Azizah Isa1 TOPIC 4 MONETARY ECONOMICS. Azizah Isa 2 MONEY

Azizah Isa 1

TOPIC 4

MONETARY ECONOMICS

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MONEY

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In the ancient time, where money is not yet introduced,

transactions were done by exchanging one goods with another in a Barter System.

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Barter Trade System

• A barter system is a direct trading or exchanging of goods between one person to another.

• Barter system of course does not work successfully in a modern economy.

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Problems in Barter System

• Double Coincidence of Wants.

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• Double Coincidence of Wants.• Value instability

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• Double Coincidence of Wants.• Value instability• Storage are impossible

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• Double Coincidence of Wants.• Value instability• Storage are impossible• Indivisible

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• Double Coincidence of Wants.• Value instability• Storage are impossible• Indivisible• No Standard of unit of account

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• Double Coincidence of Wants.• Value instability• Storage are impossible• Indivisible• No Standard of unit of account• Difficulties in paying debt

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• Double Coincidence of Wants.• Value instability• Storage are impossible• Indivisible• No Standard of unit of account• Difficulties in paying debt

These problems may caused to:

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Problems in Barter System• Double Coincidence of Wants.• Value instability• Storage are impossible• Indivisible• No Standard of unit of account• Difficulties in paying debt

These problems may caused to: waste of time, inconvenience,

cumbersome and difficulties in making an

exchange.

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.Due to limitations in the Barter System,

Money is needed in a modern economy which act as a means of payment in the transaction of goods and services.

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WHAT IS MONEY?

HOW DO YOU DEFINE MONEY?

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Definition of Money

• Money can be anything that is generally accepted by the public as a medium of exchange in the transaction activities.

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Money act as a means of payment:

Money act as:a medium to transfer ownership of goods

and services from one person to another and for the repayment of debts.

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Evolution of Money

As time passed by, the money used varies accordingly to meet the needs and purpose of using money.

In the ancient time Commodity Money is used.For example;

gold, silver, stones, seashells, corns, wool and bones.

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Museum of Bank Negara Malaysia

The different types of commodity money.

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Commodity Money

In the use of gold, for example;

its:

Precious metal such as gold and silver had its

intrinsic value as a full-bodied money.

Thus, if its intrinsic value is stated on its face therefore it is said that:

Face Value = Commodity Market Value.

Intrinsic value = Commodity Market Value.

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Modern Money• But nowadays, in the modern

economy, there are many forms of money:

Fiat money

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2. Fiat Money

Face Value (FV) > Commodity Market Value (CMV)

o Example: coins and paper money (banknotes).o Although its FV is larger than its CMV, but still it

is acceptable as money because of the truth and faith in its acceptance as a legal tender in each specified country .

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• The Ringgit and Sen (as in the picture above) are issued by Bank Negara Malaysia (BNM) as a legal tender in Malaysia.

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Modern Money• But nowadays, in the modern economy,

there are many forms of money:

Fiat money

Bank money

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A form of Near Money – i.e. a financial asset which closely resemble money.

Examples: Current/Demand Deposits in banks (cheques),

Credit Cards, Debit Cards, Stored Valued Cards, Smart Card ATM Cards and Saving Accounts.

3. Bank Money

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Modern Money• But nowadays, in the modern economy,

there are many forms of money:

Fiat money

Bank money

Electronic Money

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4. Electronic Money/ e-money / e-purse / e-cash.

Transfer of money electronically made over the internet.The acceptance of electronic payment in the transactions via internet.Example: e-cash and e-cheques

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“Money is what money does”

• What does money can do for you?

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• MONEY can does its FUNCTION for you.

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What are the FUNCTIONS of MONEY ?

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Four Main Functions of Money:

As a Medium of Exchange

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As a Medium of Exchange As a Standard Measurement / unit

of account

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As a Medium of Exchange As a Standard Measurement / unit

of account As a Store of Value

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Four Main Functions of Money: As a Medium of Exchange As a Standard Measurement / unit

of account As a Store of Value As a Standard of Deferred Payment

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1. As a Medium of Exchange

• For transactions purposes – in purchasing and selling of goods and services.• It act as an instrument – to make payment or to

receive payment in the transfer of ownership.

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2. As a Standard of Measurement• Can be used in measuring the value of

goods and services in terms of its monetary value.

• Have a standard monetary units (RM) – as a unit of account.

For e.g. RM1, RM2, 0.50 cents 0.20 cents etc.

• Comparing relative value of goods and services transacted.

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3. As a Store of Value

• For saving purposes

– as a store of wealth.

• Has the ability to hold its value

– has the non-perishable

criterion.

• Can reserve for the purpose of future purchasing.

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4. As a Standard of Deferred Payment

• As a means of settling debts maturing in the future.

• As money acts as a unit of account and store of value, it makes easier to settle debt.

• Lenders make loans and buyers repay loans with money.

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As long as inflation does not exist in an economy, money may does its functions successfully.

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As long as inflation does not exist in an economy, money may does its functions successfully.

It is said that,

“money is what money does.”

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LETS THINK OF

• WHAT MONEY CAN BUYS?

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CAN MONEY BUYS

ANYTHING THAT YOU WANT?

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CAN MONEY BUY YOUR TRUE LOVE?

CAN MONEY BUY YOUR FRIENDSHIP?

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LETS THINK OF WHAT ACTUALLY MONEY CAN

DO FOR YOU?

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5 minutes rest ,

Please !

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Money as the Most Liquid Asset

• According to the Liquidity Approach : Money is the most liquid asset.

• All assets have some degree of liquidity, but some have more than others.

• Indeed, money is perfectly liquid although in the real world money is not absolutely liquid.

• Refer to a Simple Liquidity Spectrum.

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A Simple Liquidity Spectrum

More liquid

Less liquid

CASH (most liquid asset)

CURRENT ACCOUNT

OTHER BANK DEPOSITS

DEPOSITS AT NON-BANKS

SHORT-TERM SECURITIES

LONG-TERM SECURITIES

PHYSICAL ASSETS (least liquid asset)

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Liquid Assets and Near Money

• Liquid Assets refer to any financial instruments that can be converted into money easily.

• The most liquid asset is the cash – coins and notes.

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Liquid Assets and Near Money

• Near Money are those financial instruments or assets which are readily convertible into money.

• Examples are;

current deposits (cheques),

savings deposits,

short term bills.

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Categorization of Monetary Aggregates

NARROW MONEY

BROAD MONEY

BROADER MONEY

A Measure of Monetary Aggregates according to a Diamond Spectrum.

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NARROW MONEY, M1Also known as Transaction Money – can be used to make direct payments.M1 constitute of: Currency in Circulation (coins and paper money/notes/bank notes) Banks Till Money Current Deposits Traveler’s Checks issued by non-bank

companies. Other Checkable Deposits

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BROAD MONEY, M2M2 constitute of: M1 + Fixed Deposits Saving Deposits Repurchase Agreements (REPOs) Negotiable Instrument of Deposits (NIDs) Bank Negara Certificate all of which are held at commercial banks only.

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BROADER MONEY, M3 broader medium of exchange and as a store

of value. Constitute of:

M2 +Fixed DepositsSaving DepositsREPOsNIDs all of which are held at other financial

institutions.

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MONEY SUPPLY

Fiat money (coins and notes)Banks Till MoneyCurrent DepositsTraveler’s Checks.Other Checkable Deposits

M1

Fixed DepositsSaving DepositsREPOsNIDs

M2M3

Held at commercial banks only)

Held at commercial banks & other financial institutions.

Narrow Quasi Money (M2 – M1)

Broad Quasi Money (M3 –M1)

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Quasi Money

• Less liquid money which excludes the M1.• Consists of fixed and savings deposits and

other financial instruments offered by financial institutions, such as NIDs and REPOs.

• Narrow Quasi Money = M2 – M1• Broad Quasi Money = M3 – M1

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Exercise 1: Question To PonderITEMS RM mil

Coins 13,300

Fixed deposits in other financial institutions 26,880

Savings deposit in commercial banks 44,660

Fixed deposits in commercial bank 55,600

Negotiable certificates 25,000

Savings deposit in other financial institutions 25,580

Current deposits in commercial bank 30,650

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Calculate:

a. Bank Notes if Fiat Money is RM39,000 millions.

b. M1

c. M2

d. M3

e. Narrow quasi-money

f. Broad quasi-money

g. Give 4 functions of money.

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ANSWERS:

a. Bank Notes if Fiat Money is RM39,000 millions.

Bank Notes/dollars + coins = 39,000 mil.

Bank notes = 39,000 – 13,300

= 25,700 mil.

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ANSWERS:

b. M1 = fiat money/cash + Current deposits in commercial/cheques.

= 39,000 + 30,650

= 69,650 mil.

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ANSWERS:

c. M2 = M1 + Savings deposit in commercial bank

+ fixed deposits in commercial bank + Negotiable certificates.

= 69,650 + 44,660 + 55,600 + 25,000

= 194,910

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ANSWERS:

d. M3 = M2 + Fixed deposits in other financial institutions + Savings

deposits in other financial institutions.

= 194,910 + 26,880 + 25,580

= 247,370

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ANSWERS:

e. Narrow quasi-money = M2 – M1

= 194,910 – 69,650

= 125,260 mil.

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ANSWERS:

f. Broad quasi-money = M3 – M1

= 247,370 – 69,650

= 177,720 mil.

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FISHER’S QUANTITY THEORY OF MONEY

• is given by: the Equation of Exchange / Fisher’s identity MV = PT M = money in circulation V = velocity of money P = price T = number of transactions (goods produced).

Look in Manual, page 71: topic 6 (Inflation)

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• Fisher’s assume that V and T are constant in a specific period of time.

• Therefore, any changes to an increases in money(M) would lead to a higher increase in price (P) or inflation in an economy.

• Excess of money supply would caused to inflation.

Take this note

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• If, price increases by 10 %, Money supply will increase by 10% too.

• Fisher’s equation is given as an identity, where both sides must be identical.

• Therefore, there will always be a direct and same change of Money Supply with Prices (assuming that V and T are constant.)

Take this note

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Relationship of Money and Prices• When there is inflation (price rises), it is

said that , the value of money falls since the purchasing power of money falls.

• the purchasing power of dollar money is said to fall as price increases.

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Purchasing Power of Money

• is the ability of money that is used in acquiring goods and services.

• So, the Value of Money is determined by the quantity of goods and services you can purchased with it.

• If price rises, then a given sum of money will afford to buy less amount of goods and services.

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For example: with RM50 note here,

you can spent and purchased

5 flasks which cost you RM10 each.

RM10.00

Take this note

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For example:

with RM50 note here,

you can spent and purchased

5 flasks which cost you RM10 each.

But, let say now, PRICE RISES to

RM25 each.

Instead now, you can buy only 2 flasks.

RM25.00

Take this note

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• It is said that, when price increases, the

power that you have to purchase goods with the same amount of money that you have is said to be less now;

In other words, the value of money falls.Take this note

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Changes in Purchasing Power or changes in the

Value of Money

may affect money’s usefulness and its ability to serve all the main functions of money.

• Households lost their believe and acceptance of money if hyperinflation are expected to occur.

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Effects of Inflation on its Function:

May affects all the four main functions of money:Lost its ability as a role of a Medium of

Exchange – inflation reduced the purchasing power of money.

Affects its usefulness as a Store of Value –lost of trust and believe in savings money.

Defeat the function as a Standard of Measurement thus, cannot serve as a Standard of Deferred Payment.

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To Measure Value of Money

Price Index (PI) is used to measure the change in the value of money over time.

• If there is an increase in PI from 100 to 120 for example, it is said that inflation had rises by 20 %.

• As price increases (inflation), value of money falls. The higher the inflation the lower is the value of money.

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In Islamic perspective:

• cost for holding money is minimum.• Speculation purpose in Islam was still allowed

but is limited to certain condition following the Islamic principles.

• Demand for money for transaction purpose is because Muslims spends for sufficient expenditure only.

• Excess money is used for investment purposes.

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Islamic view regarding speculation• The Syariah Law of Islam provides detailed

instructions for the Muslims for conducting their business affair.

• In general, the requirements are as follows: a) All business transactions must be free

as possible from riba, gharar, unfair speculation, and deceit or dishonesty.

b) Production relations are based on the principle of trust, mutual benefit and cooperation.

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Risk takings:

• However, in Islam; speculation in the form of risk takings is still

being allowed - as to attain profit as well as for the benefit or welfare of the society.

• But, speculative activities that involve riba must be avoided.

• Muslims are not allowed to freeze their wealth. The objective of risk taking or investment is

not only to attain profit but Islam emphasis on the welfare of the society.

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Riba is prohibited

• Speculations must not have any element of riba.

• It refers to the excession to wealth and an addition to the principle or capital stock or increment on capital, such as the interest payment on the principle savings and interest-bearing credits available that sometimes is expensive than they could afford which denied the aim to serve for the welfare of the society.

•

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“Gharar” sale

• The “Gharar” sale is a kind of sale in which uncertainty is involved,

• such as the sales of goods and services they have not produced.

• It involves speculative risk in the contract.

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• non-physical delivery and riba.

In Islamic framework, although speculation is not lawful, but should not involve for the reasons such as:

Instead, for an interest that is paid on loans, profit-sharing such as mudharabah, murabahah and al-baibithamin-ajil could be the solutions for investment loans in Islam.

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Documents

Azizah Isa1 TOPIC 4 MONETARY ECONOMICS. Azizah Isa 2 MONEY