Chapter 2: Money and Monetary Policy

Question 1

What is the double coincidence of wants?

Answer 1

A trait of the barter economy. Each party has something the other wants.

Question 2

What are the 3 functions of money and their uses?

Answer 2

1. Money is an intermediary or unit of exchange: Generally accepted as payment of goods and services or as settlement of a debt.
2. Money as a unit of account: An agreed measure for stating prices of goods and services.
3. Money as a store of value: hold it to purchase goods and services at a later date. Due to this it is also a standard of deferred payment so you can measure the value of future payments (home loans etc)

Question 3

Are income and wealth money?

Answer 3

No. Income is paid in money and wealth is valued in monetary terms.

Question 4

Differentiate between M1, M2 and M3.

Answer 4

M1: The conventional measure. Based on money as a medium of exchange. ONLY coins and notes in circulation (outside of the money sector) and demand deposits. Cash in the hands of the public.

M2: Broader definition. M1 + short (30 days) and medium-term (6 months) deposits in the money sector. Short and medium-term are known as quasi money because they are ‘almost’ money.

M3: Most comprehensive measure of money. M2 + all long term deposits. Most reliable indicator of development in the money sector. Store of value and not just a medium of exchange.

Question 5

What are surplus and deficit units?

Answer 5

Money saved by households (surplus) and money needed by entrepreneurs (deficit). Instead of interacting directly the bridge is made through financial intermediaries.

Question 6

What does the financial intermediary facilitate and what form does this take?

Answer 6

The intermediary facilitates the flow of money from surplus to deficit units. This takes the shape of security contracts with interest rates. In macroeconomics, we refer mostly to bonds.

Question 7

What is the demand for money and how does Keynes refer to it?

Answer 7

The amount that participants plan to hold in the form of money (cash and deposits). It is not the want for money.

Keynes refers to it as liquidity preference.

Question 8

What are the two basic components of the demand for money?

Answer 8

Transaction demand: money as a medium of exchange.

Demand for money as an asset: store of value.

Question 9

What is the relationship between transactions demand for money and total level of income?

Answer 9

Transactions demand for money is a function of total income and includes the demand for bank loans.

This means an increase in income results in a RIGHT shift of the curve.

L (money demanded)

Y (total income) is independent of I (interest rates)

Question 10

1. What is the speculative motive of money and what does it depend on?
2. What is the nature of the relationship?

Answer 10

The speculative motive relates to money as a store of value and the choice between holding money or bonds.

This choice depends on the interest rate. When the interest rate is high the demand for money for speculation is high.

The relationship is inverse / negative.

Question 11

What are other names for transactions and speculative demand?

Answer 11

Transactions -> active balances determined by income
Speculative -> passive balances determined by the interest rate

Question 12

What is L = f (Y , i)

Answer 12

Quantity of money demanded is a function of income levels and interest rates.

Question 13

How is the stock of money determined?

Answer 13

By the quantity of money demanded and the interest rate.

Also known as demand-determined or Endogenous money.

Question 14

What is the role of the SARB?

Answer 14

1. Primary objective: Protect the value of the currency in the interest of balanced and sustainable growth in the Republic
2. Perform functions independently without fear, favour or prejudice but must consult minister regularly

Question 15

What are the functions of the SARB?

Answer 15

• Formulate and implement monetary policy
• Service to the government
• Provision of economic and statistical services
• Maintenance of financial stability

Question 16

How does the SARB maintain financial stability?

Answer 16

• Bank supervision - issuing licenses, monitoring
• National payment system - transfer of funds from one deposit to another. To reduce interbank settlement risk
• Banker to other banks - private banks have to hold a fixed percentage of total deposits in the form of cash with SARB
• Banknotes and coins - solely controlled by reserve bank and distributes through purchase of assets
• Lender of last resort

Question 17

What is the role of monetary policy?

Answer 17

Influence quantity of money or interest rates to achieve stable prices, full employment and economic growth. MPC (Monetary Policy Committee) make these decisions. Governor and deputy are the main people.

Question 18

What is the repo rate and how does the SARB use it?

Answer 18

It is a repurchase agreement that agrees to repurchase a security given - usually 7 days later.

Also called an accommodation.

A bank will sell a security to the SARB to make up a deficit - first leg of repo transaction, second leg is the repurchase. This is also called accommodation.

SARB uses policy measures to ensure banks have financial deficits so that SARB can influence the economy.

Question 19

What makes up the liquidity deficit of the financial sector?

Answer 19

All money owed to the SARB by private banks:

Cash reserve: needs to be 2.5% of total deposits with SARB.

Tax and loan account: transfer out by government from private bank to SARB creates liquidity deficit

Open market operations: the buying and selling of securities by SARB in the domestic financial market.

Question 20

Discuss the money flows to and from the SARB?

Answer 20

When the SARB sells securities to a private bank their liquidity deficit increases.

When the SARB buys securities deficit decreases. Referred to as Quantitative Easing.

Question 21

What is the impact of monetary policy on the real sector called?

Answer 21

The transmission mechanism of monetary policy.