As a reminder, there are three functions of money:
|Function of Money||Purpose|
|Medium of Exchange||Used as an intermediary to facilitate non-barter based trade; in other words, it allows us to get what we want (e.g., debit card, cash, check)|
|Store of Value||Has a recognized value that can be stored and retrieved|
|Unit of Account||Allows comparison of the value of different items; used in financial transactions and record keeping|
Now, most people likely tend to think of bills and coins when they hear the word "money." However, if money is anything that fits those three functions and allows us to get what we want, wouldn't checks and debit cards also be considered money? What else could it be?
Well, depending on how easy or difficult it is to spend a certain type of money, we classify it accordingly.
Some forms of money, like cash, are very easy to go out and spend right now. Other forms, like the money in a savings account, involve a few more steps to be able to spend, like transferring the money into a checking account and then taking the money out at an ATM.
This concept is known as liquidity, which is the focus of this tutorial.
As mentioned, money can be classified by its liquidity. We will discuss each category in detail.
So, if we include money that we can easily spend, M1 will include our checking accounts. It is not actual physical cash, but you can swipe your debit card almost everywhere now and immediately purchase something.
EXAMPLEYou probably could not use a debit card to buy Girl Scout cookies from your neighbor, but in all likelihood, you could have written her a check. That check would have come out of your checking account.
Thus, because of all of those abilities to use on checking accounts, M1 is still considered to be fairly liquid.
This is the broadest way of defining what money is. This includes all the ways that you are holding money that you cannot immediately pay for something, such as:
Typically, you have to hold this form of money in an account for a certain amount of time.
EXAMPLESuppose after Christmas, you needed to transfer some money from your savings account into your checking account to pay your credit card bills. In this case, you were taking money from your M2 and putting it into your M1 so that you could actually spend it. Because it involved additional steps, this money is not quite as liquid.
The FOMC, or Federal Open Market Committee, is part of our Federal Reserve System. They meet eight times a year to manage our nation's money supply.
The tools that the FOMC uses to control each of these components of our money supply are:
Each of these will be a subject of a future tutorial, but as a brief overview, the reserve requirement is the amount of money that banks have to hold on reserve. The FOMC can change that, making it either easier or more difficult for banks to lend out money.
Open market operations are the buying and selling of Treasury securities, like bonds. When they engage in buying bonds, they are putting money in circulation. When they engage in selling bonds, they are taking money out of circulation.
The fed funds market and the discount rate are rates that banks have to pay to borrow. In the case of the fed funds market, they are borrowing from each other, whereas the discount rate applies when they are borrowing from the Fed. If the FOMC is targeting these rates and raising or lowering them, again, it makes it either easier or more difficult for the banks to access money and loan it out.
So, as we discuss them in other tutorials, think about how all of these tools will impact these components--M0, M1, and M2--of our money supply.
Source: Adapted from Sophia instructor Kate Eskra.