Money: functions and types

Functions: The function of money as a medium of exchange solves all difficulties of barter system. There is no necessary for a double coincidence of wants in the money economy.

Types: 1) Money is a medium of exchange, 2) Money as measure of value (unit of account), 3) Standard of deferred payment, 4) Money as a store of value.

 

Supply for money.

Money definition(aggregates):

·M0

·M1

·M2

·M3

 

M0- all currency (notes and coins) in circulation

 

M1- it includes:

·all currency (notes and coins) in circulation,

·all checkable deposits(bank money)

·all traveler's checks

 

M2- it includes:

·all of M1

·plus savings and time deposits

 

M3- it includes:

·all of M2

plus large denomination, long-term time deposits

The role of banking sector - creation process.

There are 2 crucial functions:

·they receive funds from depositors and, in return, provide these depositors with a checkable source of funds or with interest payments.

·they use the funds that they receive from depositors to make loans to borrowers; that is, they serve as intermediaries in the borrowing and lending process.

 

When banks receive deposits, they do not keep all of these deposits on hand because they know that depositors will not demand all of these deposits at once.

Instead, banks keep only a fraction of the deposits that they receive.

· The deposits that banks keep on hand are know as the banks' reserves.

· The reserve requirement is the fraction of deposits set aside for withdrawal purposes (is determined by the nation's banking authority).

· Deposits that banks are not required can be lent to borrowers, in the form of loans.

·Banks profits is the difference between higher rates of interest

 

Money – creation system. Money multiplier.

Money creation - is the process by which the money supply of a country or a monetary region is increased

Money Multiplier.

The amount by which bank deposits expand in response to an increase in excess reserves is found through these of the money multiplier.

·If some loan funds are held as currency, then there is a leakage of money out of the banking system

·money multiplier will still be greater than 1, but less than inverse of the reserve requirement.

Mm=1/rr*100%

 

Monetary policy: goals and instruments.

Goals.

To assist the economy in achieving

·a full-employment

·noninflationary level of total output

Tools of monetary policy.

·Open-market operation;(операции на открытом рынке: купля-продажа гос. ценных бумаг)

·The reserve ratio;(норматив обязательного резервирования)

·The discount rate.(учетная ставка или ставка рефинансирования)

 

Types of monetary policy.

Open-market operation

Buying and selling (from/to commercial banks and the public) of government bonds by the Central Bank in the open market.

Buying from commercial banks

·Commercial banks give up part their holding of securities

·The CB pay for these securities by increasing the reserves of commercial banks.

 

The reserve ratio

Raising the reserve ratio increases the amount of reserves banks must keep. Banks lose excess reserves, diminishing their ability to create money by lending. They are forced to contract the money supply.

Effectiveness of monetary policy.

--the actions taken by central banks to stem inflation and foster sustainable levels of employment and production--since the time of the Great Depression in the 1930s

IS –LM” model: equilibrium.

Model IS - LM (investment - savings, liquidity preference - the money) - a model of commodity-money balance, allowing to identify economic factors that determine the function of aggregate demand. The model allows to find such a combination of market rate (R) and income (Y), at which time equilibrium is reached in the commodity and money markets. It is a concretization of the model AD-AS.

 

The curve IS - the equilibrium curve for the commodity market. The lower rate%, the higher the level of income. Under the influence of increased public spending or tax cuts IS curve shifts to the right.

 

The curve LM - the equilibrium curve in the money market. It captures all the combinations of Y and R, which satisfy the demand for money at a given value of Central Bank money supply (Ms). At all points of the demand for money equal to their proposal.

 

The curve LM - the higher the income, the higher the interest rate. Increasing the money supply or decrease in the price level shifts the LM curve to the right. Equilibrium in the model at the point of intersection of the IS and LM.

The Phillips curve.

Graphic representation of the economic relationship between the rate of unemployment (or the rate of change of unemployment) and the rate of change of money wages. Named for economist A. William Phillips, it indicates that wages tend to rise faster when unemployment is low.

 

The adaptive and rational expectations theories.

The adaptive expectations theory

- Assumes people form their expectations of future inflation on the basis of previous and present rates of inflation. When people do, the U rate return to the natural rate.

- The long-run Phillips Curve is therefore vertical.

 

The rational expectations theory

- Assumes that increases in nominal wages lag behind increases in the price level because the increases in the price level are not anticipated.

- Workers will anticipate the inflationary effects of monetary and fiscal policy and will build these expectations into their wage demands.

- As a result, not even a short-run Phillips curve will exist.

- The economy will simply move along its vertical long-run Phillips Curve when government undertakes expansionary policies.