III Currency

Currency. The money you are most familiar with, currency, consists of the paper money and coins that you use almost daily. Currency is legal tender. This means the law requires that it must be accepted in payment for a debt.

Demand deposits. The largest single component of money supply is listed under the heading demand deposits. Demand deposits are checking accounts held by commercial banks. They are called “demand deposits” because they are available “on demand” simply by writing a check. Commercial banks, which are used by both business and the general public, do most of the nation’s banking business. But why are checking accounts listed as a component of the “money supply”?

The answer takes us back to our definition of money, which is anything that is generally accepted in payment for goods and services. Since checks are generally accepted (they are virtually the only form of payment used by business), they are a form of money.

The value of checks an individual or firm can write depends on the amount of money on deposit in the checking account of that individual or firm. Thus, the total amount of checkbook money available at any point in time is equal to the total of all demand deposit.

Other checkable deposits. A checkable deposit is one that enables the depositor to make withdrawals and payments by check. Most savings banks, savings and loan association, and credit unions offer check-writing privileges with some of their accounts. These comprise the second largest component of the money supply.

Traveler’s checks. Traveler’s checks are checks sold in a variety of denominations by bank and travel agencies. Buyers pay the face amount of the check plus a small fee for the service. Traveler’s checks owe their popularity to the fact that, unlike cash, they can be replaced if they are lost or stolen. The $8 billion in travelers’ checks is the smallest component of the money supply.

Give the definition of every kind of deposit.

IV What are the causes of inflation?

Demand-pull inflation. A situation in which there is “too much money chasing too few goods” is often described as demand-pull inflation. When demand increases faster than industry’s ability to satisfy that demand, prices will increase. During the Vietnam War, for example, government spending for military goods served to increase the purchasing power of many Americans since it was not accompanied by a tax increase. Meanwhile, factories that might have been producing consumer goods turned to the production of goods for use in the war. The result was the increase in the demand for goods and services at the very time that industry’s ability to satisfy that demand was being redirected. Since it was mot possible to increase output to satisfy demand, prices rose.

Cost-push inflation. A period of rising prices due to an increase in the cost of production is called cost-push inflation. When, for example, labor unions win wage increases greater than workers increases in productivity, management may choose to raise prices to maintain profits. With prices going up, other unions and workers might demand wage increases to keep up with the increased cost of living, and so on, in an inflationary spiral. Similarly, efforts by producers to increase profits by increasing prices rather than by reducing costs could also trigger an inflationary spiral.

Although “demand-pull inflation” and “cost-push inflation” explain how certain round of inflation begin, there are other factors to consider. Sometimes, for example, sudden unexpected shortages of a basic commodity can cause price increases. This happened in 1974 and 1980 when OPEC oil boycotts ran the price of petroleum up to record levels, creating severe cost-push inflation.

Explain the difference between demand-pull inflation and cost-push inflation.