[MUSIC] To understand monetary policy, we first have to understand some of the terms that we use, and the big one is, what is money? We may just think, well, that's obvious right? It's the cash you pull out of your pocket, but the definition of money, can very widely, in general, we consider anything to be money that you can use as a standard of exchange, or you can use as a store of value. So over history there have been a lot of different kinds of money ranging from shells to the salt blocks that were used in Sub-Saharan Africa. And when we talk about money in our times, we're normally talking about different aggregates, so we add up different kinds of money that are used in our cash-based economies. The first one is something we call M0, so we're working with concentric circles here. M0 is all the currency and all the coins that circulate in an economy at any given time, and then we go a little bit wider and we go to M1, which is currency and coins, plus the money we have in banks that we can spend immediately, in what we call maybe demand deposits or checking accounts, or site deposits, money that you can actually spend using your debit card or writing a check, or that you can withdraw from the bank and then immediately spend in a store. So this is M1, and then if we take this concentric circles out further, we come to M2, and M2 includes, of course, all of the previous. So it includes M1, which itself includes M0, plus savings accounts which are accounts that where we put the money but we can't spend it directly, so usually there's some sort of restriction on the account., You have to go to the bank and take it out and technically they could ask you to wait up to three days, or maybe it's an account that you can only write a number of checks on a month, so there's some kind of restrictions that make it not as liquid as M1, and then we continue to move outward and we see other assets. Each kind being a little less liquid. The criterion is, can I spend this directly? If so, it's M1. If I can't spend it directly, how hard is it to convert it into M1 for spending? And so, we move out. To M2, M3, some countries track M4. On this slide, here, you can see a picture of these monetary aggregates in Europe up until the crisis. Now, in the crisis, as we'll be seeing, a lot of interesting things started to happen to money, so I've stopped it here just as, as the crisis begins, but you can see on this chart, the yellow line at the bottom is what we might call M0. Alright, that's just cash and paper money and currency circulating in the countries that form the Euro zone, that share a currency in Europe, and so you can see M0 is actually very small. Then the next area, which is sort of a purplish blue, is M1 or the purple blue area plus the yellow is M1, so M1 again including not only cash, but the money that we have in banks that we can spend immediately. And then you can see when we add the red area to the blue and the yellow, we get M2, and M2 includes deposits with agreed maturity up to two years, plus deposits redeemable of a period of notice up to three months as you see on the chart. So this is, these are savings that can't be spent directly, but can very easily converted into M1 to be able to spend. And then you can see M3 which would be the black, the red, the purple, plus the yellow, and M3 has other kinds of, of money which have to be converted before they can be spent. So the idea is, authorities somehow have to keep track of how much money is washing around in the economy, because it could be quickly spent. If there's too much of it then probably the number of goods being produced in the economy can't rise fast enough to meet this amount of money, and so we might have an inflation problem. So with money supply, what the monetary authorities have to do is get the amount right so that it's enough to buy our GDP, it's enough to allow some growth, but it's not so much that inflation begins to accelerate. Okay, so it's much harder than it seems to get the money growth, or the money supply right. So, who takes care of the money supply? Well, we have some institutions, which are called central banks. Now, in the United States, suddenly, there's been a lot of conspiracy talk about central banks, but in most countries, we don't know a whole lot about them. Central banks are public institutions. They're sometimes owned by the government, sometimes owned by the private sector, but they are institutions that an easy way to think about it is, they do the same thing for commercial banks, for the banks in our banking system, as those banks do for us. In other words they lend them money when they need them. They hold extra cash for these banks when these banks don't need them, and they kind of keep an eye on them to make sure that they're following reasonable policies, that they're not being too risky. In much the same way that a cen, a commercial bank might watch us, and would lend money to us and take our deposits. Now, one thing that's important about these central banks is that they should be removed from politics we say that they're independent, alright? What independence actually means is kind of tricky, and so there's lots of literature on this of, you know, which central banks are most independent, but in general we consider a central bank to be independent. Number one, if its leaders and its decision makers are removed from the political cycle, so they're appointed in time periods that don't coincide with, say, presidential election or other national elections, right. So they're out there and they have a long tenure, 14 years in the United States, and so they can think for themselves. So that's one thing that makes them independent. Another thing that makes them independent, and this becomes very important when you think about our last weeks session in monetizing the debt is, if they're independent they cannot lend to the government, alright? So they, the government cannot go to these central banks and say, I need some money. Print it and send it to me for my spending needs. They are separate. The government doesn't talk to them. They don't talk to the government. And they certainly cannot lend to the government if they're independent. So these are some important criterion for Central Banks, criteria for Central Banks to be considered independent. Another one, and here we see differences among some other Central Banks of our time is, that they have some very independent target that they work with. Now, in many cases, this target is the inflation rate. Okay, so there are some central banks whose only job, according to their charter, is to keep inflation low and stable in the countries that they oversee. Now, not all central banks are like that, so we have two different groups, we might say, of central banks. One group has a single mandate, we say. That means they only target inflation. Now, the most prominent of those banks with a single mandate is the European Central Bank that we'll be talking about in a moment. There are another group of banks that we say have a dual mandate. That means they target inflation, but they also target GDP growth, and they think in some cases about the unemployment rate. Now banks that are like that are, for example, the Fed, which is the central bank of the United States. Right now, they're actually targeting the unemployment rate in their policy-making. The Bank of England is like that as well. Which, these are banks that have sort of a broader policy objective, than simply keeping inflation low and stable. [MUSIC] [BLANK_AUDIO]
