44- Money and Banking Flashcards
Ch- 44
Money
Money is an item generally accpetable as a means of payment
Explain in detail
4 Functions of Money
- Medium of Exchange - overcome the problem of double coincidence of wants
- Store of Value - enables people to save
- Unit of Account - measure of value, prices of diffrent items compared in monetary terms
- Standarad for deferred payments - borrow and lend. Buy now and pay later
Double coincidence of wants
a situtaion where two people each ahve something the other person wants
With example explain
most imporatnt characteristics of Money
generally acceptable - people are willing to accpet in exchange of goods.
people in Zimbabwe lost confidence in the Zimbabwean dollar and they had to use $
7 other charcteristics apart from acceptibility
- Portable: can be carried around easily
- Divisible: can be divided into differnt units of values. ₹10, ₹20, ₹50, ₹100
- Homogenous/uniform
- Limited in supply
- Durable
- Stable value
- Not easy to counterfiet
Why is having limited supply important
So that money doesn’t lose its value.
Zimbabwe printed a lot of money making it abundant and lose itps value
Money Supply
The total amount of money in an economy
Currency in circulation + relevant deposits
Why does the government calculate the money supply
Gain information on
- Aggregate demand (AD)
- state of financial market
- and determine the direction of the monetary policy
Limitations of calculating money supply
Difficult to decide what to include in the money supply
Two main measures of money supply
- Narrow money –> high liquidity
- Broad money –> low liquidity
narrow money
money that can be spent directly
notes and coins in circulation
medium of exchange
broad money
narrow money + other store of value
cash+saving
Quantity theory of money
The theory that links inflation in an economy to changes in the money supply.
change in money supply causes euqal percentage change in the price levels, inflataion.
velocity of circulation
the number of times money changes hands
Fisher Equation
MV=PT
both sides show nominal income
m = money supply
v = velocity of circulation
p = price level
t or y = output/transcation/real GDP
assumptions of the quantity theory of money
V and Y are constant and unaffected by the money supply
keynesians appose this belief
An exmaple, when people anticipate that the inflation rates are going to rise they most likely would want to spend their money. Therefore, the velocity of circuation would increase.
Volume of transaction
nominal GDP,
PY
price* output
Differences between Keynesian and Monetaraist theory approach
- K - Believe in government intervention budget deficit (spending) to incraese AD
- M - Gs will only lead to inflation in LR, more stable with a stable money supply
- K- employement, M - Inflation key priority
3.
2 primary function of commercial bank
- Accept deposists
- Give loans
Explain the function of a commercial bank
Loans :
-Overdraft and loans
Deposits :
- Savings and current/demand deposit account
Government Bonds and equities
Demand deposit account
- Where money can be easily withdrawn for purchsaes by the holder
Also known as a current account
Savings deposits account
- Interest is received on the savings
-A notice may be required before withdrawal
Overdraft
- A consumer can withdraw more than what they have in their demand deposit accounts
- Higher interest rates are charged
Loans
money lent at an agreed rate of interest for a given period of time
government securities
Bills and bonds issued by the government to raise money
3 objectives of a commercial bank
- Profitability
- Security
- Liquidity
Explain in detail the objective of a commercial bank
Profitability
The interest rates they charge on money lent to the customers
Explain in detail the objective of a commercial bank
Liquidity
Also explain what is liquidity
- Assets in liquid form are not profitable
- ## However banks have to have enough money to meet expected withdrawals requests by holders
The ability to turn an asset into cash without loss
Security
Firms have to keep some of thier profits for
- Some lenders do not repay
- Invested businesses go out of business
This is important to ensure credibility
Reserve Ratio
the proportion of liquid assets to total liabilities
legal minimum fraction of deposits which the banks are mandate to keep as cash with themselves.
Capital ratio
Bank’s available financial assets as a percentage of it’s riskier assets
financial assets/ riskier assets
The higher the capital ratio the more unexpected losses can be covered by the bank. Less risk taking and allows survivals during hard times.
5 main causes of changes in the Money Supply
- Increase in lending by commercial banks
- Increse in G finaced by financial central/commercial banks
- quantitative easing — Selling of givernment bonds to financial institutes
- More money entering than leaving the eocnomy
Money Multiplier
1/cash reserve ratio
100/liquidity ratio
value of new assets created/change in liquid assets
potential increase in liabilities of a bank
credit multiplier * Intial deposits
Potential increase in bank lending
liabilities - intial amount
Assumptions of the credit creation process
- All transaction happen through bank
- During any given period of time only a few of the customers will need to withdraw cash
- All customers would not withdraw cash at the same time
Why may banks not choose to lend as much as the credit multiplier implies?
- Lack of households/firms who want to borrow
- Lack of credit worthy borrowers –> will affect their liquidity as the people do not pay back on time
commercial bank and credit creation
Functions of Central Bank
