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Money as a Medium of Exchange

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Money is an intermediary and acts as a medium of exchange. This is unique to and defines money. anything that is generally accepted as payment for goods and services or that is accepted in settlement of debt. Money: anything that is generally accepted as payment for goods and services or that is accepted in settlement of debt.

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an agreed measure for stating the prices of goods and services. Unit of account: an agreed measure for stating the prices of goods and services. Prices expressed in monetary terms. Common measure of cost allows decisions on how best to spend our income. Could you measure GDP in a barter economy??? Accounting unit when prices increase, nominal values adjusted for price increases to obtain real values; only possible with money.

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Wealth can be held property, shares etc. BUT, money is liquid When inflation is high money loses purchasing power and is not a good store of value. Money can serves as a standard of deferred payment credit can be granted.

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Income Natural resources, labour, capital and entrepreneurship = rent, wages and salaries, interest and profit.Wealth Includes ALL assets

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Earliest forms of money were commodities. Suitability depended on Uniformity Uniformity Durability Durability Divisibility Divisibility Portability Portability

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Standardised coins produced, but not ideal for large transactions Paper money created by goldsmiths in exchange gold/silver deposits they received (certificates of deposit). Initially, paper money backed fully backed by gold gold standard Followed by fractional reserve system - total value of the paper money > value of gold backing it. (fiduciary or credit money). Modern banknotes based solely on confidence of SARB to control supply of notes so that purchasing power not eroded. Then came cheque accounts - bank deposits now accessed by cheques, electronic transfers, debit cards.

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SARB uses three measures of the quantity of money. The conventional measure (M1) M1 quantified on basis of money as a medium of exchange. 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. M1: 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. In circulation outside the monetary sector cant include cash in bank vaults until withdrawn. Demand deposits - deposits that can be withdrawn immediately.

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Calculating M1 MC + D M = C + D M M = quantity of money C C = cash (coins/notes outside monetary sector) D D = demand deposits (eg by cheque, debit card, electronic)

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A broader definition of money (M2) M1 + short and medium-term deposits of the domestic private sector with monetary institutions. M2 = M1 + short and medium-term deposits of the domestic private sector with monetary institutions. Short-term deposits: Short-term deposits: < 30 days Medium-term deposits: Medium-term deposits: < 6 months Can be withdrawn earlier only at a cost. Regarded as quasi money

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The most comprehensive measure of money (M3) M2 + long-term deposits of the domestic private sector with monetary institutions. M3 = M2 + long-term deposits of the domestic private sector with monetary institutions. Long-term deposits > six months. Used to evaluate success of monetary policy M3 reflection of store of value function and not only the function of money as a medium of exchange.

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Money led to advent of financial institutions specialising in purely financial transactions. no goods or non- financial services are involved. Financial transactions: no goods or non- financial services are involved. Financial institutions act as an intermediary between surplus units and deficit units in the monetary economy.

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Lesetja Kganyago

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Watch this video on the functions of the SARB https://www.youtube.com/watch?v=Scz_DE0So 14

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Established in 1920 Constitution states Primary object of SARB is to protect the value of the currency in the interest of balanced and sustainable economic growth in the Republic. SARB must perform its functions independently and without fear, favour or prejudice, but there must be regular consultation between the Bank and the Cabinet member responsible for national financial matters.Functions Formulation and implementation of monetary policy Service to the government Provision of economic and statistical services Maintenance of financial stability Provider of economic and statistical service

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Price stability = primary objective. How does the SARB do this? Bank supervision responsible for bank regulation/supervision The National Payment System Oversees safety and soundness of system. Banker to other banks Custodian of minimum cash reserves of commercial banks SARB provides liquidity to banks Banknotes and coins SA Mint Company & SA Bank Note Cash comes into circulation through the purchase of assets (usually financial assets) by the Bank.

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amount that participants in the economy plan to hold in the form of money balances (i.e. cash or bank deposits). Demand for money: amount that participants in the economy plan to hold in the form of money balances (i.e. cash or bank deposits). Opportunity cost of holding money? Interest that could have been earned from bonds. Money held if it provides a service as good as opportunity cost of holding it. 2 basic components of demand for money The transactions demand for money which arises from the medium of exchange function The demand for money as an asset which arises from the store of value function

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2 main motives identified by JMK (liquidity preference) 1. Transactions motive Participants hold money as a medium of exchange needed to enter into transactions. Money held to buy goods/services between paydays. How much money is needed depends on the level of income. At macro level - transactions demand for money is a function of the total income in the economy. > level of economic activity = > demand for bank loans.

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2. Speculative motive Demand for money as an asset. Money as a store of value. Holding money (little or no interest) VS. holding bonds (which earn interest)??? Depends on interest rate

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Transactions demand Transactions demand - purpose is to spend the money. Known as active balances. Speculative demand Speculative demand - purpose to hold money passively as a store of value. Known as passive balances (idle balances).

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The quantity of money demanded for transactions purposes depends on the level of income in the economy (Y) and is largely independent of the interest rate. For a given level of income (Y1) there is thus a given quantity of money demanded (L1). Represents demand for active balances. (L1) not sensitive to interest rate variations. Position of L1 is determined by the income level

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Quantity of money demanded for speculative purposes low when interest rate is high (opportunity cost of money is also high) Quantity of money demanded for speculative purposes higher when interest rate lower (opportunity cost of money low). Negative (inverse) relationship between quantity of money demanded for speculative purposes & level of the interest rate. Represents demand for passive balances. Inverse relationship btwn. interest rates & Q of passive balances demanded. At (i1) no funds will be demanded to be used for speculative purposes.

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Total money demand curve/total liquidity preference (LL). Add demand for active and passive balances (L 1 + L 2 ) Negative slope: Negative slope: inverse relationship between interest rate level & Q of money demanded for speculative purposes (i.e. as an asset). Position: Position: determined by demand for active balances (i.e. for transactions purposes) - determined by the income level. Increases in income shifts total demand curve to the right (vica versa)

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L = f(Y, i) L = quantity of money demanded Y = national income i = interest rate Demand for money is a function of the income level and the interest rate level.

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Demand deposits constitute >90% of quantity of money. What determines the size of these deposits?

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Money is created largely by banks and not by a mint or printing press. How do they do it? Banks create deposits by making loans. Watch this short video that explains how money is created. https://youtu.be/pZRvja7Mvrwhttps://youtu.be/pZRvja7Mvrw

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How many loans can banks create? Banks can create loans only if demand from creditworthy borrowers exists. Quantity of loans demanded depends on interest rate. Quantity of money demanded inversely related to interest rate.

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Instability of banking system necessitates central bank. Growing economy requires growing money stock. BUT excessive money = inflation. SO SARB regulates money creation process. Sounds great how do they do this???

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Interest rates influence the rate at which new money is created. Affects demand for loans via the price of loans, i.e., the interest rate. This is the essence of monetary policy.

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No independent money supply curve. Quantity of money depends on demand for money & interest rate. Known as a demand-determined money stock or endogenous money.

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measures taken to influence quantity of money or the rate of interest with a view to achieving stable prices, full employment and economic growth. Monetary policy: measures taken to influence quantity of money or the rate of interest with a view to achieving stable prices, full employment and economic growth. Formulated and implemented by SARBs Monetary Policy Committee

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Primary objective of the SARB to protect value of R in the interest of balanced and sustainable economic growth.

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1960s - 70s: 1960s - 70s: direct intervention limits to extension of bank credit) 1970s 80s: 1970s 80s: more market-oriented policy approach through creation of incentives for financial institutions to react in the desired manner. 1986 onwards: 1986 onwards: explicit monetary growth targets for M3 announced annually. pursued by changes in Bank rate. March 1998: March 1998: informal inflation target of 1 - 5 % set. 23 February 2000: 23 February 2000: formal inflation target 3 6% set by Minister of Finance

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The key instruments include accommodation policy accommodation policy (refinancing of the liquidity requirement) open-market policy open-market policy

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Classical cash reserve system - banks obliged to hold 2,5% of their total liabilities with Reserve Bank. Shortage of cash reserves? Change financial assets into cash or borrow funds. Borrow from overnight interbank market - borrow from other banks with excess funds. If all banks experience liquidity shortage, Reserve Bank, acts as lender of last resort Banks obtain funds by means of the repo system. Fixed rate determined SARB represents interest rate that banks pay for reserves they need.

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Read Box 6.7 on page 150

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Changes in repo rate regulate quantity of money through variations in cost of credit. Changes in the repo rate changes in interest rates at commercial banks cost of credit directly linked to the repo rate.

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sale/purchase of Open-market transactions: sale/purchase of domestic financial assets (eg. Treasury bills/ government bonds) by SARB to influence interest rates & quantity of money, via influence on cash reserve of the banks.

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