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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
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 2
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
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 3
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 Goodhart
born 1936
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 4
Introduction
“Money is what money does. Money is defined by its functions.”
John Hicks
John Hicks 1904-89
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 5
Functions of money
• Medium of exchange
• Unit of account
• Store of value
• Payment function
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 6
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”.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 7
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.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 8
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.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 9
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.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 10
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
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 11
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
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 12
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.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 13
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.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 14
Historical development of the forms of money
• 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”.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 15
Historical development of the forms of money
• 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
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 16
Historical development of the forms of money
• 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
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 17
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
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 18
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”
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 20
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)
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 21
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.
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 22
Function and Structure of Financial Markets
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
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 23
Function and Structure of Financial Markets
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
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 24
Function and Structure of Financial Markets
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
Paul Bernd Spahn, Goethe-Universität Frankfurt/Main 25
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.
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