Money & Financial Institutions

Circular Flow of Income

What is Money?• a store of value,• A unit of account• A medium of exchange”

• Without money you would have…………….

• Barter

• Problems with barter?

• Double coincidence of wants

Properties Of Money

• Liquidity • Scarcity • Portability • Uniformity• Durability

Kinds Of Money• Convertible paper money The

paper money that can be converted into gold and silver. Examples are Gold and Silver certificates…

• ‘I promise to pay the bearer the sum of one pound on demand’

Commodity MoneyO Has value and

can be used for other purposes.

Inconvertible money – legal tender - Notes and Coins issued by government.

Bank deposits• – Bank deposits Savings.

• Either cash or deposit accounts.

Electronic moneyO - Examples are

Credit Card, Debit card, Charge card

Interest Rates and Money

O People hold more when interest rate is low and hold less when interest rate is high.

Why is this the case?

Money Supply Definitions

O M1 cash and notes and cash accounts in banks.

O M2 includes M1 + deposit accounts in banks

O M3 (M1 +M2) cash at non-bank institutions, e.g. Insurance companies and in Pension Funds.

Money Supply – Quantity Theory of Money

MV=PT OM = MoneyOV =Velocity of CirculationOP = PricesOT = number of transactions

Why have money?O Transactions Demand purchases

O Precautionary Demand For uncertain expenses

O Speculative DemandDemand affected by changes in interest

rates (what will happen to the demand for money if interest rates increase?)

Determination of Interest Rate

O Supply and demand for money (if floating)

O In most economies it is set by the central Bank.

BankingO Retail Banking day to day banks

O Wholesale Banking – commercial and investment banks

MAIN FUNCTIONS OF THE BANK OF ENGLAND• Banker to the Government• Manages the issue of Government Debt• Banker to the Commercial Banks• Holds gold and foreign-exchange

reserves• Manages the issue of notes and coins• Implements domestic monetary policy• It sets interest rates.

Tools for Changing the Money Supply

O Changing the discount rate.

O i.e. the rate the Central Bank charges when they make loans to large organizations.

O Buying or selling bonds.

O Buying bonds……… increases cash deposits within banks increases the nation’s M1 or M2 and therefore increases the money available to lend.

O Selling bonds………. Reduces cash deposits within banks.