Question

a. What are the 3 functions of money? b. The one-dollar-bill in your pocket/purse is a fiat money. Why? c. List the 2 ways of measuring the money supply of the United States. In addition, list the components of each measurement of money supply. d. True or False : Of the 2 measurements of money supply, M1 is broader. (If you answer false, you must provide a corrected statement.) e. What is another term for time deposits? f. Fill in the Blank: Fifth Third Bank borrowed money from the Federal Reserve Bank of Cleveland. The interest rate charged by the Federal Reserve Bank is called _______________.

Answer 1

a) Money is a medium of exchange. Different economist money in different ways. But the most acceptable definition of money is the definition given by Crowther. According to him “Money can be defined as anything that is generally acceptable as a means of exchange and that at the same time acts as a measure and store of value”.

The three important functions of money are 1) Medium of exchange, 2) Measure of value and 3) Store of value.

Money has removed the problem of ‘double coincidence of wants’ under barter system. A person can sell his goods for money and he can use that money to buy the goods he wants from others. Thus money facilitates the process of exchange.

Another important function of money is that the money serves as a common measure of value or a unit of account. With money the value of different goods and services can be measured and their relative values can be easily compared.

Thirdly money acts as store of value. Money is the most convenient way of storing wealth without causing deterioration or wastage.

b). Unlike gold and silver, the fiat money does not has an intrinsic value. Its value is promised by the government. One dollar in your pocket is a fiat money since it does not has an intrinsic value. Its value is imputed by the Federal Reserve.

c) The Federal Reserve Bank measures money supply as M1 and M2. M1 includes coins and currency in circulation, checkable or demand deposit and traveler’s cheque. M2 includes M1 and savings and time deposits, certificates of deposits and money market funds.

d) M1 is a narrow definition and measure of money supply. A broader definition and measurement of money supply is M2 because it includes everything in M1 and it adds other types of deposits like savings deposits in banks, money market funds, certificates of deposits or time deposits.

The savings deposit in the banks can be easily withdrawn from the bank or from a teller machine. The money market funds such as shorter bonds can be easily converted into liquid cash by selling them at a price lower than its par value. The time deposit is tagged to a fixed period of time. But this can be withdrawn immediately by paying a penal interest to the banks. In short M2 is a broader measure of money supply.

e) The term deposit is otherwise known as time deposit or fixed deposit. This deposit is known so because this deposit can be withdrawn after the expiry of a fixed period of time and the amount deposited is fixed. Since the time and amount is fixed, it is known as time deposit or fixed deposit.

f. The rate charged by the central bank for lending funds to commercial bank is known as the bank rate.

Answer: Bank rate.