Chapter 11 Flashcards
Describe Burma’s resources and is the country poor?
Burma is a resource-rich country, with an abundance of natural gas, gold, oil, timber and arable land.
Burma is the poorest country in terms of GDP per capita in ASEAN
what does burma suffer from?
serious economic mismanagement, corruption and poverty
how does burma suffer from corruption?
military leaders and corrupt business owners exploit the country’s natural resources
according to the Asian Development Bank
how much of the burmese population live below the poverty line?
Asian Development Bank has reported that around 26 per cent of the population live below the poverty line, with the highest concentration of poverty located in rural areas
due to serious macroeconmic mismanagement, what does Burma face?
fiscal deficits, defaults on international debt repayments, high rates of inflation and a lack of reliable statistics on basic economic variables.
describe the inflation in burma
2005-10 averaged 20%
Burmese government printing money to finance building projects and the pay rises of public servants.
The rapid inflation led to many Burmese people turning to other means of payment rather than the local currency such as
why?
Gold
When inflation is high the value of savings kept in bank deposits falls rapidly.Gold was much more reliable as a store of value than money, so people kept gold rather than put their money in a bank.
What is money and why do we need it?
what is money and asset
money is any asset that people are generally willing to accept in exchange for goods and services or for payment of debts.
An asset is anything of value owned by a person or a firm.
what was used as money during WWII?
During World War II prisoners of war used cigarettes as money in some prisoner or war camps
what is barter
§exchange of goods or services for other goods or services.
what does barter require?
explain
double coincidence of wants
two people each person must want what the other one has
what happens in barter economies
goods and services are traded directly for other goods and services
what is a shortcoming to bartering?
due to the double coincidence of wants, it may take several trades before the farmer is ultimately able to trade for what the neighbour with the cow wants.
Locating several trading partners and making several intermediate trades can take considerable time and energy.
what is commodity money
A good used as money that also has value independent of its use as money
money makes what easier
Trading goods and services
The functions of money
1 Medium of exchange
2 Unit of account
3 Store of value
4 Standard of deferred payment
functions of money
how can money serve as a medium of exchange
Money serves as a medium of exchange when sellers are willing to accept it in exchange for goods or services
e.g. supermarket accepts your $10 note in exchange for bread
functions of money
An economy is more efficient when
a single good is recognised as a medium of exchange.
functions of money
describe units of account
This function of money gives buyers and sellers a unit of account, a way of measuring value in the economy in terms of money
Australian economy uses dollars as money, each good has a price in terms of dollars.
functions of money
describe store of money
if you do not use all your accumulated dollars to buy goods and services today, you can hold the rest to use in the future (particularly b/c it is liquid; better than selling investment house at short notice)
function of money
standard of deferred payment
Money is useful because it can serve as a standard of deferred payment in borrowing and lending e.g. pay within 30 days in return for ___
how can money facilitate exchange?
Money can facilitate exchange at a given point in time by providing a medium of exchange and unit of account.
It can facilitate exchange over time by providing a store of value and a standard of deferred payment.
what can serve as money
what are the 5 criteria that make a good suitable for use as a medium of exchange
- The good must be acceptable to (i.e. usable by) most people.
2 It should be of standardised quality so that any two units are identical.
3 It should be durable so that value is not lost by spoilage.
4 It should be valuable relative to its weight so that amounts large enough to be useful in trade can be easily transported.
5 The medium of exchange should be divisible because different goods are valued
differently.
What can serve as money
what is commodity money? what is the shortcoming?
Commodity money
shortcoming: it’s value depends on purity/quality
e. g. fake gold, supply depended on unpredictable discoveries of new gold fields.
What can serve as money
what is fiat money?
Money, such as paper currency, that is authorised by a central bank or government body and that does not have to be exchanged by the central bank for gold or some other commodity money.
e.g. Australian dollars are fiat money, the RBA is not required to give you gold or silver for your dollar notes
What made Zimbabwe’s currency almost worthless?
the zimbabwe government decided to pay for all of its expenses by printing more and more money. The faster the government printed money, the faster prices rose
why did local businesses in zimbabwe struggle to supply coke?
they could not obtain US dollars, local Coke bottlers were not able to import from the United States the concentrated syrup used to make the soft drink.
what is the narrowest measure of money?
currency
Notes and coins held by the private non-bank sector.
what is m1
it is the narrowest definition of money supply
is composed of currency plus the value of all demand deposits with banks
what are demand/current deposits?
deposits in financial institutions that are transferable by cheque, by debit cards at EFTPOS terminals and through electronic transfer between accounts.
They are called demand deposits because they are available on demand, and are repayable on demand in notes and coins.
what is m3?
M1+ all other deposits of the private non-bank sector with domestic and foreign-owned banks operating in Australia
in addition to M1, what does M3 also include?
Includes certificates of deposit, term deposits and deposits with banks from building societies, credit unions and other authorised deposit-taking institutions (ADIs)
what are certificates of deposit
Certificates of deposit are large savings deposits written in certificate form that also pay high interest and behave like commercial bills.
what is broad money?
comprises M3, plus deposits with non-bank deposit-taking institutions MINUS holdings of currency and deposits of non- bank depository corporations.
Non-bank depository corporations include
§ finance companies, money market corporations and cash management trusts - they are registered with APRA
what is credit used as?
Credit is not a form of money, but it is now used by the RBA as the main measure of monetary movements in Australia.
enables the RBA to determine in general whether more funds are being loaned, or whether there has been a contraction in the volume of funds advanced.
Credit is defined as
loans, advances and bills provided to the private non-bank sector (individuals and firms) by all financial intermediaries—not just ADIs
example of why credit cards are not included in money supply
when you buy something with a credit card you are in effect taking out a loan from the bank that issued the credit card.
Only when you pay your credit card bill at the end of the month—usually at an ATM or via the Internet or telephone from your bank account—is the transaction complete.
The key role that banks and other financial institutions play in the economy is
accept deposits and make loans.
By doing this they create demand deposit accounts, from which money can easily be withdrawn ‘on demand’.
other financial institutions include
building societies and credit unions
Bank balance sheets
corporations shareholder equity is also referred to as
what does it represent
net worth
value of company if all assets were sold and all liabilites were paid
Bank balance sheets
what are reserves?
deposits that a bank has retained, rather than loaned out or invested by, for instance, buying a government bond.
Bank balance sheets
how do banks keeps reserves?
Banks keep reserves either physically within the bank, as vault cash, or on deposit with the RBA
Bank balance sheets
why hold reserves?
safeguard against loan losses, adverse economic trends and excessive withdrawals by depositors which could cause the bank to become insolvent.
key assets on a bank’s balance sheet
bank balance sheet
what kind of loans do banks make?
Banks make consumer loans to households and commercial loans to businesses.
Bank balance sheet
why is a loan an asset to the bank?
A loan is an asset to a bank because it represents a promise by the person taking out the loan to make certain specified payments to the bank.
Bank balance sheet
the largest liability for most banks are?
deposits
Bank balance sheet
deposits include
Deposits include savings accounts, cheque accounts and certificates of deposits.
Bank balance sheet
why are deposits a liability?
Deposits are liabilities to banks because they are owed to the households or firms that have deposited the funds
If you deposit $100 in your savings account, the bank owes you the $100 and you can ask for it back at any time.
what are excess reserves? what may the bank do?
banks usually keep 10 per cent of deposits as reserves. Because banks do not earn interest on reserves they have an incentive to loan out or buy securities with the other 90 per cent.
Save-IT can keep $100 as reserves and loan out the other $900, which represents excess reserves.
what happens when the bank makes a $900 loan from $1000 reserve?
The initial $1000 in currency you deposited into your savings account has been turned into $1900 in savings account deposits—a net increase in the money supply of $900.
what happens a person buys a motorcycle for exactly $900?
buyer pays by writing a cheque on his bank account at Save-IT.
the seller will now deposit the cheque into her savings account Thrifty Bank
Once she deposits the cheque, Thrifty will send it to Save-IT Bank to be cleared and collect the $900
Save-IT has lost $900 in deposits—the amount loaned to the motorcycle buyer—and $900 in reserves—the amount it had to pay Thrifty when Thrifty sent it the motorcycle buyer’s cheque.
Thrifty has an increase in account deposits of $900—the deposit of the cheque for $900 by the motorcycle seller—and an increase in reserves of $900—the amount it received from Save-IT..
simple deposit multiplier?
The ratio of the amount of deposits created by banks to the amount of new reserves
RR = bank’s reserve ratio
what is the simple deposit multiplier if the reserve ratio is 10% of reserves?
RR = 0.1
Simple deposit multiplier = 1/0.1 = 10
what is the change in demand deposits if $100 000 in currency is deposited in a bank and the reserve ratio is 10 per cent, then:
Suppose you deposit $5000 in currency into your savings account at a branch of Thrifty Bank, which we will assume has no excess reserves at the time you make your deposit. Also assume that their reserve ratio is 0.10.
1 Use a T-account to show the initial effect of this transaction on Thrifty’s balance sheet.
Because the bank now has your $5000 in currency in its vault, its reserves (and therefore its assets) have risen by $5000.
your savings account balance increases by $5000 because the bank owes you this money, the bank’s liabilities have also risen by $5000.
Suppose you deposit $5000 in currency into your savings account at a branch of Thrifty Bank, which we will assume has no excess reserves at the time you make your deposit. Also assume that their reserve ratio is 0.10.
- Suppose that Thrifty makes the maximum loan it can from the funds you deposited. Use a T-account to show the initial effect on Thrifty’s balance sheet from granting the loan. Also include in this T-account the transaction from question 1.
reserve ratio - 10%
so bank 5000x 0.1 = 500 kept as reserves and loan the remainder 4500
loans go up by 4500 (they are an asset b/c borrowers owe the bank) + saving deposits of the borrower go up by 4500
whoever took out the loan in question 2 writes a cheque for this amount and that the person receiving the cheque deposits it in Save-IT Bank. Show the effect of these transactions on the balance sheets of Thrifty Bank and Save-IT Bank, after the cheque has been cleared.
describe what happened to thifty’s T account?
Once Save-IT sends the cheque written by the borrower to Thrifty, Thrifty loses $4500 in reserves and Save-IT gains $4500 in reserves.
The $4500 is also deducted from the account of the borrower.
whoever took out the loan in question 2 writes a cheque for this amount and that the person receiving the cheque deposits it in Save-IT Bank. Show the effect of these transactions on the balance sheets of Thrifty Bank and Save-IT Bank, after the cheque has been cleared.
why is thrifty satisfied?
when a $5000 deposit in currency was received, it was in the bank vault, not earning any interest
Now $4500 of the $5000 has been loaned out and is earning interest. These interest payments allow Thrifty to cover its costs and earn a profit, which it has to do to remain in business.
whoever took out the loan in question 2 writes a cheque for this amount and that the person receiving the cheque deposits it in Save-IT Bank. Show the effect of these transactions on the balance sheets of Thrifty Bank and Save-IT Bank, after the cheque has been cleared.
describe what happens to save IT’s account
Save-IT now has an increase in deposits of $4500, resulting from the cheque being deposited, and an increase in reserves of $4500.
Save-IT now has excess reserves as a result of this transaction and a strong incentive to lend them out in order to earn some interest.
Suppose you deposit $5000 in currency into your savings account at a branch of Thrifty Bank, which we will assume has no excess reserves at the time you make your deposit. Also assume that their reserve ratio is 0.10.
- What is the maximum increase in savings account deposits that can result from your $5000 deposit?
What is the maximum increase in the money supply? Explain.
Change in money supply = increase in demand account deposits - decline in currency in circulation
50,000 -5000 = 45000
describe the simple deposit multiplier and how it operates
an increase in reserves in the banking system leads to the creation of new deposits and therefore an increase in the money supply
why is the real-world deposit multiplier smaller than the simple deposit multiplier because:
- banks may hold excess reserves - not necessarily keep only 10% in reserves assumed under teh simplied deposit multiplier
- households and firms do not deposit all their money
the real-world deposit multiplier smaller than the simple deposit multiplier because people do not deposit all their money.
give an example
when Save- IT makes the initial $900 loan to the borrower who wants to buy a used motorcycle, the seller of the motorcycle cashes the cheque and spends the money, instead of depositing it in her bank account.
In that case Thrifty Bank does not receive any new reserves and does not make any new loans.
Whenever banks gain reserves
they make new loans and the money supply expands.
Whenever banks lose reserves
they reduce their loans and the money supply contracts.
two major roles of the Reserve Bank
- To maintain the financial integrity and stability of the Australian financial system.
- To manage and implement the monetary policy.
what is the cash rate
The interest rate that financial institutions charge on loans or pay to borrow funds in the overnight money market.
banks and other financial institutions experience what at the end of the day?
a shortage or a surplus of funds
what happens when banks and other financial institutiions experience a shortage at the end of the day?
there will be an increase in demand for overnight funds –> cash rate rises
Similarly, a surplus of funds at the end of a day would
increase the supply of funds (a cash surplus) on the overnight money market, and put downward pressure on the cash rate.
describe open market operations
The RBA purchasing or selling financial instruments such as Commonwealth Government Securities and private bonds and securities, either by outright purchase or sale, or by the use of repurchase agreements.
Repurchase agreement:
when the RBA offers to buy (or sell) CGS and other eligible financial instruments, from banks or other authorised financial dealers, provided the same banks or dealers are prepared to repurchase (or resell) them in the immediate future, often in a few days’ time, at a price agreed at the outset.
The majority of RBA intervention in financial markets is to
offset daily liquidity changes to keep interest rates at the same level.
describe RBA’s role in exchange rate management
the value of $AU is usually determined by international market forces
RARE FOR RBA TO intervene
if the RBA wanted to increase the value of $AU, it will purchase $AU in foreign currencies to increase demand for $AU –> REDUCING FOREIGN RESERVE STOCK
OR
to decrease the value of $AU, it could sell $AU to increase the supply of $AU on foreign currency markets –> INCREASING FOREIGN RESESERVE STOCK
The RBA also has the role of investing its stock of
he RBA also has the role of investing its stock of foreign reserves—such as foreign currency and bonds—and is also the custodian of Australia’s gold reserves.
What is the quantity theory of money?
A theory of the connection between money and prices that assumes that the velocity of money is constant
According to the theory, in the long run, if the quantity of money increases the price level will also rise.
formalised by Irving Fisher
what is velocity of money
The average number of times each dollar in the money supply is used to purchase goods and services which are included in GDP.
The quantity theory explanation of inflation
what is the equation of exchange?
shows the relationship between changes in the money supply and changes in inflation.
Inflation rate = growth rate of the money supply +
growth rate of velocity – economic growth rate
The quantity theory explanation of inflation
If Irving Fisher was correct in thinking that velocity is constant, then
velocity will be zero; its percentage change from one year to the next will always be zero.
Inflation rate = growth rate of the money supply – economic growth rate
The quantity theory explanation of inflation
what predictions can be made from this equation?
Inflation rate = growth rate of the money supply – economic growth rate
- If the money supply grows at a faster rate than economic growth there will be inflation.
2 If the money supply grows at a slower rate than economic growth there will be deflation.
3 If the money supply grows at the same rate as economic growth the price level will be
stable, and there will be neither inflation nor deflation.
was irving fisher right in stating that the velocity of money is constant?
No, from year to year there can be significant fluctuations in velocity –> predictions of the quantity theory of money do not hold every year
even if irving fisher was wrong in stating that velocity of money is constant, what do economists agree on?
most economists agree that the quantity theory provides a useful insight into the long-run relationship between the money supply and inflation: in the long run, inflation results from the money supply growing at a faster rate than the economic growth rate.
BUT there is not always a clear correlation between the growth rate of the quantity of money and the rate of inflation
Hyperinflation is caused by
central banks increasing the money supply at a rate far in excess of the economic growth rate
e. A high rate of inflation causes
money to lose its value so rapidly that households and firms avoid holding it
Economies suffering from high inflation usually also suffer from
very slow economic growth, if not severe recession.
Given the dire consequences that follow from high inflation, why do governments and central banks allow it by expanding the money supply so rapidly?
governments often want to spend more than they are able to raise through taxes
governments often want to spend more than they are able to raise through taxes so they allow money supply to expand rapidly
Developed countries, such as Australia, can usually bridge gaps between spending and taxes by
by borrowing through selling government bonds to the public.
governments often want to spend more than they are able to raise through taxes so they allow money supply to expand rapidly
Developing countries?
difficulty selling bonds because the public is sceptical of their ability to pay back the money (corruption)–> governments in developing countries will force their central banks to purchase them –> when a central bank buys bonds the money supply will increase, which can be inflationary
describe the hyperinflation in germany
Post-WWI: germany had to make reparations (payments to the Big 4).
- tax revenue was not enough to cover normal spending and reparations
- German gov sold bonds to the Central Bank –> increased money supply –> cause hyperinflation (consistent with the qty theory)
Suppose the money supply is currently growing at 4% per year, while real GDP is growing at 2%. Calculate the inflation rate assuming Irving Fisher is correct in his assumption regarding the velocity of money.
Inflation = growth rate of money supply - economic growth rate
Inflation = 4-2 =2
