Macroeconomics Study Set 64

Business

Quiz 8 :
Money, the Price Level, and Inflation

bookmark
Unbookmark

Quiz 8 :
Money, the Price Level, and Inflation

Money has been recognized as a measure of settling of debt which, in turn, implies a means of payment that is acceptable universally. Apart from medium of exchange, money serves a very important function of store of value. It's another function is to serve as a unit of account. In the United States, money comes in two forms: Currency and Deposits at Banks or other depositary institutions. A credit card, a checkable deposit, and other measures cannot be readily serve as a means of payment since there are conditions attached to their usage. Hence, cash available in Bank's cash machines and the U.S. dollar bills are a form of money but Credit card and loan for school fee payment are not money.

Note that M1 consists of currency in circulation, traveler's checks, checkable deposits, savings and loan associations, saving banks and credit unions. In contrast, and in a broader way, M2 consists of M1 with the addition of money market mutual funds, time deposits, and savings deposits. These two measures are official measures of money supply in the United States. Given that currency in circulation was $1,124 billion, traveler's checks were $4 billion, checkable deposits were $1402 billion. There are no savings and loan associations, saving banks and credit unions. Hence, the total amount of M1 is the addition of money available in these three categories which amount to $2,530 billion in June 2013. As mentioned, a broader way of money supply is M2. This consists of M1 which was $2,530 billion with market mutual funds amounting to $647 billion, time deposits being $583 billion and savings deposits amounting to $6,884 billion. This gives the total of M2 measure of money as $10,644 billion.

A commercial bank operates in order to earn profit, just like any other firm. This profit is the difference of the interest amount it receives from lending and the interest that it pays on deposition. The bank cannot always earn profits; at time when there are losses, banking functions have to be carried out. It is in these adversities that the banks must hold a minimum capital to continue its operations. This capital is the portion of total liabilities of the bank that it does not require to repay. This is available to the bank when the value of assets possessed by it declines and there is a possibility of capital loss. The more such capital is held by the bank, the more it would be safer for the bank as it will cushion the bank from a financial shock.