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MONETARY ECONOMICS
MONEY
Definition: An item
that is widely
acceptable as a
medium of
exchange (in order to
get something you
must give something
as a return)
Barter System
CHARACTERISTICS OF
MONEY
Recognizable must be acknowledged
by everyone in the economic system.
Scarcity limited in supply but not too
scarce. If it is too easy to obtain money, it
will not be acceptable to be exchanged with
goods and services. If it is too hard to find it
will limited the economic activities.
Durable last long and does not easily
deteriorate
CHARACTERISTICS OF
MONEY, cont..
Stable in value it will be difficult for
people to use money as a mean of payment if
its value changes or fluctuates frequently; too
much supply of money will reduce its value
Portable easy to carry
Divisible and standardized money
must be able to be divided into smaller units
to the extend of countable and standardized
FUNCTIONS OF MONEY
medium of exchange demanded for
transaction purposes.
store of value money does not suffer
from any physical deterioration; it can be
stored and can be turned into other forms of
wealth quickly.
FUNCTIONS OF MONEY,
cont..
a unit of account the value of goods
and services are expressed in terms of a
common measurement; which is money
a standard for deferred payment
money can be used as a payment at later
date and not necessarily when the goods
and services are purchased.
TYPES OF MONEY
1. Coins
1. Coins,cont..
also known as token money; the face
value is GREATER than the metallic
content of the coins fiat money
Standardized in weight, and produced
in large quantities to facilitate the trade.
Cont..
pieces of hard material used as a medium
of exchange or limited legal tender.
Legal tender; made legally by government
which must be accepted as a medium of
exchange and in settlements of debt.
Limited legal tender; certain values of
coins can only be used in a limited amount.
2. Notes
3. Current Deposits
also known as demand deposit, sight
deposit, bank deposit or cheque deposit
transferable from person to person
through the use of cheques
considered as money because it
possesses the functions of medium of
exchange and a store of value.
not legal tender like coins and notes.
4. Near Money
consists of saving deposits and fixed
deposits at commercial banks, Bank
Negara Malaysia and other financial
institutions and other short-term bills.
why near money? insufficiently liquid
to be a medium of exchange but it serves
the function of a store of value
how to use it? convert it into cash
(coins and notes) first.
SUPPLY OF MONEY
Total supply of money refers to the total
money in economic circulation; not the same as
the amount of money that the gov print.
How we measure total money supply in the
economy? using a narrow or broad definition
of money
So, in measuring the total money supply, we
classify them according to the definitions as given
by Bank Negara Malaysia (BNM), namely M1, M2
and M3.
M1 Supply of Money
Comprises of the most liquid assets only
coins, notes and demand deposit/current
deposit (current accounts) at commercial
banks.
The most liquid assets since they can be
used as payments and settlements of debts
directly, without having to convert.
M1 = (coins + notes) + demand deposit
M1 = fiat money + demand deposit
M2 Supply of Money
also called as narrow near money
Includes some less liquid assets because
they need to be turned into cash first before can be
used as a medium of exchange
Can be converted easily
Comprises of M1 and savings and fixed
accounts at commercial banks and Bank Negara
Malaysia (BNM), negotiable bills and Bank Negara
Malaysias certificates.
M3 Supply of Demand
Includes all the M2 money supply PLUS
saving and fixed deposits at other financial
institutions, merchant banks and discount
houses.
The savings and fixed deposits at other
institutions are part of near money because
they need to be converted into cash too
before using it to make payments or settling
the debts.
M3 Supply of Money
M3 = M2 + (savings and fixed deposits with
other financial institutions, merchant banks
and discount houses)
Broad near money = M3 M1
Fiat Money
M1
Notes
Demand deposits at commercial banks
Narrow
Savings and fixed deposits at com. Banks
near
money
Negotiable bills and BNMs certificates
Savings & fixed deposits with other fin. Institutions,
merchant banks & discount house
M2
M3
Broad near
money
Fishers Equation
Any changes in the total
Cont..
Therefore, MV = PT means,
Total expenditure in economy = total value of
national output
Since V and T are constant, therefore,
M = P.
It means that, change in money supply, M will lead
to change in the general price level, P with the
same rate. (CB increase money supply by 5%, the
general price level will also increase by 5%, with
assumption, V and T are constant.
Example
Suppose:
1)transactions,
2)Precautionary
and
3)speculative
1) Transaction Purpose, Lt
people hold money to buy goods and
services which depends on the level of
income and has no relation to interest
rate at all.
the higher the income of individuals, the
greater the amount of money that they want
to hold to do transaction.
positively related with income level
Quantity of Lt
2) Precautionary Purpose, Lp
Individuals demand money for the
emergency or unexpected circumstances
accidents, sickness, fire and others.
total money demanded for precautionary
is influenced by the level of income and not
related to interest rate.
Quantity of Lp
3) Speculative Purpose, Ls
Individuals hold money to speculate on
securities (bonds and shares)
The quantity of money depends on the
rate of interest and not influenced by income
level anymore.
they hold money for the purpose of getting
profit from the speculation activities.
Speculators will buy more securities when
the prices are low and sell the securities
when the prices are expensive
Speculative Purpose, Ls
Interest rate, r
Bonds and shares prices
are negatively related with
rate of interest
r1
r0
r*
Ls
Q1 Q0
Low r (r0) and high Psec
expect r to and Psec to
Security now
quantity of money balances (Q0)
Quantity of Ls
sell
Monetary Policy
One of the major stabilization policies adopted by
the government to overcome two major
macroeconomic problems inflation and
deflation.
this policy is designed to influence the supply of
money and/or interest rate through Central Bank.
Tools (methods) of monetary policy are all
related to the financial and banking system raise
or reduce the amount of money supply in the
economy
banks
banks
ratio
ratio
reserves
reserves
ability to give
ability to
Cont..
Discount Policy (Bank rate)
- the rate charged by the Central Bank on banks and
discount houses loan.
- any loan made by the banks from the CB will be
discounted by certain rate called as bank rate which
influence the interest rate charged by the banks on the
loans made to the public.
To
To
interest rate
reserves
interest rate
reserves
Cont..
Selective Credit Control
- the gov control ways of giving loans by
the commercial banks and other financial
institutions.
- the gov (through CB) can either tighten
or loosen the provisions of giving loan to
the public.
To
To
credit
credit
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