Money Function Comp

7/30/2019 Money Function Comp

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MEANING OF MONEY

In ordinary conversation, we commonly use theword money to mean income ("he makes a lot of

money") or wealth ("she has a lot of money").

Money ( or money supply) refers to anything that isgenerally accepted in payment for goods or

services or in the repayment of debts.

Money is a stock concept. It is a certain amount at

a given point in time.


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TYPES OF MONEY:

Money consists of

Currency: The paper notes and coins thatpeople use in a country. They are moneybecause government declares them so. (legaltender)

Deposits at banks and other depositoryinstitutions are also money. Deposits are moneybecause they can be converted into currency

and because they are used to settle debts.


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Medium of exchange

Standard of value

Store of value

Standard of deferred payment


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The most important job of money is to serve as a

medium of exchange

When any good or service is purchased, people usemoney

Money makes it easier to buy and sell because money

is universally accepted

Money, then, provides us with a shortcut in doing

business

By acting as a medium of exchange, moneyperforms its most important function


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Money facilitates exchange by reducing the cost of

trading.

Without money, we would have to barter.

Money does not have to have any inherent value to

function as a medium of exchange.

All that is necessary is that everyone believes that

other people will exchange it for their goods.


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Money is a common denominator in which the

relative value of goods and services can be

expressed

A job that pays $2 an hour would be nearly

impossible to fill, while one paying $50 an hour

would be swamped with application


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Store of Value

The function of money as a store of value refers to

the use of money to save purchasing power from

the time income received until the time it is spent.

This function facilitates the exchange of goods and

services over time.

Money is not unique as a store of value. There are

many other assets can be used as a store of valuesuch as stocks, bonds, real estate, collectibles,

arts, etc.


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In fact many such assets have advantages over

money as a store of value. They earn a returnwhile money (as cash) does not earn a return.

However, money is the most liquid of all assets

because it is the medium of exchange; it does

not need to be converted into anything else to

make purchase. Other assets involve

transaction costs when they are converted into

money.


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Money is used as a common denominator to

measure the relative values of goods and services.

Without money, we would have to measure thevalue of goods and services in terms of other goods

and services.

Money is a useful unit of account only if its value

relative to the average of all other prices doesnt

change too quickly.


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The money multiplier (also called as Credit multiplier

or debit multiplier) is the measure of extent to whichthe creation of money in the banking system causesthe growth in the money supply to exceed in themonetary base.

Some terminologies: Monetary Base B (also reserve money) Reserve-deposit ratio rr (minimum reserves each commercial

bank must hold) Currency-deposit ratio cr (Refers to the amount of currency (C)

people hold as a fraction of their deposits (D)). Money Multiplier m Money supply M (or money stock, the amount of money in the

economy.)


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The money multiplier is a multiplicative factor on the

monetary base.

E.g. If multiplier is 10, then Rs. 1 increase in monetary base

will increase the money supply by 10 times.

M= m*B

m= 1 +cr/cr+rr

Where

M= Money supply ( M=C+D)

m= Money Multiplier

B= Monetary Base


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Changes in the required reserve ratio (rr) The money multiplier and the money supply are

negatively related to rr

Changes in the currency ratio (cr)

The money multiplier and the money supply arenegatively related to cr

Changes in the excess reserves ratio (er)

The money multiplier and the money supply arenegatively related to the excess reserves ratio e

The excess reserves ratio eis negatively related tothe market interest rate

The excess reserves ratio eis positively related toexpected deposit outflows


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A Bank has a Reserve Ratio (RR) of 20% and an initial deposit of 100.00

Calculate:

the money multiplier and the re-lending process assuming no

currency drain

Calculate Money Multiplier (m):

m = 1 /RR =1 /0.2 = 5


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The money multiplier model asserts that, in afractional-reserve banking system, the totalquantity ofloans that commercial banks canextend (the bank credit money they are allowedto create) is amultiple of the quantity ofreserves they hold in advance of the loans theyextend.

This multiple is a money multiplier and is the

reciprocal if the reserve ratio.


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Measures of money are typically classified as levels of M The monetary base or high powered money is smallest and

lowest M-level: M0. Base money can be described as the

most acceptable (or liquid) form of final payment. The govt. institutions generally control change in the

monetary base through open market transactions (like thebuying and selling of government bonds).

They also typically have the ability to influence banking

activities by manipulating interest rates and changing bankreserve requirements


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The monetary base is called high-powered because an

increase in the monetary base (M0) can result in a much

larger increase in the supply of bank money, an effect often

referred to as the money multiplier.

An increase of 1 billion currency units in the monetary base

will allow (and often be correlated to) an increase of severalbillion units of "bank money.

Consider the following example:


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Suppose there is a $100 deposit of gold coins.

Assume the Reserve Ratio (e) is 10%, so the bank keeps 10%of all deposits as reserves. Therefore, the bank can loan outthe remaining $90 of gold coins.

Assuming the public holds no currency, the new $90 loan willbe spent and then redeposited by the new holder of the $90

The bank keeps $9 to meet the 10% reserve requirement andthen can make another loan of $81.

This process repeats and repeats and ultimately the originaldeposit of $100 leads to the creation of upto $1000 units ofmoney, all in the form of bank deposits!


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Money is anything that serves thecommonly accepted medium ofexchange.


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Medium of exchange

Store value

Unit of account


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Transaction motive

Precautionary motive

Speculative motive


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In economics, the money supply or money stock, is

the total amount of monetary assets available in an

economy at a specific time.

Money supply data are recorded and published,

usually by the government or the central bank of the

country. Public and private sector analysts have long

monitored changes in money supply because of itspossible effects on the price level, inflation, the

exchange rate and the business cycle.


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Monetary policy refer to steps taken by RBI to

regulate cost and supply of money in order to

achieve certain Socio Economic objective like price

stabilization full employment, exchange regulation

and increased economic growth.


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There is no unique measure to money aggregate

M : M1 + M2 + M3 + M4


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It consist of

Currency notes and coins with public ( excluding

cash in hand of all banks). Demand deposit ( excluding inter bank deposit)

Deposit held with RBI ( excluding IMF,PF,

guarantee fund & adhoc liabilities).

N A R R O W M O N E Y


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Consists of M1

Saving deposit with post office saving bank.

Represents money and "close substitutes" for money.

M2 is a broader classification of money than M1.

Economists use M2 when looking to quantify the

amount of money in circulation and trying to explaindifferent economic monetary conditions.

M2 is a key economic indicator used to forecastinflation.


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Consists of M1

Time deposit of commercial bank & cooperativebank ( excluding inter bank deposit)

It includes net bank credit to government +bankcredit to commercial sector + net foreign exchangeassets + government currency liability to the public

B R O A D M O N E Y


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Consists of M3

All deposits with post office savings banks

(excluding National Savings Certificates).


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If we see the components of money supply, we can

see bank deposits form bulk of the money supply.

Within deposits, it is time deposits which form

around 3/4th of the money supply. The share of time

deposits has declined from 74.7% in Oct Dec 09 to

74% on 9 April 2010. The share of demand deposits

has risen from 11.3% in Oct

Dec 09 to 12% on 9April 2010. The percentage contributions of each

item in components of money supply do not change

much in the year.


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Components of Money Supply (in %)

April 09

June 09

July 09

Sep 09

Oct 09

Dec 09

Jan 10-

Mar 10

As on Apr

9, 2010

Currency with the public 14.1 13.6 13.9 14.0 13.9

Demand deposits with banks 11.4 11.6 11.3 12.0 12.0

Other deposits with RBI 0.2 0.1 0.1 0.1 0.1

Time deposits with banks 74.3 74.7 74.7 74.2 74.0

Money Supply 100.0 100.0 100.0 100.0 100.0

As both demand and time deposits form around 75%

of money supply, whatever the growth in deposits, isalso the growth in money supply. RBI changes both

these targets together and keeps them near similar.


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The growth in money supply must be higher then the growth inthe real national Income This stems for two reasons

(i) As income grows ,the demand for money as one of the

component of saving tends to increase.

(ii) An increase in money supply is also necessitated by gradualreduction of the non-mentioned sector of the economy.

In our country, the rate of increase in money supply has been farexcess of the rate of growth in real national income.


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Documents

Money Function Comp