The Definition of Money

Lecture 1

Copyright, 1996 © Dale Carnegie & Associates,

 Introduction
This lecture examines the definition of
money.
What is meant by money?
Why is it important that we define it
correctly?
What are the problems associated with
measuring money
 Financial Innovation &
Deregulation
• Global markets have seen financial
innovation and deregulation.
• This has led to the breakdown in the
traditional relationships between the
measures of money and economic activity.
• This has raised the issue as to what is meant
by money.
 Definition - a procedure
• One of two procedures.
• Attach labels to real world objects -
Nominalist.
• Attach labels to concepts and then search
for the corresponding real world entity -
Empiricist.
 Characteristics of Money
• Medium of Exchange - (concrete)
• Unit of Account - (abstract)
• Store of Value.
• “Nothing is more ultimate than money.
Instead of going out of existence, unwanted
money gets passed around until it ceases to
be unwanted” Yeager
 Artificial historical
framework
• Commodity money - problem of jointness
• Localised issue - reputation
• Government issue - legal tender
 Forms of money
• No generalised market for titles - (Paul
Davidson)
• Legal restrictions - (Neil Wallace)
• Means of Final Payment - (Charles
Goodhart)
 Liquidity
• Separation of money from other assets is its
superiority in liquidity
• potential to liquidate - use in transactions
• term to maturity - low capital risk
 Pesek and Saving -1
• Money is contrasted with debt. Debt pays
interest while money does not. Debt is
Inside money
• Non-interest bearing deposits are an asset to
the holder but a liability to no one, while
interest bearing deposits are a debt like a
bond
 Pesek and Saving - 2
• Interest payment on deposits loses its
property of ‘moneyness’
• Demarcation between ‘money’ and ‘debt’
• moneyness measured by (rd-rm)
• debtedness measured by rd
 Critique
• Friedman & Schwartz - transactions
services have become a ‘free good’,
available without cost to the holder
• ‘moneyness’ is a joint product with
‘debtedness’
• Newlyn suggests - criterion of ‘neutrality’
Empirical measures - Constant
Elasticity of Substitution
technology

 
1
ˆ 
M  M 1  M   1 
2
Other empirical approaches
- Laumas

n k
Y    i M 1t i    j M 2t  j
i 0 j 0
 Divisia - 1
• di - rate of growth of the ith medium of
exchange
• Di - stock of the ith medium of exchange
• marginal cost = interest income foregone =
‘user cost of money’
• wi = DiUi and Ui = Rmax - Ri
 Divisia - 2

m
 ii
w d
i  1,2,....n
 i
w
 Divisia - 3

Asset Net interest cost

Notes and Coin Treasury Bill Rate
Non-interest bearing demand deposits Treasury Bill Rate
Interest bearing demand deposits TBR – Demand deposit rate
Time deposits TBR – Time deposit rate
Building Society deposits TBR – BS share rate
Treasury Bills TBR – TBR
 Conclusion
• The definition of money has become
important for 2 reasons
• 1 Trends in financial innovation have
blurred the distinction between money and
non-money
• 2 measuring money is important for policy
How can the emergence of
money be explained?
• Money must emerge as an optimal
exchange system from a world of barter.
• What are the specific properties of money
that make its use general?
• Money is a social phenomenon - exists only
in societies where exchange takes place.
 Classical View
• Money exists on efficiency grounds.
• The problem of double coincidence of wants
• The search for a trading partner involves
costs. The longer the search time the lower
the transaction cost.
• But the longer the search time, the higher the
waiting cost
A Dynamic Model by
Niehans - Assumptions
• All exchanges involve transactions costs
• lower transactions costs involved with using
good xn
• The greater the frequency of exchange, the
lower the transactions cost.
U  U ( x1 , x2 , x3 )
E  Z
x1 Ex2  { x1 , x2  Z }
x1 Ex2
x1 Ex3
x2 Ex3
Efficiency gain for n good
world

1
2 n( n  1) •Trades
with barter

n 1 •Trades with
money
 Clower – Cash in Advance
Model
• Goods buy money
• Money buys goods
• But goods do not buy goods
• How can the Classical transactions costs
approach give us Clower’s result?
 Evolution of Money

• By assumption 1 – all transactions incur costs

• By assumption 2 – a) x3Ex2 and b) x1Ex3 incur
lower costs than c) x1Ex2
• Therefore a) and b) will be more frequent than c)
• By assumption 3 the costs of a) and b) will fall
relative to c)
• In the limit c) dissappears
 Niehans – Evolution of
Money
•x2

•E

•x1