Money as a Medium of Exchange Money is an intermediary and acts as a medium of exchange. This is...
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Money as a Medium of Exchange Money is an intermediary and acts as a medium of exchange. This is unique to and defines money. anything that is generally
Money is an intermediary and acts as a medium of exchange. This
is unique to and defines money. anything that is generally accepted
as payment for goods and services or that is accepted in settlement
of debt. Money: anything that is generally accepted as payment for
goods and services or that is accepted in settlement of debt.
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an agreed measure for stating the prices of goods and services.
Unit of account: an agreed measure for stating the prices of goods
and services. Prices expressed in monetary terms. Common measure of
cost allows decisions on how best to spend our income. Could you
measure GDP in a barter economy??? Accounting unit when prices
increase, nominal values adjusted for price increases to obtain
real values; only possible with money.
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Wealth can be held property, shares etc. BUT, money is liquid
When inflation is high money loses purchasing power and is not a
good store of value. Money can serves as a standard of deferred
payment credit can be granted.
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Income Natural resources, labour, capital and entrepreneurship
= rent, wages and salaries, interest and profit.Wealth Includes ALL
assets
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Earliest forms of money were commodities. Suitability depended
on Uniformity Uniformity Durability Durability Divisibility
Divisibility Portability Portability
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Standardised coins produced, but not ideal for large
transactions Paper money created by goldsmiths in exchange
gold/silver deposits they received (certificates of deposit).
Initially, paper money backed fully backed by gold gold standard
Followed by fractional reserve system - total value of the paper
money > value of gold backing it. (fiduciary or credit money).
Modern banknotes based solely on confidence of SARB to control
supply of notes so that purchasing power not eroded. Then came
cheque accounts - bank deposits now accessed by cheques, electronic
transfers, debit cards.
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SARB uses three measures of the quantity of money. The
conventional measure (M1) M1 quantified on basis of money as a
medium of exchange. coins and notes (in circulation outside the
monetary sector) as well as all demand deposits (including cheque
and transmission deposits) of the domestic private sector with
monetary institutions. M1: coins and notes (in circulation outside
the monetary sector) as well as all demand deposits (including
cheque and transmission deposits) of the domestic private sector
with monetary institutions. In circulation outside the monetary
sector cant include cash in bank vaults until withdrawn. Demand
deposits - deposits that can be withdrawn immediately.
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Calculating M1 MC + D M = C + D M M = quantity of money C C =
cash (coins/notes outside monetary sector) D D = demand deposits
(eg by cheque, debit card, electronic)
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A broader definition of money (M2) M1 + short and medium-term
deposits of the domestic private sector with monetary institutions.
M2 = M1 + short and medium-term deposits of the domestic private
sector with monetary institutions. Short-term deposits: Short-term
deposits: < 30 days Medium-term deposits: Medium-term deposits:
< 6 months Can be withdrawn earlier only at a cost. Regarded as
quasi money
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The most comprehensive measure of money (M3) M2 + long-term
deposits of the domestic private sector with monetary institutions.
M3 = M2 + long-term deposits of the domestic private sector with
monetary institutions. Long-term deposits > six months. Used to
evaluate success of monetary policy M3 reflection of store of value
function and not only the function of money as a medium of
exchange.
Slide 17
Money led to advent of financial institutions specialising in
purely financial transactions. no goods or non- financial services
are involved. Financial transactions: no goods or non- financial
services are involved. Financial institutions act as an
intermediary between surplus units and deficit units in the
monetary economy.
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Lesetja Kganyago
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Watch this video on the functions of the SARB
https://www.youtube.com/watch?v=Scz_DE0So 14
Slide 21
Established in 1920 Constitution states Primary object of SARB
is to protect the value of the currency in the interest of balanced
and sustainable economic growth in the Republic. SARB must perform
its functions independently and without fear, favour or prejudice,
but there must be regular consultation between the Bank and the
Cabinet member responsible for national financial matters.Functions
Formulation and implementation of monetary policy Service to the
government Provision of economic and statistical services
Maintenance of financial stability Provider of economic and
statistical service
Slide 22
Price stability = primary objective. How does the SARB do this?
Bank supervision responsible for bank regulation/supervision The
National Payment System Oversees safety and soundness of system.
Banker to other banks Custodian of minimum cash reserves of
commercial banks SARB provides liquidity to banks Banknotes and
coins SA Mint Company & SA Bank Note Cash comes into
circulation through the purchase of assets (usually financial
assets) by the Bank.
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amount that participants in the economy plan to hold in the
form of money balances (i.e. cash or bank deposits). Demand for
money: amount that participants in the economy plan to hold in the
form of money balances (i.e. cash or bank deposits). Opportunity
cost of holding money? Interest that could have been earned from
bonds. Money held if it provides a service as good as opportunity
cost of holding it. 2 basic components of demand for money The
transactions demand for money which arises from the medium of
exchange function The demand for money as an asset which arises
from the store of value function
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2 main motives identified by JMK (liquidity preference) 1.
Transactions motive Participants hold money as a medium of exchange
needed to enter into transactions. Money held to buy goods/services
between paydays. How much money is needed depends on the level of
income. At macro level - transactions demand for money is a
function of the total income in the economy. > level of economic
activity = > demand for bank loans.
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2. Speculative motive Demand for money as an asset. Money as a
store of value. Holding money (little or no interest) VS. holding
bonds (which earn interest)??? Depends on interest rate
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Transactions demand Transactions demand - purpose is to spend
the money. Known as active balances. Speculative demand Speculative
demand - purpose to hold money passively as a store of value. Known
as passive balances (idle balances).
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The quantity of money demanded for transactions purposes
depends on the level of income in the economy (Y) and is largely
independent of the interest rate. For a given level of income (Y1)
there is thus a given quantity of money demanded (L1). Represents
demand for active balances. (L1) not sensitive to interest rate
variations. Position of L1 is determined by the income level
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Quantity of money demanded for speculative purposes low when
interest rate is high (opportunity cost of money is also high)
Quantity of money demanded for speculative purposes higher when
interest rate lower (opportunity cost of money low). Negative
(inverse) relationship between quantity of money demanded for
speculative purposes & level of the interest rate. Represents
demand for passive balances. Inverse relationship btwn. interest
rates & Q of passive balances demanded. At (i1) no funds will
be demanded to be used for speculative purposes.
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Total money demand curve/total liquidity preference (LL). Add
demand for active and passive balances (L 1 + L 2 ) Negative slope:
Negative slope: inverse relationship between interest rate level
& Q of money demanded for speculative purposes (i.e. as an
asset). Position: Position: determined by demand for active
balances (i.e. for transactions purposes) - determined by the
income level. Increases in income shifts total demand curve to the
right (vica versa)
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L = f(Y, i) L = quantity of money demanded Y = national income
i = interest rate Demand for money is a function of the income
level and the interest rate level.
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Demand deposits constitute >90% of quantity of money. What
determines the size of these deposits?
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Money is created largely by banks and not by a mint or printing
press. How do they do it? Banks create deposits by making loans.
Watch this short video that explains how money is created.
https://youtu.be/pZRvja7Mvrwhttps://youtu.be/pZRvja7Mvrw
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How many loans can banks create? Banks can create loans only if
demand from creditworthy borrowers exists. Quantity of loans
demanded depends on interest rate. Quantity of money demanded
inversely related to interest rate.
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Instability of banking system necessitates central bank.
Growing economy requires growing money stock. BUT excessive money =
inflation. SO SARB regulates money creation process. Sounds great
how do they do this???
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Interest rates influence the rate at which new money is
created. Affects demand for loans via the price of loans, i.e., the
interest rate. This is the essence of monetary policy.
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No independent money supply curve. Quantity of money depends on
demand for money & interest rate. Known as a demand-determined
money stock or endogenous money.
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measures taken to influence quantity of money or the rate of
interest with a view to achieving stable prices, full employment
and economic growth. Monetary policy: measures taken to influence
quantity of money or the rate of interest with a view to achieving
stable prices, full employment and economic growth. Formulated and
implemented by SARBs Monetary Policy Committee
Slide 39
Primary objective of the SARB to protect value of R in the
interest of balanced and sustainable economic growth.
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1960s - 70s: 1960s - 70s: direct intervention limits to
extension of bank credit) 1970s 80s: 1970s 80s: more
market-oriented policy approach through creation of incentives for
financial institutions to react in the desired manner. 1986
onwards: 1986 onwards: explicit monetary growth targets for M3
announced annually. pursued by changes in Bank rate. March 1998:
March 1998: informal inflation target of 1 - 5 % set. 23 February
2000: 23 February 2000: formal inflation target 3 6% set by
Minister of Finance
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The key instruments include accommodation policy accommodation
policy (refinancing of the liquidity requirement) open-market
policy open-market policy
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Classical cash reserve system - banks obliged to hold 2,5% of
their total liabilities with Reserve Bank. Shortage of cash
reserves? Change financial assets into cash or borrow funds. Borrow
from overnight interbank market - borrow from other banks with
excess funds. If all banks experience liquidity shortage, Reserve
Bank, acts as lender of last resort Banks obtain funds by means of
the repo system. Fixed rate determined SARB represents interest
rate that banks pay for reserves they need.
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Read Box 6.7 on page 150
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Changes in repo rate regulate quantity of money through
variations in cost of credit. Changes in the repo rate changes in
interest rates at commercial banks cost of credit directly linked
to the repo rate.
Slide 46
sale/purchase of Open-market transactions: sale/purchase of
domestic financial assets (eg. Treasury bills/ government bonds) by
SARB to influence interest rates & quantity of money, via
influence on cash reserve of the banks.