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Main content
Current time:0:00Total duration:10:04
MEA‑3 (EU)
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MEA‑3.C.4 (EK)

Video transcript

what I want to explore in this video is the different ways of measuring the amount of money we have in circulation so we're going to start things with our central bank in the US this would be the US Federal Reserve and let's say that they print let's say that they print $4 and we're going to focus just for visualization purposes on that they're doing it physically they could also do it electronically but we're just going to focus on the physical and the way that they get this into circulation is that they'll take these four dollars and they'll go buy securities in the open market normally very safe and very liquid securities liquid means it's very easy to buy and sell those securities and large quantities for example government Treasuries is a liquid security or liquid asset Pez dispensers would not be a liquid asset if I bought a billion dollars worth of Pez dispensers it would be very hard for me to set what would be very hard for me to buy a billion dollars worth and would be even probably even harder for me to sell a billion dollars worth in in any short or medium timeframe so the central bank goes out and let's say they go and buy one liquid security for $4 so this is the security right over here and the person that they bought the security from decides to deposit it in a bank they could either directly deposit in a bank or they could use that money that they got from selling their security to buy things and the person they bought things from could deposit in a bank but one way or another we can imagine that it all gets deposited in the bank so this is our private bank I'll call this private bank number one so now all of these dollars are transferred they are all transferred to private bank private bank number one and they are no longer the Federal Reserve or the central bank in the general case is no longer in possession of them they've been transferred right over here and I want to cross these out just so that we can make we can keep track of things now when they deposit it in private bank number one they said well I need three three of these dollars on demand and I want to write checks against them so they put three of these dollars in a checking account they write three of these dollars in a checking account so checks up to so write write checks checks up to up to three dollars and so they can get a little bit more interest in the banks willing to give a little bit more interest on an on a savings account because they don't have to keep the reserves they put $1 into a savings account $1 into a savings account and they cannot write checks against that savings account now there are special circumstances now but for simplicity let's just make let's just say that they cannot write checks there are some that have restricted check writing and things like that now so this this Bank says okay well this dollar I don't have to have even have any reserves against it I could loan out this dollar and the person they lend it to let's say that they immediately go and deposit it into another bank so they immediately go and deposit this in private bank I'll call this private bank too so it's no longer in private bank 1 let me draw a private bank to private bank 2 is right over here private bank number 2 and they deposit it into a savings account in private bank number 2 and let's say all of this out of all of this the bank says well this is it on this is a demand deposit I have to keep some reserves this is a fractional reserve system but I can lend out in the u.s. I could lend out up to 90% of this let me be this banks a little bit more conservative they only lend out two-thirds of this so they lend out two out of these three dollars now let's say that a person they lend it to also happens to deposit it in private bank number two just coincidentally so these these two also end up in private bank number two and so they are no longer they are no longer in private bank private bank number one all this person can still write checks up to $3 and now here in private bank number two and let's say these are deposited in a checking account these are deposited right over here in a checking account now private bank number two it can do a couple of things in this checking account it has to keep some reserves let's say it's even more conservative it only decides to lend out half of this even though it could lend out 90% and so it lends out it lends out one of these dollars and the person that they lend it to just takes that dollar and they put it in their wallet so they just put it in their wallet and they could also lend out this entire savings and let's just say that the person that they lend that one dollar and savings to also puts it in their wallet also puts it in their wallet and notice the original $4 are still there one two three four now and just to be clear this person right over here can write checks up to three dollars and this person right over here could write checks write checks let me do that same check checking account color they can write write checks up to two dollars up to two dollars now let's think about the different forms of money there are here well we could think of money in a very very narrow way which is just what did the central bank print or create electronically as electronic reserves of its member account of member banks but for simplicity here you can just think about the physical currency that it printed its base money and so that an often term it's just referred to as base base money and in the US and other countries it's often the same thing as m0 there's slight differences from country to country and in this example as soon as they printed it put into circulation that was four dollars we had four dollars of base money and that's obvious because as soon as you they printed this and they bought the security with it and it was in circulation that four dollars could be used to buy things it could be used to facilitate transactions now that clearly isn't all of the stuff that can be used as money in this little universe we created this guy you have the four dollars but these people can also write checks right over here and so we can have a slightly broader definition of money and over here we will call it m1 and here there's a couple of ways you could think about it you could think about it is all of the currency that's in people's pockets plus all of the cheque writing capabilities so if you view it that way it would be this two dollars plus five dollars of check writing capabilities right over here so you could have two dollars of physical currency that's in people's wallets not in bank reserves plus plus the five dollars of check writing capability plus five dollars of check writing capability which would give you seven dollars another way you could view it you could view it as M 0 M 0 plus checkable deposits plus I'll just write checks here plus check while right checkable deposits but if you do that you are now double counting because some of the m0 is reserves in the checkable deposits where AG you should say some of the checkable deposits is held as reserves for m0 so then you would have to subtract out the bank reserves the reserves reserves and so then you would get $4 because we don't want to double count these right over here you would get m0 is $4 and I want to do that in white M 0 M 0 is 4 dollars the checkable deposits is is $5 is let me do that in the pink plus the $5 and then you would want to subtract out the reserves and the reserves here there are two dollars of the reserves so - two dollars - two dollars and you would get yourself back to get yourself back to the $7 and the whole point of this is so you're not double counting something you're not double counting this right over here as part of checkable deposits and part of and part of the the m0 you're not you're not using this twice so it's not part of the basement it's it is both base money and checkable deposits and we don't want to count it twice so and the simplest way to think about is well what can be used in this broader definition to facilitate transactions these two dollars in people's pockets and this ability to write up to five dollars of cheques so that's this view right over here and if we want to get an even broader than that we can get to something called m2 and here we could say okay what's immediately usable as to facilitate a transaction right now so that would be our m1 so that would be our seven dollars of m1 plus things that can be easily converted to m1 so for example these savings accounts can be easily converted to checking accounts they don't might only take a couple of days there might be some restrictions but it can be converted when it gets converted it will change the bank's reserve requirements a little bit but it will allow if this person converts it they will have the ability to write more checks so m2 includes m1 plus things that are very easy to convert to m1 and so they'll include things like savings accounts savings accounts money market accounts which I won't go into detail here but they are really kind of similar that you get slightly higher interest but they're restrictions on your ability to access it but it's not too hard to turn it into checking accounts and things like and small dollar value time deposit CD accounts but for the sake of simplicity in this example it would be the saving accounts so it would be our seven dollars of m1 seven dollars of m1 plus the two dollars of savings accounts right over here plus the two dollars of savings accounts so this is just to give you a picture when someone talks about the money supply you really have to say well what are you talking about the the most typical one is that you're really talking about m1 because this is the stuff that's directly usable to facilitate transactions things like the ability to write a check or dollar bills in someone's wallet but they might be talking about base money m0 narrow money all ways of referring to the same thing especially in the United States or they might be referring to something even broader and there are broader definitions even than m2 although m3 they've stopped reporting about it but m3 would have things that are a little bit further from being true money from being a checking account but they are already fairly liquid and so they'll include other types of assets but the Fed has stopped reporting this in the in the recent past so these are the ones that are typically referred to