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Monetary Policy July 14, 2010

Posted by petrarcanomics in Role of Government.
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Measures of Money

Medium of exchange means money must be accepted by people when they buy and sell goods and services. Standard of value or unit of account means money must be useful for quoting prices. Store of value means money must be durable so it can be kept for future use.

M1 includes paper currency and coin, demand deposits, and other checkable deposits and travelers checks. (Primarily used as a medium of exchange.)

M2 is everything included in M1 plus the amount held in savings and small time deposits, money market deposit accounts, and non-institutional money market mutual funds and certain other short-term money market assets. (M2 includes items that are used as a store of value.)

M3 includes everything in M2 plus a number of financial assets and instruments generally employed by large businesses and financial institutions. (M3 includes items that serve as a unit of account.)

Monetary Equation of Exchange

MV = PQ

  • M = the amount or stock of  money in circulation
  • V = the income velocity of circulation the average number of times a dollar is spent on final goods and services per time period (usually one year)
  • P = the average price level of final goods and services in GDP (the GDP deflator)
  • Q = real output which is the quantity of goods and services in GDP
Milton Friedman
Milton Friedman

Monetarists such as Milton Friedman believe that the rate of increase in the money supply has a big impact on inflation and growth in the economy.

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