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Learning Objectives
• Review the functions of money—particularly money as a medium of exchange, unit of account and store of value.
• Define what acts as money in our economy—the M3 and broad
money definitions.
Learning Objectives (cont.)
• Determine what ‘backs’ the supply of money—what gives it its value and ability to be used almost universally.
• Explain the transactions demand and asset demand for money.
• Examine the institutional structure of the financial system.
• Discuss the current role of the Central Bank.
The Functions of Money
What is money?
• Anything that performs the function of money is money
• Money is what money does
The Functions of Money (cont.)
• Medium of exchange– Buying and selling goods and services
• Unit of account– Assisting measurement of relative worth
of various goods, services and resources
• Store of value– A form in which to store wealth, due to its
liquidity and convenience
Money Defined: M3
Three components:
• Currency (coins and notes)
• Current deposits in banks upon which cheques can be drawn
• Non-current accounts such as savings
Currency
• Token money– intrinsic value is less than face value of
the money
• Coin and note component of the money supply
Current Deposits
• Cheques enable the ownership of current deposits to be transferred
• Generally acceptable as a medium of exchange
• Can be readily converted into currency
Non-Current Deposits
• Highly liquid financial assets
• Can be readily converted into currency or current deposits
• New technologies (such as EFTPOS(Electronic Funds Transfer at Point of Sale) important
Broad Money
• M3 plus borrowings from the
private sector of non-bank financial intermediaries (NBFIs) less holdings of currency and bank deposits by the NBFIs
Credit Cards
• Not money• Simply a convenient method of
obtaining a short-term loan from the card-issuer
• Facilitate the synchronisation of receipts and expenditures, reducing the demand for cash
Monetary base
Composed of:
• Currency held by the public
• Currency held by the banks
• Banks’ demand deposits with the Central Bank.
Backing the Money Supply
• Money as debt
• Acceptability of money
• Legal tender– Fiat money
• Relative scarcity
Money and Prices
Government’s responsibility in stabilising the value of money involves:
• Application of appropriate fiscal policies
• Effective monetary management
Demand for Money
• The demand for money is the demand for real money balance
2 reasons why people demand money:
• Transactions demand
• Asset demand
Transactions Demand
• The demand for money as a medium of exchange
• Level depends on money GDP (not interest rates!)
• Money demand curve is vertical
Assets Demand
• The demand for money as financial assets and store of wealth
• Level depends on interest rates
• Down-sloping money demand curve
Total Demand for Money (Dm )
• Transactions demand and assets demand are added horizontally
• Changes in interest rates lead to movement along the curve
• Anything that changes money GDP leads to a shift in the money demand curve
Demand for Money
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Rat
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Amount of moneydemanded (billions
of dollars)
Amount of moneydemanded (billions
of dollars)
Amount of moneydemanded (billions
of dollars)
0 50 100 150 200 250 300
TransactionsDemand, Dt
Dt
10
7.5
5
2.5
0
10
7.5
5
2.5
0
10
7.5
5
2.5
0
AssetDemand, Da
Da0 50 100 150 200 250 300 0 50 100 150 200 250 300
Total Demandfor Money, Dm
Dm
The Money Market
• The combination of the money demand and money supply determines the equilibrium interest rate
• The interest rate represents the opportunity cost of holding money balances
Equilibrium Interest Rate
Ra
te o
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Amount of money demanded(billions of dollars)
10
7.5
5
2.5
0
Dm
ie
0 50 100 150 200 250 300
Sm
Equilibrium Interest Rate
The Central Bank
• Responsibilities set out in the Reserve Bank Act 1959
• Main functions:– Control of note issue– Banker to the Banks
Exchange Settlement Accounts non-callable deposits
The Central Bank(cont.)
• Main functions (cont.):– Banker to the Government
vital role in financing government deficits
– Management of the international means of payment
– Implementation of monetary policy