Money, Banking, and International Financeissues in Chapter 5). The M3 definition contains the amount of U.S. dollars held outside the
United States.
Which definition of the money supply is the best? Four monetary aggregates grow at
different rates, at different times, and even in different directions. Before 1981, a stable
relationship existed between M1 and GDP, but the government had begun deregulating the
financial markets during the 1970s and early 1980s, obscuring this relationship. Currently, many
economists use the M2 definition of the money supply to explain changes in the GDP, inflation,
and employment. Accordingly, the Fed does not formulate M1 targets and concentrates on M2
instead.
Key Terms
financial market
financial institution
information
risk
liquidity
money
money supply
central bank
Federal Reserve System
Fed
monetary policy
inflation
business cycle
Gross Domestic Product (GDP)
interest rates
nominal GDP
real GDP
barter
double coincidence of wants
medium of exchange
specialization of labor
unit of account
store of value
purchasing power
legal tender
standard of deferred payment
currency
commodity money
full-bodied money
seigniorage
representative full-bodied money
fiat money
hyperinflation
check
debit card
automated teller machines (ATM)
Bitcoin
clearinghouse
transaction approach
liquidity approach
M1
M2
M3
LChapter Questions
- Identify the purpose of financial markets and financial institutions.
- Which advantages do financial institutions provide when compared to the financial markets?