CFA Level 1

By Investopedia AAA

Macroeconomics - Money, Banks, and the Federal Reserve

I. Basics

Money is a part of everyone's life, and we all want it, but do you know how it gains value and how it is created? Check out the following link for more:

The following page will prime you for the topics discussed in this chapter:
What Is Money?


What Are the Functions of Money?
Money has three basic functions.

  • It acts a medium of exchange. If money did not exist, we would have much more complicated lives. If you wished buy bananas, you would need a barter arrangement where another party valued something you had and could also provide you with bananas. Anything can serve as money (ie. Coins, cigarettes, shells) as long as someone else will accept it as a medium of exchange.
  • Money is a way to store value. Although many things (land, gold, etc.) can serve as a store of value, money has one large advantage in the sense that it can quickly be converted into other goods. One problem with using money as a way to store value is that some forms of money do not pay interest. Another problem is that inflation destroys the value of money over time.
  • Money is also used as a unit of account. The values and costs of goods, services, and assets can be expressed as a unit of money. Prices expressed as money are used to help consumers make choices among numerous goods and services.

What is the Money Supply?
The supply of money is the amount of money available in a country; it is measured in many ways. The two most frequent ways to measure money are referred to as M1 and M2.

M1 is the narrowest definition of the money supply. It includes:

  • cash (currency) in circulation
  • checking accounts (demand deposits) - both non-interest earning and interest-earning
  • travelers' checks

M2 includes:

  • all components of M1
  • money market mutual funds
  • deposits in savings accounts
  • time deposit of less than 100K at depository institutions (banks, credit unions, savings and loans)

Using Commodities as Money
Problems that arise when using commodities include requiring a double coincidence of wants (does the person you want food from want your cigarettes?) and the difficulties in making price comparisons.

Look Out!
Within the context of our discussion, "Money" means anything that can be used in exchange for goods or services. It is not referring to currency (in the form of coins, dollar bills, debit cards, etc.) that modern societies use every day to purchase goods and services.
The Banking System

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