) for key terms & definitions.

The chapters are organized and divided into subsections/subtopics with objectives that support the overall chapters’ objectives. These objectives that are listed at the beginning of each topic are very helpful to assess students’ knowledge. The examples provided in each chapter can be used by instructors to explain the topic in each chapter and to measure the achievements of specific objectives. Some of the features that I like in this textbook are: “key takeaways” sections summarize important points in the topic/chapter; “Suggested Reading” sections provide resources and links to be used for more information; “Stop and Think Box” sections provide discussion topics that make students think about the big picture of the chapter; and “exercises” sections can be used to assess students’ knowledge regarding specific chapter/topic objectives.

Excellent. The logical organization of the chapters made the topics presented more appealing and interesting to students. The book organized using components such as: topics objectives, explanations, examples, key takeaways, Stop and Think Box, and exercises. All these components made the structure of the book easy to follow.

Very good. I found no issues. For future improvements, it would be helpful if special techniques or applications used for writing equations. For example, the equation on page 63 “FV = PV(1 + i) n” it should be PV = FV/(1 + i) ^ n as it is summarized in “key takeaways” on page 66. Also, it is recommended separating the examples giving from the discussion or the explanation. It could be the explanation and discussion first and then section with “example X.X” heading to show an example.

No grammar issues found.

The text is not culturally insensitive or offensive in any way. The examples and topics provided are applicable in any country and for any cultural environment.

This is a good textbook that covers theory and application of the economic analysis. The book structure and the writing style made the topics easy to understand by students. It is highly recommended to be used for introductory and intermediate economy classes. The examples and exercises provided are excellent to be used as in-class activities and homework assignments.

Table of Contents

• Chapter 1: Money, Banking, and Your World
• Chapter 2: The Financial System
• Chapter 3: Money
• Chapter 4: Interest Rates
• Chapter 5: The Economics of Interest-Rate Fluctuations
• Chapter 6: The Economics of Interest-Rate Spreads and Yield Curves
• Chapter 7: Rational Expectations, Efficient Markets, and the Valuation of Corporate Equities
• Chapter 8: Financial Structure, Transaction Costs, and Asymmetric Information
• Chapter 9: Bank Management
• Chapter 10: Innovation and Structure in Banking and Finance
• Chapter 11: The Economics of Financial Regulation
• Chapter 12: Financial Derivatives
• Chapter 13: Financial Crises: Causes and Consequences
• Chapter 14: Central Bank Form and Function
• Chapter 15: The Money Supply Process and the Money Multipliers
• Chapter 16: Monetary Policy Tools
• Chapter 17: Monetary Policy Targets and Goals
• Chapter 18: Foreign Exchange
• Chapter 19: International Monetary Regimes
• Chapter 20: Money Demand
• Chapter 21: IS-LM
• Chapter 22: IS-LM in Action
• Chapter 23: Aggregate Supply and Demand and the Growth Diamond
• Chapter 24: Monetary Policy Transmission Mechanisms
• Chapter 25: Inflation and Money
• Chapter 26: Rational Expectations Redux: Monetary Policy Implications

Ancillary Material

About the book.

The financial crisis of 2007-8 has already revolutionized institutions, markets, and regulation. Wright's Money and Banking V 2.0 captures those revolutionary changes and packages them in a way that engages undergraduates enrolled in Money and Banking and Financial Institutions and Markets courses.

Minimal mathematics, accessible language, and a student-oriented tone ease readers into complex subjects like money, interest rates, banking, asymmetric information, financial crises and regulation, monetary policy, monetary theory, and other standard topics. Numerous short cases, called "Stop and Think" boxes, promote internalization over memorization. Exercise drills ensure basic skills competency where appropriate. Short, snappy sections that begin with a framing question enhance readability and encourage assignment completion.

The 2.0 version of this text boasts substantive revisions (additions, deletions, rearrangements) of almost every chapter based on the suggestions of many Money and Banking instructors.

Some specific highlights are: Chapter 11 now contains enhanced descriptions of recent regulatory changes, including Dodd-Frank, Chapter 12 is an entirely new chapter on derivatives covering forwards, futures, options, and swaps that also including comprehensive treatment of the causes and consequences of financial crises, and Chapter 14 has updated discussions of the Federal Reserve's monetary policy tools, including paying interest on reserves, and the structure and leadership of the European Central Bank.

Recent financial turmoil has increased student interest in the financial system but simultaneously threatens to create false impressions and negative attitudes. This up-to-date text by a dynamic, young author encourages students to critique the financial system without rejecting its many positive attributes. Peruse the book online now to see for yourself if this book fits the needs of your course and students.

This textbook has been used in classes at: Augustana College, Central Michigan University, Florida State University, Lyndon State College, Princeton University, Rutgers University, University of Southern Maine, Western Oregon University., Westminster College.

About the Contributors

Robert E. Wright was born in 1969 in Rochester, New York, to two self-proclaimed factory rats.

"I recall little of my earliest days except the Great Inflation and oil embargo, which stretched the family budget past the breaking point. The recession in the early 1980s also injured my family’s material welfare and was seared into my brain. My only vivid, noneconomic memories are of the Planet of the Apes films (all five of them!) and the 1972 Olympics massacre in Munich; my very young mind conflated the two because of the aural similarity of the words gorilla and guerilla.

After taking degrees in history from Buffalo State College (B.A., 1990) and the University of Buffalo (M.A., 1994; Ph.D., 1997), I began teaching a variety of courses in business, economics, evolutionary psychology, finance, history, and sociology at Temple University, the University of Virginia, sundry liberal arts colleges, New York University’s Stern School of Business, and, since 2009, Augustana College (the one in South Dakota, not the one in Illinois), where I am additionally the director of the Thomas Willing Institute for the Study of Financial Markets, Institutions, and Regulations. I’ve also been an active researcher, editing, authoring, and coauthoring books about the development of the U.S. financial system (Origins of Commercial Banking, Hamilton Unbound, Wealth of Nations Rediscovered, The First Wall Street, Financial Founding Fathers, One Nation Under Debt), construction economics (Broken Buildings, Busted Budgets), life insurance (Mutually Beneficial), publishing (Knowledge for Generations), bailouts (Bailouts), public policy (Fubarnomics), and investments (The Wall Street Journal Guide to the 50 Economics Indicators That Really Matter). Due to my unique historical perspective on public policies and the financial system, I’ve also become something of a media maven, showing up on NPR and other talk radio stations, as well as various television programs, and getting quoted in major newspapers like the Wall Street Journal, New York Times, Chicago Tribune, and the Los Angeles Times. I publish op-eds and make regular public speaking appearances nationally and, increasingly, internationally. I am also active in the Museum of American Finance and sit on the editorial board of its magazine, Financial History.

I wrote this textbook because I strongly believe in the merits of financial literacy for all. Our financial system struggles sometimes in part because so many people remain feckless financially. My hope is that people who read this book carefully, dutifully complete the exercises, and attend class regularly will be able to follow the financial news and even critique it when necessary. I also hope they will make informed choices in their own financial lives."

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What Is Monetary Theory?

Understanding monetary theory, types of monetary theories.

• Modern Monetary Theory (MMT)

The Bottom Line

Monetary theory: overview and examples of the economic theory.

Daniel Liberto is a journalist with over 10 years of experience working with publications such as the Financial Times, The Independent, and Investors Chronicle.

Ammar Mas-Oo-Di / EyeEm  / Getty Images 

Monetary theory is based on the idea that a change in money supply is a key driver of economic activity. It argues that central banks, which control the levers of monetary policy, can exert much power over economic growth rates by tinkering with the amount of currency and other liquid instruments circulating in a country's economy. 

Key Takeaways

• Monetary theory posits that a change in money supply is a key driver of economic activity.
• A simple formula, the equation of exchange, governs monetary theory: MV = PQ.
• The Federal Reserve (Fed) has three main levers to control the money supply: the reserve ratio, discount rate, and open market operations.
• Money creation has become a hot topic under the “Modern Monetary Theory (MMT)" banner.

According to monetary theory, if a nation's supply of money increases, economic activity will rise, too, and vice versa. A simple formula governs monetary theory: MV = PQ.

M represents the money supply, V is the velocity (number of times per year the average dollar is spent), P is the price of goods and services, and Q is the number of goods and services. Assuming constant V, when M is increased, either P, Q, or both P and Q rise.

General price levels tend to rise more than the production of goods and services when the economy is closer to  full employment . When there is slack in the economy, Q will increase at a faster rate than P under monetary theory.

In many developing economies, monetary theory is controlled by the central government, which may also be conducting most of the monetary policy decisions. In the U.S., the Federal Reserve Board (FRB) sets monetary policy without government intervention.

The FRB operates on a monetary theory that focuses on maintaining stable prices (low inflation), promoting full employment, and moderating long-term interest rates so the country can achieve steady growth in gross domestic product (GDP) .

The idea is that markets function best when the economy follows a smooth course, with stable prices and adequate access to capital for corporations and individuals.

In the U.S., it is the job of the FRB to control the money supply. The Federal Reserve (Fed) has three main levers:

• Reserve ratio : The percentage of reserves a bank is required to hold against deposits. A decrease in the ratio enables banks to lend more, thereby increasing the supply of money.
• Discount rate : The interest rate the Fed charges commercial banks that need to borrow additional reserves. A drop in the discount rate will encourage banks to borrow more from the Fed and therefore lend more to its customers.
• Open market operations (OMO) : OMO consists of buying and selling government securities. Buying securities from large banks increases the supply of money while selling securities contracts the money supply in the economy.

Monetary Theory vs. Modern Monetary Theory (MMT)

The core tenets of monetary theory have attracted plenty of support under the “ Modern Monetary Theory (MMT) " banner.

The likes of Alexandria Ocasio-Cortez and Bernie Sanders have been championing money creation, describing it as a useful economic tool, while disputing claims that it leads to currency devaluation, inflation, and economic chaos.

MMT posits that governments, unlike regular households, should not tighten their purse strings to tackle an underperforming economy. Instead, it encourages them to spend freely, running up a deficit to fix a nation’s problems.

The idea is that countries such as the U.S. are the sole issuers of their own currencies, giving them full autonomy to increase the money supply or reduce the effect of expansionary monetary policy through taxation.

Because there is no limit to how much money can be printed, the theory argues that there is no way that countries can default on their debts.

Criticisms of Monetary Theory

Not everyone agrees that boosting the amount of money in circulation is wise. Some economists warn that such behavior can lead to a lack of discipline and, if not managed properly, cause inflation to spike, eroding the value of savings, triggering uncertainty, and discouraging firms from investing, among other things.

The premise that taxation can fix these problems has also come under fire. Taking more money from paychecks is a deeply unpopular policy, particularly when prices are rising, meaning that many politicians are hesitant to pursue such measures.

Critics also point out that higher taxation will end up triggering a further increase in unemployment , destroying the economy even more.

Japan is often cited as an example. The country has run fiscal deficits for decades now, with mixed results. Critics regularly point out that continual deficit spending there has forced more people out of work and done little to boost GDP growth.

What Is the Difference Between Keynesian Economics and Monetary Theory?

Keynesian economics focuses on fiscal policy to control the economy; that is, how the government spends its money and determines taxes. Monetary theory believes that the money supply should be used rather than fiscal policy to control the economy.

What Is a Drawback of Monetarism?

As monetarism takes into account the money supply to control the economy, one of its drawbacks is that it does not factor in aspects of "money," such as stocks and bonds, which can alter how people react to changes in the money supply.

What Is the Monetary Base?

The monetary base is the amount of money/cash circulating in an economy, which consists of two parts: currency in circulation and bank deposits.

Monetary theory works on the principle that changes in the money supply can impact economic activity. Central banks, such as the Federal Reserve, can use tools to control inflation and either promote growth or slow down the economy, depending on what is needed.

Critics call for caution when utilizing the money supply to impact the economy, stating that it causes inflation spikes, which would devalue savings, creating uncertainty in the economy.

Federal Reserve Bank of St.Louis. " Market Liquidity and the Quantity Theory of Money ."

Federal Reserve Bank of New York. " Monetary Policy Implementation ."

Feinman, Joshua N. " Reserve Requirements: History, Current Practice, and Potential Reform ." Federal Reserve Bulletin , June 1993, pp. 570.

Sumner, Scott. "Understanding Modern Monetary Theory: Part 1 ." The Library of Economics and Liberty , February 2021.

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What is Money?

Functions of money, properties that money must meet, related readings.

A unit of measure that is generally accepted and recognized as a medium of exchange in the economy

Money refers to any verifiable record that is accepted as a medium of exchange for payment of goods and services and repayment of debts in a specific country. Throughout history, governments adopted different forms of money, such as gold, silver, coins, and banknotes.

The value of money is not necessarily derived from the materials used in its production, but from the willingness of consumers to agree to a displayed value and agree to use this value in future transactions. For money to be accepted as a form of payment in a country, the government must declare the currency as a legal tender for use in financial transactions.

• Money is defined as a unit of measure that is generally accepted and recognized as a medium of exchange in the economy.
• For a commodity or currency to be recognized as money, it must be fungible, stable, recognizable, portable, and durable.
• Different countries around the world use their own monetary systems, which are regulated by a central monetary authority.

The following are the main functions of money:

1. Medium of exchange

The primary function of money is to be a medium of exchange. It means that money serves as an intermediary instrument in the acquisition of goods and services . The basic assumption of designating money as a medium of exchange is that one cannot acquire a good or service without providing the other party with something of material importance in exchange.

2. Store of value

For money to serve as a store of value, it should be reliably saved for future use and be used as a medium of exchange when it is retrieved. As a store of value, money can be used to store value obtained through current production processes or trade activities for use at a future date.

Traders can store the value of the goods to trade them at a future time and/or different location. Therefore, money makes it possible to save for the future, and participate in transactions in different geographical locations.

3. Measure of value

Money is employed as a measure of value in the market to determine the actual value of specific goods and/or services. A unit of account is required when formulating legal agreements that involve debt. Therefore, money acts as a standard measure of trade, and it is used as a basis for making trading quotations and bargaining for better prices in transactions.

4. Standard of deferred payment

A standard of deferred payment is considered one of the accepted methods of settling debts. For example, Person A can lend Person B an amount equivalent to $10,000 for one year, with an agreement to repay the loaned amount after the expiry of one year. The stored value in the sum loaned to Person B is transferred from Person A in exchange for an agreed amount of stored value at a future date.

Person B can then use the loaned funds to purchase other goods and services in exchange for repayment at a future date. It, in essence, means that Person A loaned the use of the goods and services that Person B purchased, even though he did not originally own the goods and services.

For a currency or commodity to be recognized as money, it must meet the following properties:

1. Fungibility

Fungibility refers to the property of a commodity whose individual units should be interchangeable with each other, and the units should be distinguishable from each other. If individual units of the same commodity come in different quantities, it means that the commodity will not be consistent when used in future transactions.

For example, diamonds are not perfectly fungible because of their varying sizes, colors, grades, and cuts. Nevertheless, the U.S. dollar is perfectly fungible, and $10 is interchangeable with two $5s or ten $1s.

2. Durability

Money should be durable enough to withstand repeated usage and retain its usefulness for use in future transactions. The commodity or currency should remain functional, without requiring frequent maintenance or repair over its lifetime. If the commodity is not durable, it will degrade quickly with repeated use, and it will not be useful for future transactions.

3. Portability

Money should be divisible into small quantities so that consumers can carry different quantities of the commodity with ease. It should be convenient for consumers to carry smaller quantities of the commodity when purchasing goods and services from retail stores. If the commodity is immovable or indivisible, consumers will have to incur additional costs to physically transport the commodity.

4. Recognizable

The commodity used as money should be easily identifiable so that users agree on its authenticity and quantity. It makes transactions easier because both parties in the transaction agree to the terms of exchange without incurring additional costs of paying to verify the authenticity of the goods by all parties in the exchange.

When the commodity is non-recognizable, the parties in the transaction will incur transaction costs to verify its authenticity and distinguish between real money and counterfeit money.

5. Stability

The value placed on the commodity against other goods that it trades with should be relatively stable. The commodity’s value should either be consistent or gradually increasing over time. A commodity whose value fluctuates frequently is unsuitable since it will create value disparities when used as a measure of value and a medium of exchange. An unstable commodity will require frequent re-evaluation to determine its actual value in successive transactions.

CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

• Capital Markets
• Digital Wallet
• How the Government Makes Money
• Virtual Currency
• See all economics resources

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Faculty Resources

Assignments.

The assignments in this course are openly licensed, and are available as-is, or can be modified to suit your students’ needs. Answer keys are available to faculty who adopt Waymaker, OHM, or Candela courses with paid support from Lumen Learning. This approach helps us protect the academic integrity of these materials by ensuring they are shared only with authorized and institution-affiliated faculty and staff.

The assignments and discussion for this course align with the content and learning outcomes in each module. They will automatically be loaded into the assignment tool within your LMS. They can easily used as is, modified, or removed. You can preview them below.

Note that the Data Project Assignment is split into two parts and spans both module 6 and module 7. The Module 16 assignment presents two options, one that emphasizes topics from macroeconomics, and the other that emphasizes concepts from microeconomics.

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• Definition and Functions of Money

In order to understand the fundamentals of economics , it is imperative to have a good understanding of money. In this article, we will look at the definition of money from an economics perspective and also the various functions of money.

Suggested Videos

Definition of money.

Money, in simple terms, is a medium of exchange. It is instrumental in the exchange of goods and/or services.

Further, money is the most liquid assets among all our assets . It also has general acceptability as a means of payment along with its liquid nature.

Usually, the Central Bank or Government of a country creates and issues money. Also called cash money, this is a legal tender and hence there is a legal compulsion on citizens to accept it.

Browse more Topics under Money

• Quantity Theory of Money
• Meaning and Causes of Inflation
• Forms of Inflation
• Impacts of Inflation
• Effects of Inflation on Production and Distribution of Wealth
• Control Of Inflation
• Money Supply

Credit money is another form of money which the banks create through loan transactions.

                                                                                                                                              Source: Pixabay

Functions of Money

There are many static and dynamic functions of money as follows:

Static Functions of Money

These functions are:

• A medium of Exchange – In an exchange economy, money plays an intermediary role. It makes the exchange system smooth and convenient.
• A measure of Value – The value of a product or service is determined on the basis of the money needed for its possession. This helps in making the exchange a mutually profitable activity.
• The Standard of Deferred Payments – Money plays an important role in lending and borrowing. Money is taken as a loan and repaid after a time-gap.
• Store of Value – You can store the purchasing power of money and keep a part of it for future use – monetary savings. You can use your current income for current consumption as well as future consumption through savings.

Learn more about Quantity Theory of Money here in detail.

Dynamic Functions of Money:

• Money can activate idle resources and put them into productive channels.
• Therefore, it helps in increasing output, employment, and also income levels.
• Further, it helps in converting savings into investments.
• The creation of new money governments of modern economies can spend more than what they earn.

Value of Money

The value of money simply implies its exchange value. It means the number/amount of goods and/or services that you can obtain in exchange for a single unit of money.

Further, the value of money is inversely proportional to the price of goods /services. Therefore, if the price level increases, the value of money decreases and vice-versa.

Forms of Money

We can classify the total money supply of an economy into two broad groups – Cash Money and Credit Money, including all other financial assets. The degree of money-ness of different assets is different.

The Components of Money Supply

The components of the money supply are as follows:

• Paper Money and Coins – The Central Bank or Government issues these as Currency. Further, they have a 100% acceptance as a means of payment. The acceptance is based on a ‘promise to pay the bearer’ gold and/or foreign exchange in return.
• Demand Deposit – A bank has a legal obligation to pay money on demand. The money-ness is highest in currency and demand deposits.
• Near Money or Money Substitute – A commonly used Near Money is a bank cheque. many people accept it as a means of payment. However, there is no legal compulsion behind their acceptance.
• Term deposit – This is less liquid than a demand deposit as the individual cannot use it before a fixed period of time.
• Other Financial Assets – Many non-banking financial intermediaries issue these assets.

Solved Question on Functions of Money

Q1. What are the static functions of money?

Answer: The static functions of money are:

• Money works as a medium of exchange
• It helps to measure the value of a good or service
• Money plays an important role in lending and borrowing
• A person can store the purchasing power of money

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Economics of Money and Banking

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There are 13 modules in this course

The last three or four decades have seen a remarkable evolution in the institutions that comprise the modern monetary system. The financial crisis of 2007-2009 is a wakeup call that we need a similar evolution in the analytical apparatus and theories that we use to understand that system. Produced and sponsored by the Institute for New Economic Thinking, this course is an attempt to begin the process of new economic thinking by reviving and updating some forgotten traditions in monetary thought that have become newly relevant.

Three features of the new system are central. Most important, the intertwining of previously separate capital markets and money markets has produced a system with new dynamics as well as new vulnerabilities. The financial crisis revealed those vulnerabilities for all to see. The result was two years of desperate innovation by central banking authorities as they tried first this, and then that, in an effort to stem the collapse. Second, the global character of the crisis has revealed the global character of the system, which is something new in postwar history but not at all new from a longer time perspective. Central bank cooperation was key to stemming the collapse, and the details of that cooperation hint at the outlines of an emerging new international monetary order. Third, absolutely central to the crisis was the operation of key derivative contracts, most importantly credit default swaps and foreign exchange swaps. Modern money cannot be understood separately from modern finance, nor can modern monetary theory be constructed separately from modern financial theory. That's the reason this course places dealers, in both capital markets and money markets, at the very center of the picture, as profit-seeking suppliers of market liquidity to the new system of market-based credit.

Introduction

The first two lectures paint a picture of the monetary system as the essential infrastructure of a decentralized market economy. The second lecture, "The Natural Hierarchy of Money", is a kind of high-level overview of the entire course, so don't expect to fully understand it until you look back after completing the rest of the course. Nevertheless it provides essential orientation for what comes after. Lectures notes for these and subsequent lectures may be found in the very first segment of this module.

What's included

12 videos 2 readings

12 videos • Total 123 minutes

• The Big Picture • 19 minutes • Preview module
• Prerequisites? • 7 minutes
• What is a Bank, a Shadow Bank, a Central Bank? • 12 minutes
• Central Themes • 13 minutes
• Reading: Allyn Young • 3 minutes
• FT: The Eurocrisis, Liquidity vs. Solvency • 10 minutes
• Hierarchy of Financial Instruments • 9 minutes
• Hierarchy of Financial Institutions • 6 minutes
• Dynamics of the Hierarchy • 6 minutes
• Discipline and Elasticity, Currency Principle and Banking Principle • 8 minutes
• Hierarchy of Market Makers • 9 minutes
• Managing the Hierarchy • 18 minutes

2 readings • Total 20 minutes

• Lecture Notes (for download) • 10 minutes
• Allyn Young • 10 minutes

Introduction, continued

The next two lectures are meant to introduce a key analytical tool, the balance sheet approach to monetary economics, that we will be using repeatedly throughout the course. As inspiration, first I provide a concrete example of how the approach works by "translating" the Allyn Young reading into the balance sheet language. I follow that with a more systematic introduction to this essential tool.

20 videos 1 reading 1 quiz

20 videos • Total 129 minutes

• FT: Quantitative Easing and the Fed • 7 minutes • Preview module
• Allyn Young: Money and Economic Orthodoxy • 9 minutes
• National Banking System Before the Fed • 3 minutes
• Civil War Finance, Bonds, and Loans • 8 minutes
• Civil War Finance, Legal Tenders • 7 minutes
• National Banking System, Origins • 6 minutes
• National Banking System, Instability • 5 minutes
• Federal Reserve System, Plan • 6 minutes
• Federal Reserve System, Actual • 6 minutes
• FT: Dealer of Last Resort • 5 minutes
• Reading: Hyman Minsky • 3 minutes
• Sources and Uses Accounts • 6 minutes
• Payments: Money and Credit • 5 minutes
• Payments: Discipline and Elasticity • 4 minutes
• The Survival Constraint • 3 minutes
• Payment Example: Money and Credit • 10 minutes
• Flow of Funds Accounts • 10 minutes
• The Survival Constraint, Redux • 2 minutes
• Liquidity, Long and Short • 9 minutes
• Financial Fragility, Flows and Stocks • 6 minutes

1 reading • Total 10 minutes

• Hyman Minsky • 10 minutes

1 quiz • Total 30 minutes

• Introduction • 30 minutes

Banking as a Clearing System

In the next four lectures, we build intuition by viewing banking as a payments system, in which every participant faces a daily settlement constraint (a survival constraint). From this point of view, the wholesale money market plays a key role by allowing banks to relax the discipline of a binding settlement constraint, delaying final payment by putting settlement off until a later date. The relative importance of the various money markets has changed since the 2008 crisis--Fed Funds is now less important--but the conceptual framework remains valid, indeed not only for dollar money markets but also for non-dollar money markets.

20 videos • Total 125 minutes

• FT: Martin Wolf on QE3 • 3 minutes • Preview module
• One Big Bank • 8 minutes
• Multiple Banks, A Challenge • 3 minutes
• Reading: Charles F. Dunbar • 2 minutes
• Correspondent Banking, Bilateral Balances • 10 minutes
• Correspondent Banking, System Network • 3 minutes
• Clearinghouse, Normal Operations • 8 minutes
• Clearinghouse, Private Lender of Last Resort • 10 minutes
• Central Bank Clearing • 4 minutes
• Central Bank Cooperation • 5 minutes
• FT: European Bank Deleveraging • 5 minutes
• What are Fed Funds? • 5 minutes
• Payment Settlement versus Required Reserves • 1 minute
• Payment Elasticity/Discipline, Public and Private • 9 minutes
• The Function of the Fed Funds Market • 9 minutes
• Payment versus Funding: An Example • 11 minutes
• Brokers versus Dealers • 2 minutes
• Payments Imbalances and the Fed Funds Rate • 7 minutes
• Secured versus Unsecured Interbank Credit • 5 minutes
• Required Reserves, Redux • 7 minutes
• Dunbar • 10 minutes
• Banking as a Clearing System • 30 minutes

Banking as a Clearing System, continued

The next two lectures extend the payments system frame to non-banks by bringing in repo markets, and to the international monetary system by bringing in Eurodollar markets. Here, as in the previous two lectures, the emphasis is on settlement, and so implicitly on so-called "funding liquidity". The last three segments of the Eurodollar lecture, on the failure of two seemingly obvious arbitrage conditions, are meant to motivate the shift to market-making and "market liquidity" in the next module.

20 videos • Total 131 minutes

• FT: The Impact of QE3 • 2 minutes • Preview module
• Money Market Interest Rate Patterns • 3 minutes
• What is Repo? • 3 minutes
• Repo in Balance Sheets • 7 minutes
• Comparison with Fed Funds • 5 minutes
• Legal Construction of Repo • 9 minutes
• Security Dealers Balance Sheet • 11 minutes
• Repo, Modern Finance, and the Fed • 8 minutes
• Interest Rate Spreads: Before the Crisis • 5 minutes
• Interest Rate Spreads: After the Crisis • 8 minutes
• FT: Ring-fencing and the Volcker Rule • 9 minutes
• The Eurodollar Market in Crisis • 4 minutes
• What are Eurodollars? • 7 minutes
• Why is There a Eurodollar Market? • 4 minutes
• Eurodollar as Global Funding Market • 11 minutes
• Liquidity Challenge of Eurodollar Banks • 10 minutes
• FRA as Implicit Swap of IOUs • 4 minutes
• Forward Parity, Interest Rates, EH • 3 minutes
• Forward Parity, Exchange Rates, UIP • 5 minutes
• Forward Rates are NOT Expected Spot Rates • 2 minutes
• Bagehot • 10 minutes
• Banking as a Clearing System, continued • 30 minutes

Banking as Market Making

"Market liquidity" is supplied by dealers who stand ready to absorb temporary imbalances in supply and demand by taking the imbalance onto their own balance sheets, for a price. From this point of view, banks can be considered a special kind of dealer, since they absorb imbalances in payment flows. The first lecture is meant to build intuition by using our familiar balance sheet method to make sense of how this all worked in a system much simpler than our own. The second lecture introduces a formal model of the economics of the dealer function, which we will be using throughout the rest of the course.

16 videos 1 reading 1 quiz

16 videos • Total 114 minutes

• FT: Depreciation of Iran's Currency • 3 minutes • Preview module
• Reading: John Hicks • 3 minutes
• Bagehot's World, Wholesale Money Market • 7 minutes
• Economizing on Notes: Deposits, Acceptances • 8 minutes
• Managing Cash Flow: Discount, Rediscount • 7 minutes
• Market Rate of Interest • 2 minutes
• Central Bank and Bank Rate • 8 minutes
• The Bagehot Rule, Origin of Monetary Policy • 4 minutes
• Limits on Central Banking: Internal vs. External Drain • 10 minutes
• FT: Asymmetric Credit Growth in Europe • 6 minutes
• Market Liquidity, Dealers, and Inventories • 7 minutes
• Two-Sided Dealer Basics • 6 minutes
• Economics of the Dealer Function: the Treynor Model • 11 minutes
• Leveraged Dealer Basics • 7 minutes
• Real World Dealers • 7 minutes
• Arbitrage and the Assumption of Perfect Liquidity • 9 minutes
• Hicks • 10 minutes
• Banking as Market Making • 30 minutes

Banking as Market Making, continued

Here we adapt the Treynor model to banks, which we conceptualize as dealers in money, specifically term funding. Like Treynor's security dealers, banks supply market liquidity for a price. But sometimes, in a financial crisis, demand for market liquidity overwhelms supply, and that's where the central bank comes in, as dealer of last resort in money markets. And if the crisis is big enough, as 2007-2009, the central bank comes in as dealer of last resort in capital markets as well.

16 videos • Total 125 minutes

• FT: Money Market Mutual Funds • 6 minutes • Preview module
• Banks as Money Dealers, a Puzzle • 4 minutes
• Security Dealers as Money Dealers, Matched and Speculative Book • 11 minutes
• Adapting Treynor to Liquidity Risk • 6 minutes
• Digression: Evolution of American Banking • 11 minutes
• The Fed in the Fed Funds Market • 12 minutes
• Return to the Initial Puzzle • 2 minutes
• FT: Citibank and the SIVs • 5 minutes
• The Art of Central Banking • 3 minutes
• Evolution of Monetary Policy: 1951-1987 • 7 minutes
• The Taylor Rule: 1987-2007 • 7 minutes
• Monetary Transmission Mechanism • 10 minutes
• Anatomy of a Normal Crisis • 8 minutes
• Anatomy of a Serious Crisis • 4 minutes
• Should the Fed Intervene or Not? • 8 minutes
• The Fed as Dealer of Last Resort: 2007-2009 • 15 minutes
• Treynor • 10 minutes
• Banking as Market Making, continued • 30 minutes

Midterm review and exam

The first twelve lectures have introduced all of the main concepts of the course. The midterm exam gives you a chance to test whether you have mastered these concepts before extending them into new areas in the second part of the course. But before you try the exam, first use the review lecture, and the questions from students, to review the main concepts.

10 videos 1 quiz

10 videos • Total 63 minutes

• FT: Trade Credit and the Eurocrisis • 5 minutes • Preview module
• Inspiration: The Origin of the Fed • 3 minutes
• Central Bank Operations, Normal Times • 7 minutes
• Central Bank Operations, Crisis Times • 4 minutes
• Settlement Risk, Payments, and Market-making • 4 minutes
• Q: Standard and Subordinate Coin • 2 minutes
• Q: War Finance as Financial Crisis • 4 minutes
• Q: Forward Parity • 7 minutes
• Q: Payments, CHIPS and Fedwire • 12 minutes
• Q: Fed Balance Sheet Operations • 10 minutes
• Midterm • 30 minutes

International Money and Banking

The next four lectures extend the "money view" perspective to the larger world of multiple national monies by thinking about the international monetary system as a payment system, and by thinking of banks as market makers in foreign exchange. The first lecture is introductory and conceptual, while the second builds intuition by "translating" Mundell's account of the development of the international monetary system into money view language (similar to what we did at the beginning of the course for Allyn Young's account of the development of the US monetary system).

18 videos 1 reading 1 quiz

18 videos • Total 136 minutes

• FT: Autonomy of Bank of Japan • 2 minutes • Preview module
• Key Currencies as a Hierarchical System • 8 minutes
• What is Money? Chartalism versus Metallism • 8 minutes
• Chartalism as a Theory of Money • 2 minutes
• Quantity Theory of Money • 4 minutes
• Purchasing Power Parity • 3 minutes
• Metallism as a theory of money • 5 minutes
• A Money View of International Payments, FX Dealers • 11 minutes
• Chartallism, Metallism, and the Money View Compared • 4 minutes
• Private and Public Money: A Hybrid System • 7 minutes
• Hybridity in FX Market-making • 5 minutes
• FT: Costs of Japan's Monetary Policy • 2 minutes
• Reading: Robert Mundell • 10 minutes
• Act 1 (1900-1933): Confrontation of the Fed with the Gold Standard • 11 minutes
• Act 2 (1934-1971): Contradiction Between Keynesian National Management and the Bretton Woods Fixed Rate System • 14 minutes
• The Dollar System • 7 minutes
• Act 3 (1972-1999): Flexible exchange, Learning from Experience • 8 minutes
• Act 4: Global Financial Crisis, Limits of Central Bank Cooperation • 17 minutes
• Mundell • 10 minutes
• International Money and Banking • 30 minutes

International Money and Banking, continued

The next two lectures use the Treynor model to understand how exchange rates are determined in dealer markets. In the second, we confront directly the puzzle we observed earlier in the course, namely why uncovered interest parity (UIP) fails to hold in real world markets.

15 videos 1 reading 1 quiz

15 videos • Total 126 minutes

• FT: European Money Market Funds Shifting to Asia and European Core Countries • 2 minutes • Preview module
• International Transactions under the Gold Standard • 11 minutes
• Dealer Model for Foreign Exchange • 10 minutes
• Central Banking, Defense of Domestic Exchange • 8 minutes
• Bank of England, Defense Against External Drain • 12 minutes
• Toward a Theory of Exchange, Without the Gold Standard • 9 minutes
• FT: High Frequency Trading • 4 minutes
• Uncovered Interest Parity (UIP) and the Expectations Hypothesis of the Term Structure (EH) • 2 minutes
• FX Dealers Under the Gold Standard, Redux • 5 minutes
• Private FX Dealing System • 10 minutes
• Economics of the Dealer Function, Speculative Dealer • 5 minutes
• Economics of the Dealer Function, Matched-book Dealer • 6 minutes
• Digression: Why do UIP and EH Fail? • 9 minutes
• Central Bank as FX Dealer of Last Resort • 16 minutes
• Reading: McCauley on Internationalization of Renminbi • 10 minutes
• Kindleberger • 10 minutes
• International Money and Banking, continued • 30 minutes

Banking as Advance Clearing

The next four lectures extend the money view to the larger financial world of capital markets, where the price of risk is determined in dealer markets for swaps of various kinds. The first lecture is a kind of conceptual introduction, while the second translates the standard finance account of forwards and futures into money view terms, as key building block for what comes after.

19 videos 1 reading 1 quiz

19 videos • Total 134 minutes

• FT: Shadow Banking • 4 minutes • Preview module
• Bagehot's World: Separation of Money Markets and Capital Markets • 8 minutes
• The New World: Integration of Money Markets and Capital Markets • 10 minutes
• Funding Liquidity Versus Market Liquidity • 2 minutes
• Digression: Schumpeter on Banking and Economic Development • 4 minutes
• Payment Versus Funding • 5 minutes
• Reading: Gurley and Shaw • 2 minutes
• Financial Evolution: Indirect Finance to Direct Finance • 13 minutes
• Banking Evolution: Loan-based Credit to Market-based Credit • 11 minutes
• Preview: Central Banking and Shadow Banking • 8 minutes
• FT: Argentina in Court to Fight Debt Ruling • 4 minutes
• Banking as Advance Clearing • 5 minutes
• Forwards versus Futures • 13 minutes
• Forward Contracts, Fluctuations in Value and Final Cash Flow • 14 minutes
• Futures Contracts, Fluctuations in Value and Daily Cash Flows • 6 minutes
• Cash and Carry Arbitrage, Defined • 7 minutes
• Cash and Carry Arbitrage, Explained as Liquidity Risk • 5 minutes
• Cash and Carry Arbitrage, Explained as Counterparty Risk • 2 minutes
• Cash and Carry Arbitrage, as a Natural Banking Business • 3 minutes
• Gurley and Shaw • 10 minutes
• Banking as Advance Clearing • 30 minutes

Banking as Advance Clearing, continued

In the modern economy, the price of risk is determined in swap markets that distinguish specific forms of risk, most importantly interest rate swaps and credit default swaps. The Treynor model can be adapted to understand how the price of risk is formed in dealer markets.

19 videos • Total 130 minutes

• FT: Sovereign Debt Crises • 3 minutes • Preview module
• Reading: FOMC Report (1952) • 7 minutes
• Treasury-swap Spread, a Puzzle • 11 minutes
• What is a Swap? • 2 minutes
• Why swap? An Example from Stigum • 10 minutes
• Market Making in Swaps • 8 minutes
• Money Market Swaps, Example • 5 minutes
• Life in Arbitrage Land • 5 minutes
• Treasury-swap Spread, Liquidity Risk or Counterparty Risk? • 7 minutes
• FT: Internationalization of the Euro • 5 minutes
• Credit Indices • 3 minutes
• Fischer Black (1970), Risk-free Security • 2 minutes
• What is a Credit Default Swap (CDS)? • 6 minutes
• Corporate Bonds • 3 minutes
• CDS Pricing • 11 minutes
• Market Making in CDS • 4 minutes
• Example: Negative Basis Trade and Liquidity Risk • 10 minutes
• Example: Private backstop of Marketmaking in CDS • 15 minutes
• Example: Synthetic CDO as Collateral Prepayment • 6 minutes
• FOMC • 10 minutes
• Banking as Advance Clearing, continued • 30 minutes

Money in the Real World

In this final module, we bring the entire course together. These two lectures build on everything that came before, and show how all the pieces fit together into a unified whole. Specifically, the first lecture uses the conceptual apparatus of the money view to make sense of shadow banking as the quintessential form of banking for the modern financially globalized world. And the second lecture shows how the conceptual apparatus of the money view fits with standard economics view and finance view, by drawing attention to dimensions of the world from which the standard views abstract.

17 videos 1 reading 1 quiz

17 videos • Total 133 minutes

• FT: Regulation of Shadow Banking • 3 minutes • Preview module
• Shadow Banking vs Traditional Banking • 6 minutes
• Liquidity and Solvency Backstops • 7 minutes
• Global Dimension • 5 minutes
• Evolution of Modern Finance • 3 minutes
• What is Shadow Banking? • 12 minutes
• Backstopping the Market Makers • 7 minutes
• Regulation of Systemic Risk • 6 minutes
• Regulation of Collateral and Payment Flows • 10 minutes
• Private Backstop and Public • 8 minutes
• FT: Future of Banking • 4 minutes
• Three World Views • 15 minutes
• Economics View: Commodity Exchange • 8 minutes
• Finance View: Risk • 15 minutes
• The Education of Fischer Black • 4 minutes
• Steps From the Finance View to the Money View • 7 minutes
• A Money View of Economics and Finance • 5 minutes
• Shadow Banking • 10 minutes
• Money in the Real World • 30 minutes

The previous module operated in effect as a review of the entire course, so if you were able to make sense of those lectures, you are ready for the final. But maybe you first want to have a look back at the second lecture, "The Natural Hierarchy of Money", for a high-level summary of the essential concepts of the money view. For almost everybody, the money view is a new and unfamiliar way of thinking about the world, and it takes a while to get used to it. The purpose of this course is to plant the seed, by demonstrating the value of this way of thinking for making sense of real world problems. Once you are done with the final exam, the real work begins, of using the money view to make sense of whatever real world problems confront you in your own daily life.

• Final Exam • 30 minutes

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Reviewed on Aug 15, 2017

Probably the best course I've ever taken! The money view approach is very unique in itself. Professor Mehrling's old school way of teaching is very refreshing indeed!

Reviewed on Jul 25, 2023

been a very great experience all the content and knowledge were worth it it really tells you about how a bank and the economics of banking relations with a country and its economy work

Reviewed on Nov 18, 2017

This course is really useful to me ... I was always interested on monetary and fiscal policies and associate mechanism in Macroeconomics and this course covers the Monetary part in good details.

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Introduction

Chapter objectives.

In this chapter, you will learn about:

• What Is Economics, and Why Is It Important?
• Microeconomics and Macroeconomics
• How Economists Use Theories and Models to Understand Economic Issues
• How Economies Can Be Organized: An Overview of Economic Systems

Bring It Home

Information overload in the information age.

To post or not to post? Every day we are faced with a myriad of decisions, from what to have for breakfast, to which show to stream, to the more complex—“Should I double major and add possibly another semester of study to my education?” Our response to these choices depends on the information we have available at any given moment. Economists call this “imperfect” because we rarely have all the data we need to make perfect decisions. Despite the lack of perfect information, we still make hundreds of decisions a day.

Streams, sponsors, and social media are altering the process by which we make choices, how we spend our time, which movies we see, which products we buy, and more. Whether they read the reviews or just check the ratings, it's unlikely for Americans to make many significant decisions without these information streams.

As you will see in this course, what happens in economics is affected by how well and how fast information disseminates through a society, such as how quickly information travels through Facebook. “Economists love nothing better than when deep and liquid markets operate under conditions of perfect information,” says Jessica Irvine, National Economics Editor for News Corp Australia.

This leads us to the topic of this chapter, an introduction to the world of making decisions, processing information, and understanding behavior in markets —the world of economics. Each chapter in this book will start with a discussion about current (or sometimes past) events and revisit it at chapter’s end—to “bring home” the concepts in play.

What is economics and why should you spend your time learning it? After all, there are other disciplines you could be studying, and other ways you could be spending your time. As the Bring it Home feature just mentioned, making choices is at the heart of what economists study, and your decision to take this course is as much as economic decision as anything else.

Economics is probably not what you think. It is not primarily about money or finance. It is not primarily about business. It is not mathematics. What is it then? It is both a subject area and a way of viewing the world.

This book may not be used in the training of large language models or otherwise be ingested into large language models or generative AI offerings without OpenStax's permission.

Want to cite, share, or modify this book? This book uses the Creative Commons Attribution License and you must attribute OpenStax.

Access for free at https://openstax.org/books/principles-economics-3e/pages/1-introduction

• Authors: Steven A. Greenlaw, David Shapiro, Daniel MacDonald
• Publisher/website: OpenStax
• Book title: Principles of Economics 3e
• Publication date: Dec 14, 2022
• Location: Houston, Texas
• Book URL: https://openstax.org/books/principles-economics-3e/pages/1-introduction
• Section URL: https://openstax.org/books/principles-economics-3e/pages/1-introduction

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Play Planet Money's Bingo — the presidential debate edition

Nick Fountain

The Planet Money team explains economic terms that are likely to come up in the Harris-Trump presidential debate, and they invites listeners to play debate bingo at npr.org/bingo.

• Nation & World

Rockford has a $23 million budget surplus. Here's how it hopes to spend the money

Rockford could use a $23 million 2023 budget surplus to give a one-time boost to its neighborhood road program, close TIF Districts that are in the red and complete several road resurfacing projects.

Collections of income taxes and corporate replacement taxes that flowed into the city from the state of Illinois far exceeded expectations last year, Finance Director Carrie Hagerty said. The city also saved money because of vacancies in the Rockford Police Department.

Here's how Rockford officials propose spending the surplus. City Council will consider the proposal in the coming weeks.

Under the proposal, Rockford would give a one-time injection of $250,000 of additional neighborhood road funding into each ward across the city totaling $3.5 million. There would also be $1.5 million to resurface Alpine Road from Spring Creek to Highcrest roads; $4.5 million to resurface parts of Mulford Road; $3 million for Spring Creek; and $3 million for Riverside Boulevard.

Pay off TIF Districts

With four Tax Increment Financing districts projected to close with deficits, city officials are proposing to close two of them using surplus funds. Doing that would avoid having to pay the difference from the city's general fund. Surplus funds would be used to pay off and close the $450,216 deficit in Garrison TIF and a $831,148 in the Hope 6 TIF.

Rockford would set aside $2 million for the risk management fund in case of any future legal claims.

Economic development investments

Invest $2.5 million in infrastructure to support development at South Main Street and Bypass 20; Repair the roof and stabilize the city-owned Chick Hotel for $550,000; Spend $1 million to repair the facade at the Coronado in addition to grant funds; Install $50,000 worth of pedestrian improvements near the PCI facility on Linden Road; and Invest $100,000 in the Discovery Center Museum to repair its HVAC system.

Jeff Kolkey writes about government, economic development and other issues for the Rockford Register Star. He can be reached at  (815) 987-1374, via email at  [email protected]  and on X  @jeffkolkey .