Notesale: Turn your study into money

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MONETARY ECONOMICS

Module1: Introduction

1
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In barter trade money was not used, goods and
services were exchanged for each other and therefore double
coincidence of wants must be there for the system to be efficient
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

Unit of account: money can be used to measure the values of goods
and services
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

Store of value: one can sell an item that may not be required
immediately, keep the money and buy the same time in future when
in need to use it
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

Standard of deferred payment: services can be offered at present
time and be paid in future
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1 Models of financial development


Commercial banks- savings, deposits, loans



Thrifts- Savings and loan (S&L), Savings Bank, credit union



Insurance companies-premium against loss, savings invested & paid
back after years



Mutual funds- use customers deposit to buy stocks or bonds



Pension funds-collect savings and give retirement monthly payments



Security firms-stock and bonds advice (stock brokerage firms)

2
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Central banks have different names depending on countries
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Central bank is the
only sole supplier of notes and coins in an economy
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It is responsible for printing of currency i
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both notes and coins
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Financial
regulations and guidelines are given by the Central bank and all
financial institutions under Central bank supervisory must follow
them
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Issuance of currency and notes is the responsibility of the bank
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Money being a legal currency, requires one
authority to print, this is to minimise the duplication or emergence
of fake money
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The Central bank is a government’s bank
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The government maintains an account with the Central bank for is
transactions both payment and receipts
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Commercial banks maintain an account with the Central bank
through which they conduct their transactions
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Also it is vital for commercial banks to have accounts with
the central bank to allow easy control of monetary policies
implementation
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It is the responsibility of the Central bank to formulate and
implement monetary policies
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Foreign exchange fluctuations maybe a problem that affects the
running of the economy, therefore the bank´s role is to formulate
the guidelines for the foreign exchange
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Central bank acts as the lender of the last resort; since financial
institutions falls under central bank, they entirely rely on Central
bank when they have extreme financial problems
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In such situation the Central bank provides funds
for the ailing financial institutions since it has responsibility to
enhance financial stability in a country
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In the financial system of an
economy, they fall immediate after central bank
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Some of the roles of
these banks include;1
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One can operate an account with a commercial
bank through which deposits can be done for future use or for other
financial requirements
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Lending of money in form of loans to those who require for their
use
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The banks
benefit by charging interests
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3
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g
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They are used to make payments to different
entities, for instance through the standing orders
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Commercial banks are important in an economy more because they help in
daily financial transactions
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Therefore Financial Services in the economy becomes easier when the
commercial banks are operating efficiently
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International trade
encourages countries to compete with each other in provisions of goods
and services among countries
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Since each country has
different currency that has different values acquiring new currency would
require currency exchange transactions
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Exchange of local currency to other
foreign currencies and vice-versa is referred to as foreign exchange
transaction
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This

shows that commercial banks also contribute to the international trade
and foreign exchange transactions
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efficiency and professionalism
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The banks have consultancy

department where by individuals and companies or firms can get advice
on

their

production,

services

or

investments
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They can be in various forms depending on specialisation of services
offered
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these banks can be structured in to;i
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Small business banks
iii
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Trust banks
v
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2
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used

form

of

financial

In this system, the financial

transactions occur outside the banking sphere
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Although developing countries use
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Informal financial services may have been used in developed

countries in the early stages of their financial development
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Currently, there is expansion of

formal banks in developing countries and therefore pulling informal
financial system towards formality
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Backgrounds of these countries are diverse
and require special considerations especially when investing in this
sector
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Such Considerations are
important and should be considered when making national economic
planning
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4 Policies of financial repression and financial restriction
Central banks has mandate of financial restrictions through- monetary
policy, operations
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2
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1 Components of money supply, near money and money substitutes
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M1

Billions

Other checkable deposits

M1

demand deposits
currency
Years

M2= M1+savings+money market deposits accounts + money marke
mutual fund held by depositors+>100,000$ time deposit
M3= M2+large denomination-<100,000$ time deposits, long-term (more
than overnight)

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3 Credit creation and the money supply process
Expansion of MS by commercial bank
Acquired reserve & deposit (SA
Required reserve ratio
Bank
Rands)
R=0
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8
C
51
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24
D
40
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19
E

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Total amount of money created
SA Rands

Excess
reserve
R 80
64
51
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96
32
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...
96
32
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The reserve ratio
is to ensure that depositors can get their money anytime without problems
so the commercial banks use reserves for that purpose
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It
may deposited to the new customers account in the same bank and the
same process continues until the total loanable amount is 400 rands as
explained below using the multiplier effect
...
2 =5
Maximum deposit (D) = Excess reserve (E) x multiplier
D= E x M
=
=

80 x 5
400 SA Rands

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1
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Money can earn interest or return when it is invested and therefore it
becomes important not to stock money while you can invest for return,
although you may require it for daily use
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The amount of money held for transaction depends on
the flow of spending
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In this case the demand of money is the money that is
used for spending
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Symbol MD is used to represeant demand for
money
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Price level: quantity of nominal money is proportion to price level
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2
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When you hold money , you forgo the interest rates
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3
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When the real GDP increases then it means there will be
Bedanny80@yahoo
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The previous
amount held before the real GDP rose will increase
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Financial innovation: technological innovations influence how
much money we hold for daily transactions
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0 The Demand for Money

Interest
(per year)

Effects of an increase in interest rate

Effects of an decrease
in interest rate
MD
Real money

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1 The Quantity Equation
The number of times a currency is used annually to buy the goods and
services and this make up the GDP is called Velocity of money (V)

V= PY/M,
where PY is GDP made up of Price (P) x real GDP (Y)

Quantity theory of money in an equation:
M=1/V x (PxY) Cambridge

MxV = (PxY) American

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Transactions demand: money is used to buy goods and services
therefore it is important to hold it for that reason
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Higher real income
means more income and hence households and firms will spend
more
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2
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As much as money is held for transactions it is
also held for uncertainty reasons
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Stock market fluctuations
can give someone a reason to hold money to take advantage of the

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There is only one alternative of money: Bonds
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Interest rate

Liquidity preference (LP)

Money

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Modern Keynesian
approach first published in 1958 by Professor Tobin
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There are cash, bonds, shares etc (to give
capital gains, interests, dividends etc)
Demand for money can change due to:

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Increase in prices
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Increase in risk

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5 Relevance of demand for money theories to developing countries
(LDCs)
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1Money and prices
Inflation is general price increase in an economy or percentage change of
price level
Price level is the weighted average of several different prices
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6
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This causes disequilibrium of demand and supply hence creating inflation
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The costs of
production can be due to
o Trade unions that ask for more wages and salaries to the
workers
o Price increase of raw materials both imported or locally
produced

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Creeping inflation: Common type of inflation where the rate is
between 1 and 6%
2
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Suppressed inflation: demand exceeds supply but the prices are
controlled through the monetary policy instruments
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Discourage economic growth- due to uncertainty especially in longterm investments
2
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Lack of confidence in domestic currency thus reducing the money
functionalities
4
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Demand pull inflation may stimulate investment thus higher
employment
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4 Anti-inflation policies and practices

Monetary policy: contractionary monetary policy can be used to control
inflation implemented by Central bank
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Increasing cash or liquidity ratio of banks so that the amount of
money in circulation or available to be loaned decreases
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Increasing the bank interest rate for rediscounting bills of exchanges
and government bonds
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Fiscal policy: contractionary fiscal policy, involves:
1
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Government need to reduce its expenditure since it contributes to
having more money in circulation
3
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Control importation of goods that brings increased prices in case of
imported inflation

Module 7: Monetary Policy

Monetary policy is designed by the monetary authority in an economy
which is the central bank
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Central banks use this tool to increase or decrease the money in
circulation
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This
policy may not be effective immediately due to what is referred to as lags
in the effectiveness of policy
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Here are some of the limitations of monetary policy in brief

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Larger non-monetized sector limits the operation of monetary
policy
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2
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Selling of treasury bills and bonds may not be realistic if some of the
countries do not have developed money and capital market
3
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4
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5
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It is normally outside the banking sector in developing
countries therefore rendering monetary policy ineffective
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