[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Traveler’s
checks
$7.5
Other
$744.9
Large
saving
deposits
$884.7
Money market
mutual funds
(institutional)
$1,102.6
A
M1 (Billions, US$)
Checking
accounts
$615.6
Saving
deposits/
money market
accounts
$3,144.9
Money market
mutual funds (gen)
$806.8
Currency
$664.0
B
M2 (Billions, US$)
M1
$1,287.1
Small saving
deposits
$805.8
C
M3 (Billions, US$)
M2
$6,044.6
Figure 28.5
THE MEASURES OF MONEY IN
2003
The money supply can be measured in
many ways, including M1, M2, and M3.
SOURCE: Economic Report of the President (2003),
Tables B-69, B-70.
hard to change these funds into either currency or a checking account, so that you
can pay for the shirt with cash or a check. A car is a much less liquid asset; if you
want to convert your car into cash quickly, you may have to sell it for much less
than you might get if you had more time.
A third measure of the money supply, M3, includes everything that is in M2 (and
thus in M1) plus large-denomination savings accounts (more than $100,000) and
institutional money market mutual funds. M3 is nearly as liquid as M2. In late 2003,
M3 totaled $8.7 trillion.
Table 28.2 provides a glossary of the financial assets used in the various definitions
of money, and Figure 28.5 shows the relative magnitude of M1, M2, and M3.
MONEY AND CREDIT
One of the key properties of money, as noted, is that it is the medium of exchange.
However, many transactions today are completed without any of the elements of
the money supply presented in M1, M2, or M3. They involve credit, not money. In selling
a suit of clothes or a piece of furniture or a car, stores often do not receive money.
Rather, they receive a promise from you to pay money in the future. Credit is clearly
tied to money; what you owe the store is measured in dollars. You want something
today, and you will have the money for it tomorrow. The store wants you to buy
today and is willing to wait until tomorrow or next week for the money. There is a
mutually advantageous trade. But because the exchange is not simultaneous, the
store must rely on your promise.
Promises, the saying goes, are made to be broken. But if they are broken too
often, stores will not be able to trust buyers, and credit exchanges will not occur.
There is therefore an incentive for the development of institutions, such as banks,
that can ascertain who is most likely to keep economic promises and can help ensure
that such promises are kept once they have been made.
When banks are involved, the store does not need to believe the word of the
shopper. Rather, the shopper must convince the bank that he will in fact pay. Consider
a car purchase. Suppose the bank agrees to give Todd a loan, and he then buys the
car. If he later breaks his promise and does not pay back the loan, the car dealer is
protected. It is the bank that tries to force Todd to keep his commitment. Ultimately,
the bank may repossess the car and sell it to recover the money it lent to Todd.
Modern economies have relied increasingly on credit as a basis of transactions.
Banks have a long tradition of extending lines of credit to firms—that is, agreeing
to lend money to a business automatically (up to some limit) as it is needed. As Visa
and MasterCard and the variety of other national credit cards came into widespread
use in the 1970s and 1980s, lines of credit also were extended to millions of
consumers, who now can purchase goods even when they lack the currency or
checking account balances to cover the price. Today, many can also get credit based
on the equity in their homes (the difference between the value of the house and
what they owe on their mortgage, which is the loan taken out to buy the house).
This type of credit is called a home equity loan. When house prices increased rapidly
in the 1980s and again in the 1990s, millions of home owners gained access to
a ready source of credit.
618 ∂ CHAPTER 28 MONEY, THE PRICE LEVEL, AND THE FEDERAL RESERVE