Economics Chapter 14

Question 1

The functions of money

Answer 1

Medium of exchange
Unit of account
Store of value

Question 2

Medium of exchange

Answer 2

Due to the inadequacies of the barter system
Money therefore serves as a lubricant or intermediary to smooth the process of exchange and to make it more
efficient

Question 3

Barter system

Answer 3

An economy that functions without money where goods are exchanged for other goods

Question 4

Shortcoming of the barter system

Answer 4

Required double coincidence of wants
Trade was inefficient ,cumbersome
Transaction costs were high

Question 5

What is money?

Answer 5

Money is anything that is generally accepted as payment for goods and services or that is accepted in
settlement of debt

Question 6

Unit of account

Answer 6

Is an agreed measure for stating the prices of goods and services
enables us to obtain measures of the total value of all goods and services produced in the economy, such as GDP. Makes it easier to calculate the opportunity cost. Values of good and services can be standardized

Question 7

Store of value

Answer 7

A common form for holding wealth is money, since it can always be exchanged for other goods and
services at a later date. Wealth can, however, also be held in other forms, such as fixed property, real assets, stocks
and shares
money serves as a standard of deferred payment

Question 8

The advantage of store of value

Answer 8

It is usually more convenient and can be used immediately in exchange for other assets. We therefore say that money is the most liquid form in which wealth can be kept

Question 9

The disadvantages of store of value

Answer 9

In times of high inflation money loses its
purchasing power and is not a good store of value

Question 10

Standard of deferred payment meaning

Answer 10

Money is the measure of value for future payments

Question 11

What money is not

Answer 11

Money is not income/wealth because income and wealth are usually measured or expressed in monetary terms (eg in rand), they are often confused with money

Question 12

Income

Answer 12

is the reward earned in the production process. Natural resources, labor, capital and entrepreneurship are rewarded in the form of rent, wages and salaries, interest and profit

Question 13

Wealth

Answer 13

consists of assets that have been accumulated over time. Wealth can take many forms, such as fixed property, shares, oriental carpets or paintings

Question 14

Different kinds of money

Answer 14

The earliest forms of money were commodities, where the intrinsic value of the commodity was equal to the
exchange value assigned to it

Question 15

Properties of the commodities

Answer 15

Properties such as uniformity, durability, divisibility and the ability to be carried (which is determined by size and weight) were not to be found in all commodities

Question 16

Fiduciary/credit money

Answer 16

The total value of the paper money in issue was thus greater than the value of the gold backing it.

Question 17

Modern bank notes

Answer 17

Declared by law as legal tender. This means that such notes or
coins cannot be refused if they are tendered as payment

Question 18

The conventional measure (M1)

Answer 18

M1 is defined solely on the basis of the function of money as a medium of exchange.M1 includes 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. Everything that normally serves as a means of payment is included in the definition of M1

Question 19

Who does the monetary sector in SA include?

Answer 19

The monetary sector in South Africa includes the South African Reserve Bank, the Corporation for Public Deposits, the Land Bank, Postbank, private banking institutions and mutual building
societies

Question 20

Coins and notes (in circulation outside the monetary sector)

Answer 20

Only coins and notes in circulation outside the monetary sector constitute a part of the money stock. Only cash in the hands of the public can be used as a means of payment

Question 21

Demand deposits

Answer 21

Refer to deposits that can be withdrawn immediately by means of a cheque or electronic fund transfer (EFT)

Question 22

Definition of money can be written in the form of an equality, as follows

Answer 22

M=C+D
M=Quantity of money
C=Cash(coins and notes in circulation outside the monetary sector)
D=Demand deposits(deposits that can be withdrawn immediately and are generally accepted as payment in SA)

Question 23

A broader definition of money (M2)

Answer 23

M2 is equal to M1 plus all other short-term and medium-term deposits of the domestic private sector with monetary institutions. They are therefore regarded as quasi money (or near money). M2 can thus be defined as money plus quasi money

Question 24

The most comprehensive measure of money (M3)

Answer 24

M3 is equal to M2 plus all long-term deposits of the domestic private sector with monetary institutions. Reflection of the store of value function and not only the function of money as a medium of exchange. As we move from M1 to M2 and M3, the emphasis on the medium of exchange function decreases while the emphasis on the store of value function increase. Economists use it as a reliable measure of financial sector development

Question 25

Financial intermediaries

Answer 25

With the advent of money, a group of institutions emerged that specialized in purely financial transactions

Question 26

Financial Sector

Answer 26

In the financial sector there is a multitude of different kinds of institutions each specialising in a particular service or segment of the market. All these institutions have one main function, namely to act as an intermediary between the surplus units and the deficit units in the monetary economy

Question 27

Surplus units

Answer 27

Include households, firms and governments that have excess funds available(lenders),however ,governments are generally borrowers

Question 28

Deficit units

Answer 28

Include households ,firms and governments that need funds(borrowers).When the government borrows money it uses
Treasury bills and government stock or bonds as security

Question 29

Demand

Answer 29

Money is the amount that the various participants in the economy plan to hold in the form of money balances. It is based on choices of economic agents who earn an income and hold wealth. They must decide how they want to hold their income/wealth

Question 30

Bonds

Answer 30

A bond is a financial instrument that promises that the issuer (the borrower) will regularly pay the holder interest
and will repay the capital amount at a certain date. The government, for example, issues bonds to finance part
of its expenditure.

Question 31

Opportunity cost

Answer 31

The opportunity cost of holding any money balance is the interest that could have been earned had the money been used to purchase bonds instead

Question 32

The Constitution of the Republic of South Africa clearly states that:

Answer 32

(1) The primary object of the South African Reserve Bank is to protect the value of the currency in the interest of balanced and sustainable economic growth in the Republic.
(2) The South African Reserve Bank, in pursuit of its primary object must perform its functions independently and without fear, favor or prejudice, but there must be regular consultation between the Bank and the Cabinet member responsible for national financial matters.

Question 33

Functions Of SARB

Answer 33

Formulation and implementation of monetary policy
Service to the government(banker and advisor, custodian of gold and foreign exchange reserves, administration of exchange control)
Provision of economic and statistical services
Maintaining financial stability(Bank supervision, National payment system, banker to other banks, banknotes and coins)

Question 34

Basic components of the demand for money:
Economic agents will hold money for 2 reasons:

Answer 34

Transactions demand for money which arises from the medium of exchange function
Demand for money as an asset which arises from the store of value function

Question 35

The demand for money can be investigated in more detail by examining the two motives for holding money(Keynes 1930)

Answer 35

Transactions motive
Speculative motive

Question 36

Transactions motive

Answer 36

The amount of money required for transaction purposes will depend mainly on the total value of the transactions concerned.
This, in turn, will depend on the level of income. At the macro or aggregate level, the transactions demand for
money is therefore a function of the total income in the economy

Question 37

Speculative motive

Answer 37

Is related to the function of money as a store of value. Is that the choice between holding financial assets in the form of money or bonds will depend on the interest rate. When the level of interest in the economy is high(low),there will be less(more) money held for speculative purposes
Our conclusion is therefore that there is a negative (or inverse) relationship between the quantity
of money demanded for speculative purposes and the level of the interest rate

Question 38

The properties of the demand
curve can be summarized as follows:

Answer 38

The negative slope reflects the inverse relationship between the interest rate level and the quantity of money demanded by the speculative purposes
The position of the demand curve mainly determined by the demand for active balances, which is determined by the income level Any increase in income shifts the total demand curve to the right, while a decrease in the income level will cause the LL curve to shift to the left

Question 38

Transactions vs Speculative motive

Answer 38

The transactions demand is related to the need
to actively employ the money balances concerned. Active balances
By contrast, the speculative demand is not directly linked to
transactions. In this case the purpose is to hold the money
passively as a store of value. Passive balances

Question 39

What does the equation state

Answer 39

The equation states that the demand for money is a function of the income level and the interest rate level

Question 39

Different types of interest rates

Answer 39

Repo rate (which plays a dominant role in the money creation process)
The interbank lending rate
The prime rate of banks
Various rates on deposits
Mortgage rates and the rate on government stock, to mention only a few

Question 40

What are loans dependent on?

Answer 40

Loans are dependent on credit demand, creditability of prospective borrowers and SARB’s regulations(regulate money creation through interest rates)

Question 41

What happens when money is nor regulated properly

Answer 41

If there is excessive(too little) money creation SARB increase(decreases) interest rates to promote price stability (economic growth)

Question 42

What is monetary policy about?

Answer 42

The central bank tries to regulate money creation by affecting the demand for loans via the price of loans, that is, the interest rate

Question 43

Demand-determined money stock or endogenous money

Answer 43

Demand of money and the interest rate

Question 44

Monetary policy

Answer 44

as the measures taken by the monetary authorities to influence the quantity of money or the rate of interest with a view to achieving stable prices, full employment and economic growth.
Is formulated and implemented by the SARB. Decisions on the appropriate monetary policy stance are taken by the Monetary Policy Committee (MPC) of the SARB. The MPC consists of
the governor, the deputy governors and a few senior officials of the Bank

Question 45

The main features of the South African monetary policy framework at the time of writing can be summarized
as follows:

Answer 45

Ultimate objective is balanced and sustainable economic growth.
Intermediate objective is a pre-announced inflation target.
Operational variable is short-term interest rates, which are governed by changes in the repo rate.
Monetary control system is a classical cash reserve system

Question 46

Direct intervention vs market-oriented policy approach

Answer 46

When banks were simply instructed not to exceed certain quantitative restrictions on the extension of
bank credit vs where the authorities, through their own buying and selling conditions on financial markets, created incentives for financial institutions to react in the desired manner

Question 47

The main elements of the classical cash reserve system are:

Answer 47

1.Minimum cash reserve requirement of 2,5% of banks total liabilities
2.Various policy instruments(mainly open market policy) aimed at creating a persistent liquidity shortage
3.The provision of cash reserves through the repo system(accommodation policy)
4.The impact of the repo rate on short-term interest rates
5.The impact of short-term interest rates on credit creation, the money stock and other variables and, ultimately on the rate on inflation

Question 48

The instruments of monetary policy

Answer 48

Accommodation policy(Reserve Bank provides cash reserves to the banks)
Open-market policy(provide a summary of other policy instruments that are used to create a persistent
liquidity requirement )

Question 49

Accommodation policy

Answer 49

banks are obliged to hold 2,5 per cent of their total liabilities to the public in the form of cash reserves with the Reserve Bank. When a bank experiences a shortage of cash reserves, it can either change other financial assets into cash or borrow funds on the interbank market to eliminate the shortage

Question 50

What happens when all banks experience a shortage?

Answer 50

However, if all banks have the same liquidity problems, the
Reserve Bank, as bankers’ bank, acts as lender of last resort and the banks can then obtain funds by means of the repo system
Through the repurchase tender system (repo system)
liquidity is provided to the banks by means of repurchase agreements (repos) between the Reserve Bank and its banking clients

Question 51

Open market policy

Answer 51

Open-market transactions as an instrument of monetary policy consist of the sale or purchase of domestic financial assets (mainly Treasury bills and government bonds) by the central bank in order to exert a specific influence on interest rates and the quantity of money, via its influence on the cash reserves of the banks

Question 52

When bank wishes to enlarge its liquidity shortage

Answer 52

If it wishes to create or enlarge the banks’ liquidity shortage, the central bank sells government bonds or other
securities to the banks, thereby reducing their cash reserves (directly or indirectly)

Question 53

When bank wishes to stimulate the creation of bank deposits

Answer 53

It can also use open market operations to ease liquidity conditions and lower interest rates. In such a case (which is sometimes called quantitative easing) the central bank will buy government bonds and other securities

Question 54

Other instruments

Answer 54

Credit ceilings and deposit rate control (which were discontinued in South Africa some time ago)
Changes in exchange control regulations, central bank intervention in foreign exchange markets and public debt
management.
A final instrument at the Reserve Bank’s disposal is the informal measure of moral suasion

Question 55

Repo

Answer 55

A repo may be defined as the sale of an existing security (financial asset) at an agreed price, coupled with an agreement by the seller to purchase (buy back) the same security on a specified future date (normally seven days later) at the same price. The maturity value of the repo is determined in the initial agreement and consists of the price plus an agreed amount of interest. The interest represents the cost of obtaining the funds for a week