These slides cover the first chapter of the B.Com "Banking and Finance" syllabus: Money.
It includes the following topics: Definition, Origin, Functions, Inflation and its remedies, , Deflation and its causes, reflation, devaluation, , Monetary and Fiscal Policy, Paper Money: its kinds and advantages and disadvanatges, Monetary system, Value of Money: quantity theory of money, cash balance approach, modern theory of money.
2. DEFINITION
Money has been defined differently by different economists.
1. Descriptive Definitions
2. Legal Definitions
3. General Acceptability Definitions
3. DEFINITIONS
(1) Descriptive definitions
“Anything that is generally acceptable as a means of exchange and that at the same time acts as a
measure and store of value.” – Crowther in his book: An outline of money
“Money may be defined as a means of valuation and of payment” – Coulborn
“Money is anything that is widely used as a mean of payment and is generally acceptable in settlement
of debts.” – Cole
These are considered narrow and partial definitions, because they focus on the functions of money and not
on what money is
4. DEFINITIONS
(2) Legal Definitions:
“Anything which is defined by the state as money is money” – Professor Knap
Professor Hartley believes that money should be legal tender.
These are narrow definitions based on “state theory of money.”
The government can not force the people to accept money. e.g. German currency Mark
5. DEFINITIONS
(3) General Acceptability Definitions:
“Money is anything which is commonly used and generally accepted as a medium of exchange or as a
standard of value.” – Kents
Money is described as “anything which is widely accepted in payment of goods or in discharge of other
kinds of business obligations,” by D.H. Robertson.
“Money is anything that is generally accepted in payment of goods and services or in the repayment of
debts.” – E. Mishkin
Money here, is defined as anything which has general acceptability.
6. “MONEY IS ANYTHING THAT IS REGULARLY USED IN
ECONOMIC TRANSACTIONS AND SERVES AS A
MEDIUM OF EXCHANGE, A UNIT OF ACCOUNT AND A
STORE OF VALUE.”
DEFINITION OF MONEY
7. ORIGIN OF MONEY
Money has evolved through five different stages during history:
1. Commodity money
2. Metallic money
3. Paper money
4. Credit money
5. Electronic money
8. ORIGINS OF MONEY
1. Commodity money:
Commodity money has a value apart from its use of money.
A large number of items such as cows, goats, sheep, rice, grains, etc were used
However they lacked storage capability, durability transportability, divisibility, and homogeneity.
9. ORIGINS OF MONEY
2. Metallic money:
Coinage: gold and silver were used as coins, stamped by a competent authority.
As time passed, transportation and storage of coins became inconvenient and dangerous
10. ORIGINS OF MONEY
3. Paper Currency:
Paper currency is made of paper and functions as a medium of exchange
Initially paper currency carried a promise that it was convertible into a fixed quantity of precious metallic
gold and silver
This promise was eliminated in 1914 in England and in 1933 in America.
Fiat money: this newspaper money which is considered legal tender because the government says it is
money. It has no backing of gold, silver or government securities
11. ORIGINS OF MONEY
4. Credit money or bank money:
Bank money is the use of cheques as the medium of exchange.
Cheques have made it possible an easier to make transactions for large amounts. They are easier to
transport.
They are safe and provide receipts
Checks are not legal tender. They cannot be enforced in payments of debts
12. ORIGINS OF MONEY
5. Electronic banking stage:
This is a modern system of transferring funds using Electronic Communications.
Payments are now made through magnetic strip cards such as bank debit cards, credit cards, telephone
cards etc.
This form of banking has reduced processing costs, lead times for payments and increasing flexibility.
These are also not considered legal tender
13. FUNCTIONS OF MONEY
Primary Functions of Money
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Money as a medium of Exchange
Money as a unit of account
Money as a standard of deferred payments
Money as a store of value
Secondary Functions of
Money
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Aid to specialization, production and trade
Influence on income & consumption
Money is an instrument of making loans
Money as tool of monetary management
Instrument of economic policy
Contingent Functions of
Money
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Distribution of national income
Basis of credit system
Measure of marginal productivity
Liquidity of property
14. PRIMARY FUNCTIONS OF MONEY
1. Money as a medium of Exchange
Used to pay for goods and services
Overcame double coincidence of barter system
Introduced time efficiency of exchanging goods and services
Encouraged division of labour. People are now specializing due to easier payment of services
rendered..
2. Money as a unit of account
Common measure of money.
Used to compare goods in terms money
3. Money as a standard of deferred payments
Money is useful in the purchasing goods on credit as it is easy to borrow-and lend
4. Money as a store of value
Does not deteriorate and stores value
15. SECONDARY FUNCTIONS OF MONEY
Money has the potential to influence an economy, by influencing interest rates, price levels, resources, etc.
1. Aid to specialization, production and trade
2. Influence on income & consumption
3. Money is an instrument of making loans
4. Money as tool of monetary management
5. Instrument of economic policy
16. CONTINGENT FUNCTIONS OF MONEY
Contingent functions are derived from primary & secondary functions
Distribution of national income
Basis of credit system in banks
Measure of marginal productivity
Liquidity of property
17. QUALITIES OF A GOOD MONEY SYSTEM
The term monetary system refers to the type of standard money used for making payments. It refers to the value
of money, organization, arrangement, control and management system of money.
1. Simplicity
2. Elasticity
3. Economical
4. Price Stability
5. Legality
6. Liquidity
7. Full employment
18. INFLATION
Inflation is a continuous upward movement in the general (average) level of prices.
Two causes:
1. Demand Pull Inflation
2. Cost Push Inflation
19. DEMAND PULL INFLATION
When aggregate demand increases faster than aggregate supply of goods and services, prices will
increase and inflation occurs.
Also called aggregate demand inflation.
Occurs when there is excess demand for output.
Sources of rise in demand pull inflation
Monetarist view: (Million Friedman)
If central bank issues and prints more money into the economy than its demand.
Non monetary view: (J.M. Keynes)
Increase in purchases of goods and services due to increase in wealth.
Higher business investments
Increase in government expenditures
Foreign demand for country’s goods.
20. COST PUSH INFLATION
Cost push inflation occurs when prices are forced upward by increases in the cost of factors of
production and not by excess demand.
Sources of increased costs are:
1. Increase in money wage rates
2. Profit push inflation
3. Material push inflation
4. Higher taxes
5. Rise in import prices
21. REMEDIES OF INFLATION
1. Monetary Policy
It is a policy which influences the economy through changes in the money supply and available
credit.
2. Fiscal Policy
1. Change in taxation
2. Changes in government expenditure
3. Public borrowing
4. Balanced budget changes
5. Control of deficit financing
22. REMEDIES OF INFLATION
3. Other measures
i.
Price support program
ii. Provision of subsidies
iii. Arrangements of easy availability of goods on hire purchase to stimulate demand
iv. Imposing direct control
v.
Rationing of essential consumer goods in case of acute emergency through holding of Friday and
Sunday markets
24. DEFLATION
Deflation refers to the situation where price level fall is causing major increase in
unemployment, reduction in output and decrease in the income off the people.
“Deflation is that state of the economy where the value of money is rising or prices are falling.” --
Crowther
25. CAUSES OF DEFLATION
When the level of money income falls relatively to the current supply of goods and services.
Deflationary process may occur due to:
Fall in private investment
Persistent unfavorable balance of payments
Continued government-budgetary surplus
Sudden increase in the total output
By action of central bank to raise the discount rate or by selling securities
All are due to the combined effect of all of these factors
26. REFLATION
A real Reflation is a sustained rise in the general level of prices.
It is a situation all rising prices after the full employment is reached. This phenomenon is due to
increased in aggregation demand without any increase in production of goods and employment.
The solution is the result of efforts made by the government to lift the economy out of depression.
27. REFLATION
Similarities between inflation and reflation:
The money supply increases
Upward movement of general price level
Differences between inflation and recreation:
Inflation causes a serious problem of rising prices without any increase in output and
employment, whereas reflation leads to more production and employment.
Reflation is adopted by the government.
It takes place below the level for employment
Prices rise very slowly under reflation, but very rapidly under inflation.
28. DEVALUATION
Devaluation is the a reducing of value or exchange rate of national currency with respect to other foreign
currencies.
Under the fixed exchange rate system, the exchange rate is determined by the demand for and supply
of foreign exchange.
29. DEVALUATION
Depreciation is the lowering of currency value in a free-floating exchange rate system.
Devaluation is the lowering of currency value in a fixed exchange rate system.
30. VALUE OF MONEY
Value of money refers to its purchasing power: that is its capacity to command goods in exchange for
itself.
Value of money is high if it buys more commodities. And vice versa.
The value of money varies inversely with the general level of prices.
31. VALUE OF MONEY
1. Quantity theory of money
2. Cash balance theory of money
3. Modern quantity theory of money
32. QUANTITY THEORY OF MONEY
In the 16th century,
gold and silver inflows from the Americas into Europe were being minted into
coins, because of which there was a resulting rise in inflation.
Changes in money supply will directly impact both prices and inflation rates.
The quantity theory of money states that there is a direct relationship between the quantity of money in
an economy and the level of prices of goods and services sold.
According to QTM, if the amount of money in an economy doubles, price levels also double and value of
money is halved.
34. QUANTITY THEORY OF MONEY
Irving Fisher studied and derived an equation to demonstrate this effect, based on:
a) Supply of money
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Total volume of money in circulation during a time period = MV
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M: quantity of money in circulation
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V: Velocity of money in circulation
b) Demand of money
a) People demand money for the means of exchange.
36. QUANTITY THEORY OF MONEY
Assumptions:
Full employment: The theory is based on the assumption of full employment in the economy.
T and V are constant: The theory assumes that volume of trade (T) in the short run remains
constant. So is the case with velocity of money (V) which remains unaffected.
Constant relation between M and M1. Fisher assumes constant relation between currency money M
and credit money (M1).
Price level (P) is a passive factor. The price level (P) is inactive or passive in the equation. P is
affected by other factors in equation i.e., T, M, M1, V and V1 but it does not affect them.
37. CASH BALANCE APPROACH
Fisher’s Transaction Theory
Cash Balance Approach
Based on medium of exchange function of money
Based on store function of money.
Demand for money
Demand for cash balances
Focuses on demand/supply over period of time
Focuses on demand/supply at particular point of
time.
Demand for money increases; Price level increases
Demand for money increases; Price level decreases
because of decrease in expenditures
38. CASH BALANCE THEORY OF MONEY
Cambridge Equations:
Alfred Marshall’s Equation:
M = K P y
Keyne’s Equation:
n = P k
M : quantity of money
P : price level
y: aggregate real income
K : fraction of real income which people wish to hold in money form
P : price level of consumption goods
n : total supply of money in circulation
K : total quantity of consumption units
which people wish to hold in cash
40. VALUE OF MONEY
• Cambridge
Economists:
Keynes, Marsh
all
Quantity
Theory of
Money
• M=KPy
• n=Pk
Cash Balance
Approach to
Money
Modern Theory
of value of
money
41. MONETARY POLICY
Monetary policy is the process by which the monetary authority of a country controls the supply of
money, often targeting a rate of interest for the purpose of promoting economic growth and stability
The official goals usually include relatively stable prices and low unemployment.
42. MONETARY POLICY
Objectives:
1. Promoting high employment
2. Achieve a steady economic growth
3. Stable price level as a goal
4. Stability in interest rate
5. Promoting a more stable financial market
6. Stability in the foreign exchange markets
43. MONETARY POLICY
Expansion
• increases the total
supply of money rapidly
• combat unemployment in
a recession by
lowering interest rates
Contraction
• expands the money
supply more slowly than
usual or even shrinks it
• slows inflation to avoid
the resulting distortions
and deterioration of
asset values.
44. MONETARY POLICY
Quantitative controls
Qualitative controls
Open market operations
Varying margin requirements
Variation in the bank rates
Consumer’s credit regulation
Credit rationing
Use of moral persuasion
Varying reserve requirements
Direct action
45. KINDS OF PAPER MONEY
1. Representative paper money
This type of money is fully backed by metallic money
It possesses all the fundamentals qualities of a good money system
2. Convertible paper money
It is money which Carries a promise by the issuer that the paper can be converted into the standard
money metal at some future date.
In actual practice, the state bank never keeps a 100% metallic result. It is always less than 100%.
State bank of Pakistan does not issue this kind of money
3. Inconvertible paper money
This money cannot be converted into standard money metal
It is regulated by the law of state, and is also called Fiat money
46. PAPER MONEY
Advantages
Disadvantages
Economical
Danger of inflation
Elasticity of money supply
Internal price instability
Promotes economic growth
Exchange instability
Internal price stability
Dangerous of mismanagement
Helpful in emergency
Fear of demonetization
Regulation of exchange rates
Use within the country
Uniform quality
Notas do Editor
legal tender noun: money that the law allows people to use for paying debtsGeorg Friedrich Knapp (German: [knap]; March 7, 1842 – February 20, 1926) was a German economist who in 1895 published The State Theory of Money, which founded the chartalist school of monetary theory, which takes the statist stance that money must have no intrinsic value and strictly be used as governmentally-issued token, i.e., fiat money.Ppl still use mark over euro - deutsche mark?
Specialize in trade products becoz no more barter system.Money influences inc n cons in a coutry. All payments made in money. All striving for the same thing.4. employment.. Increases output. Distribution of wealth among ppl5. Achieve eco growth in a country. Rules set by govt.
Money distributes national incomes thru diff factors of productionBanks are creadted on credit of their cash reserves. Any change in volume is becoz of change in money supply.The term “marginal productivity” refers to the extra output gained by adding one unit of labor; all other inputs are held constant. So, the technology and efficiency of the factory stays the same. Marginal productivity is the extra jeans sewn, that is output gained, by hiring an extra worker, for example.
Does not mean that all prices increase. Some may stay constant or fall.. Average prices increase. Money is continuously losing value.
Higher biz investments due to higher profit expectations or fall in interest rates
They feed upon each other. Workers need money to adjust to increased prices level.Monopoly walay firms fix a higher profit margin. Smaller firms also then fix higher prices because of larger firmsIncrease in oil, gas, steel, chemicalsProducers throw burden of new taxes onto customersIf price of imported goods increase. Inflation.
Monetary policy– central bankFiscal policy – govt regulationsJohn Maynard KeynesTax down; inflation risesDeficit financing: When a government's expenditures exceed its revenues, causing or deepening a deficit. This excess spending needs to be financed through borrowing, likely from foreign governments. The increased government spending can help stimulate the economy as more money flows in, but the jump in borrowing can have an adverse effect by raising interest rates.
Devaluation: Stimulates exports and foreign investmentRestricts importsFavourable balance of paymentsStimulates domestic employment- increase in country income- employment
Devaluation happens in countries with a fixed exchange rate. In a fixed-rate economy, the government decides what its currency should be worth compared with that of other countries. The government pledges to buy and sell as much of its currency as needed to keep its exchange rate the same. The exchange rate can change only when the government decides to change it. If a government decides to make its currency less valuable, the change is called devaluation. Fixed exchange rates were popular before the Great Depression but have largely been abandoned for the more flexible floating rates. China was the last major economy to openly use a fixed exchange rate. It switched to a floating system in 2005.A floating exchange rate means that the global investment market determines the value of a country's currency. Pak since 1982The exchange rate among various currencies changes every day as investors reevaluate new information. While a country's government and central bank can try to influence its exchange rate relative to other currencies, in the end it is the free market that determines the exchange rate. As of 2012, all major economies use a floating exchange rate.
More supply, higher prices; more inflation. And less value of moneycausing inflation (the percentage rate at which the level of prices is rising in an economy). The consumer therefore pays twice as much for the same amount of the good or service.
Velocity= gnp/given stock of moneyAlso called velocity of circulationThey don’t demand money like we demand commodities
Developed by a group of Cambridge economists: Alred, Marshall, A.C. Pigou Robertson and J.M. KeynesStorage is for precautionary and transaction motives. Only happens when the national income grows and ppl wealth. Demand for goods decrease, prices decrease and value of monet increases.
i.e general acceptability, value, uniform quality, convenience and be economical.
