Money and banking Flashcards
Money
Generally acceptable as a medium of exchange
Functions of money
● Medium of exchange
● Unit of account
● Store of value
● Standard of deferred payment
Qualities of money
● Generally acceptable as medium of exchange
● Portable: easy to carry for high-value transactions
● Divisible: value will not fall when divided into smaller units
● Durable: can be stored for a long time
● Homogeneous: have uniform physical characteristics
Quantity theory of
money (in the long run)
MV = PY, where M is money supply, V is velocity of circulation of money, P is price level, Y is real output. In the short run, V is held constant. (In the long run, both V and Y are held constant.)
Functions of central bank / HKMA
● Issues currency
● Carries out monetary policies
● Acts as the lender of last resort
● Manages foreign exchange reserves
Functions of price
● Rationing function
● Allocative function
Fractional reserve system
● Commercial banks are required to keep a fraction of the total deposits as required reserves
● They can create credit by lending out the excess reserves which would eventually return into the banking system in the form of deposits
Credit creation process
● Cash is injected to the commercial banks as reserves
● There would be excess reserves in the banking system
● The banks would lend out excess reserves
● The bank loans will be re-deposited into the banking system
● The process will go on and on until the actual reserves are equal to required reserves
Assumptions for deposit creation
● Banks do not hold excess reserves
● There is no cash leakage
● There is sufficient demand for loans in the market
Monetary base
cash in public circulation + reserves held by commercial banks
Money supply
cash in public circulation + Deposits in commercial banks
Nominal interest rate
Opportunity cost of holding money
Fisher equation
Nominal interest rate = real interest rate + inflation rate
Effect on money supply when bank buys bonds from public
Increase
