Macroeconomics II

Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 1

Macroeconomics II

Faculty of Economics and Business Administration Faculty of Economics and Business Administration of the Johann Wolfgang Goethe of the Johann Wolfgang Goethe University University

Frankfurt, 19. April 2004Frankfurt, 19. April 2004

Introduction and OverviewIntroduction and Overview

by Professor Dr. Paul Bernd Spahnand Dipl.-Volkswirt Jan Werner


Structure

1. Introduction

2. Functions of money

3. Historical development of the forms of money

4. Measuring money

5. Function and Structure of Financial Markets

6. Conclusion


Introduction

“In a world of certainty ... there is no need for money”. Charles Goodhart

• The Walras model assumes full information.

• All markets clear perfectly and instantaneously.

• Such an economy does not require money, because every good can function as a monetary unit.

Charles Goodhartborn 1936


Introduction

“Money is what money does. Money is defined by its functions.”

John Hicks

John Hicks 1904-89


Functions of money

• Medium of exchange

• Unit of account

• Store of value

• Payment function


Functions of money

• Medium of exchange– Indeed, where people are bound together by

family, tribal or social ties, there is typically no need for money (kibbutz, monastery).

– In a barter economy, any good may take the role of a medium of exchange, but it is required that exchange intentions are mutually consistent = “double coincidence of wants”.


Functions of money

• Medium of exchange

– One good often serves as a “numéraire”, which reduces the possible exchange relationships.

– Money decomposes one act of exchange into two such acts: Good x Money Good y

– Money reduces the transaction costs.


Functions of money

Moreover the money has to be „equipped“ with the

following criteria:

1. A standardised and well-known value,

2. Widely accepted,

3. Easy to divided,

4. Easy to carry and

5. “Constant” value, does not erode over time.


Functions of money

• Therefore precious metal play an important role as forms of money

• Money in his function of Unit of Account also reduces the transaction costs, because the number of prices are dropped.

• This function is especially for a complex economy important.


Functions of money

• Store of value– Bridging the temporal gap between income

flows and expenditures– Many other store of values exist besides money

like:Real estate and properties,

Gold and jewellery,

Antiques, arts and images,

Stocks and bonds


Functions of money

• Store of value

– Normally, money has the lowest valorisation of all stores of value

– Why do individuals hold money without interest?

– Money is extremely liquid

– In a hyperinflation money loses its liquidity


Functions of money

• Payment function

– This function allows the granting of credit, the transfer of credits and liabilities, and the redemption of debentures.

– The postulate is that credit money will be provided and is accepted in a society.

– The payment function can be ditto summarised to the prior functions of money.


Historical development of the forms of money

• Commodity money in a barter economy:– “Goods” with a use value like as salt, corn,

spices, colours (e.g. indigo), cattle.– “Assets” that are rare and tradeable

such as gold, pearls, gems, feathers of rare bird, cowrie shells.

– In societies where people are considered “assets”, money could also be slaves, children, or women of marital age.



• Metal money is a result of the desire store the money and lower transaction costs: – Durable assets = sumptuous metals– Assets with an aesthetic or ideal value

such as jewellery, ritual gear and relics

• But the inhomogeneity of different forms of money requires a “standard”.



• In the middelage the nations developed their own currency to strengthen their political power:

– Portuguese “escudo”,

– French “écu” and

– Austrian “Schilling”

• „Bullionist Debate“ in 18th century



• The conception of Credit money / Fiat Money allows to introduce paper currency.

• The introduction of checks improved the efficiencey of the payments systems.

• Electronic Payment / Credit cards / EC-Card

• E-Money


Measuring money

• The Quantity theory of money is based on the following equation:

P y = P T = M V– The real income y, – The price level P, – The number of transactions T,– The velocity of circulation of money V and– The contraction of the money stock M


Measuring money

• The contraction of the money stock M is

divided by the central banks (EZB and Fed)

in the following money aggregates:

– M1 = “narrow money”

– M2 = “intermediate” money

– M3 = “broad money”


Measuring money


Measuring money

Billion euros In % of currency in circulation

Currency in circulation

364 100

M1 = “narrow money”

2510 689

M2 = “inter-mediate” money

5111 1404

M3 = “broad money” 5989 1645

Money demand in the Euro-area (end of September 2003)


Function and Structure of Financial Markets

• See „The economics of money, banking and financial markets" by Frederic S. Mishkin (2004, 7.edition, Boston, ISBN 0-321-20463-8), page 24.



Financial Markets can be classified as follow:

• Debt Market

• Equity Market

• Primary Market

• Secondary Market

• Exchanges Market

• Over-the-Counter Market

• Money and Capital Market



Why do Financial Intermediaries exists?• To lower transaction costs

– developing expertise and taking advantage of economies of scale

• To reduce risk sharing– portfolio diversification

• To solve the problems of asymmetric information– adverse selection– moral hazard



Adverse Selection (before)

– Potential borrowers most likely to produce adverse outcomes are ones most likely to seek loans and be selected.

Moral Hazard (after)– Hazard that borrower has incentives to

engage in undesirable (immoral) activities making it more likely that won’t pay loan back.

24


Conclusion• Money is defined by three (alternatively four)

functions.

• A complex economic requires an efficient form of money.

• Money supply can be measured by M1, M2 and M3.

• Indirect finance with the conception of Financial Intermediaries can lower the cost and can be more capable than direct finance.

Documents

Macroeconomics II