Difference Between M1 And M2

1550 Words 7 Pages
Devin Ray
Professor Song
Economics 1A
7 December 2017
Essay Number Two (2)
Question 1: What is money? What are the differences between M1 & M2? And how do money-market mutual funds differ from M1? Money, as defined by the textbook, “is the set of assets in the economy that people regularly use to buy goods and services from each other.” (text, Ch. 11-1) This definition of money shows the traditional usage of money as exchanged by individuals and firms, however, there is much more to money than just being used as a medium of exchange. Money, in addition to being used as a medium of exchange between buyers and sellers, is used as a unit of account and as a store of value. Money is used a unit of account in that we know the cost of goods
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But what would happen if banks could make loans at will? If banks could loan money “whenever they felt like” loaning money, the bank would most likely base its decision for loaning money on an individual’s credit and likelihood of the individual paying off the loan in full. However, by allowing banks to issue loans as they please, there would also be an increased risk for any individuals keeping their money in a bank. If you look at the situation in 2008 where the market collapsed, in large part, because of greedy banks and people not being able to pay off their home loans, you see that many banks loaned money out to individuals that simply couldn’t pay them back to begin with. This type of a crash leads banks to be stingy with their money and only give out loans to individuals with amazing credit scores. This situation leads to the belief that if banks don’t rely on set reserves before giving out loans, another crash such as the one in 2008, could lead many banks to go belly-up. Reserve requirements in a bank function to absorb the shocks that come with loans “going bad” or depositors wanting their money back. Leaving reserve requirements out of the picture and allowing banks to make loans at will would lead to a high-risk situation within the bank and would most likely lead to the bank going bankrupt if the market recedes. This is due to the fact that during a recession, people go to the banks to withdraw money that the banks don’t have since their loans are unpaid. In other words, it would be incredibly unwise to allow banks to make loans at will and banks should always keep a fraction of deposited money as

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