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Money - Malavika Nair

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Money - Malavika Nair

  1. 1. MONEY Malavika Nair Assistant Professor of Economics
  2. 2. What is Money? • Money is neither a consumption good nor production good- it is unique. Certain issues need to be addressed while trying to apply subjective theory of value to money. • Money is what money does: 1. Medium of Exchange 2. Unit of Account 3. Store of Value
  3. 3. Why use money? • Monetary or Indirect Exchange versus Barter or Direct Exchange. Why introduce an extra step into trading when you could directly barter for what you really want to consume? • Problem of the double coincidence of wants. Example: Mr. Smith grows wheat and would like to buy candles. Mr. Jones has candles but doesn’t want wheat.
  4. 4. How does money emerge? • Menger on the origins of money: • Money emerges spontaneously out of market process to overcome problems in barter • Most saleable or marketable commodity will have advantage to emerge as medium of exchange • Once established, pure monetary demand will kick in further reinforcing use as money
  5. 5. • Implications of Menger’s theory: • Government does not “create” or legislate money into existence, peoples’ actions do. • Explain the emergence of money completely through individual actors’ decisions on the margin, without recourse to omniscient overarching power: simple, elegant yet powerful.
  6. 6. Money through history • Salt, Cattle, Shells, Tobacco, Beads, Cigarettes • Metallic money: Copper, Silver, Gold (Advantages: non-perishable, easily standardized, portable, expensive to mine, malleable and divisible) • Banknotes, paper money and digital money
  7. 7. The Value of Money • Subjective theory of value: 1. exchange goods for goods (use value) 2. exchange goods for money(exchange value) • Problem of circularity: subjective value of money depends on money prices of goods and money prices of goods depend on subjective value of money
  8. 8. Mises’ Regression Theorem • Not a circular problem • Subjective value of money (at time t) depends on money prices of the immediate past ( at time t – 1) • Money prices of immediate past (t -1) depend on subjective value of money at t – 2. • Temporal sequence, not circular
  9. 9. • Implications of Mises’ Regression Theorem: Keep pushing back the problem of subjective value of money back to barter. Subjective value of money initially emerges out of use value in barter. Ties back into Menger’s account of the origin of money.
  10. 10. Role of Banks in money creation • Money Substitutes: immediately redeemable claims to money that can act as substitutes for money • Money is unique: claims to money are technically capable of performing functions of money, unlike other goods. • Banks thus have role in creation of money: through the issue of money substitutes
  11. 11. • Warehouse banking: goods or money deposited for safe-keeping. Money substitutes in the form of warehouse receipts. Money redeemable at any time. • Credit or loan banking: money lent to bank that loans it out further and promises interest return. Money redeemable only after fixed period of time.
  12. 12. • Fractional Reserve Banking: can arise in two ways • Bank over-issues warehouse receipts thus effectively creating fractional reserve of money • Bank lends redeemable checking account balances either through issuing bank notes or creating new checking accounts
  13. 13. • Fiduciary Media: Mises defines fiduciary media as unbacked (by base or commodity money) claims to money in circulation. • Banks are thus intimately involved in the money creation process through their power to issue money substitutes • Role in Business Cycle theory
  14. 14. Money and the State • Commodity Money: Gold or Silver standard (most of history) • Fiat money (relatively recent, post 1971) • Commodity standards place natural limits on governments’ ability to influence money, pure fiat money gives governments much more discretion
  15. 15. • Kings controlled the mint: melt down metal and stamp coins with royal seal • Debasement: clip coins and make them lighter, while face value remains the same thus increasing king’s revenue • As long as there is a free market for the metal, full bodied coins become undervalued and disappear out of circulation • Gresham’s Law: Bad money drives out good money
  16. 16. • Classical Gold Standard (1870-1914) • Dollar defined as 1/20th of an ounce of gold • Banks issue notes redeemable in gold • Even in the presence of central banks, gold standard causes outflow of gold reserves in any country that over-issues notes, thus checking against it. Price-specie flow mechanism.
  17. 17. • Fiat Money and Central Banks • No check on money creation other than threat of high inflation • Central Bankers more akin to Central Planners: charged with checking inflation, maintaining interest rates and full employment. • Recent crisis led to unprecedented actions on Fed’s part: “too big to fail”, bailing out insolvent banks, propping up firms that should fail.