MONEY
Money, as defined in economics, is anything that is readily and widely accepted as a medium for
the exchange for goods and services or in settlement of debts.
Before the invention of modern money in the forms of currency notes and coins as we know
today, trade had been conducted by barter, through the use of commodity monies such as
cowries’ shells, cow, manilas, iron bars, etc.
The barter system refers to a situation where goods are directly exchanged for goods.
The problems associated with the system are:
Double coincidence of wants
No common unit of measure
The absence of a means of storing wealth or value
Difficulty in making deferred payment
Problem of bulkiness and indivisibility of most goods
THE FUNCTIONS OF MONEY
A medium of exchange
A unit of account or a measure of value
A store of value
A standard of deferred payment
THE CHARACTERISTICS OF MONEY
For anything to perform the functions of money outlined above effectively, it must possess the
following attributes or qualities :
General acceptability
Homogeneity
Relative Scarcity
Divisibility
Portability
Durability
TYPES OF MONEY
Paper money and coins: These are monies issued exclusively by the financial institutions, such
as the Central Bank of Nigeria (CBN), Federal Reserve of the United States etc. They are backed
by law and hence accepted in exchange for goods and services and in settlement of debt.
Bank deposits: These are money deposited with financial institutions, especially commercial
banks which are withdrawable or transferable without prior notice by writing a cheque. Such
deposits are held in current accountof the customer, and a fee is charged for processing the
cheque
Quasi- money or near money: These are assets which adequately serve as a store of value but
do not fulfil the medium of exchange function. Examples include saving and time deposits, stock
and shares, postal and money orders, treasury bills etc. What constitute quasi – money varies
from one country to another.
THE SUPPLY OF MONEY
Money supply or money stock refers to the total amount of money in the economy for purposes
of policy. Various definitions or variants of money supply exists (e.g. M1, M2, etc). The quantity
of money in an economy has direct effect on the price level and therefore on the value of money.
Hence, to promote price stability and economic growth, the total money supply is subject to
government control through the Central Bank in every modern economy.
THE DEMAND FOR MONEY
Demand for money otherwise referred to as liquidity preference means the desire of people to
hold their resources or wealth in the form of cash i.e. currency notes and coins, instead of interest
– yielding assets. The British economist, John Maynard Keynes (1883 – 1946) identified three
reasons for demand for cash balances or why people hold money. These are:
a. The Transactions Motive: This represents cash balances held in order to carry out ordinary,
everyday transactions. For example, individual persons need to hold money to buy fares, and so
on. Similarly, business organizations need money to pay wages and electricity bills, buy raw
materials, vehicles and equipment, etc. The transactions demand for money is directly related to
income.
b. The Precautionary Motive: This refers to holding cash balances as a precaution against
unexpected expenses. For instance, people hold money to provide them with some degree of
security against sudden illness, accidents, fire or flood disaster, etc., while firms hold money
against unpredictable occurrences such as sudden breakdown of vehicles, equipments and so on.
The main factor influencing this motive is the level of income.
c. The Speculative Motive: This refers mostly to the desire to hold cash balances in order to
make speculative dealing in the bond or securities (interest – yielding assets) markets. The
demand for money for speculative purposes is interest – elastic. The higher the rate of interest,
the lower the demand for speculative cash balances. Thus, there is an inverse relationship
between the price of bond and interest rate. This motive for holding money is a decreasing
function of the rate of interest and it is also influenced by incomes.
Lord Keynes refers to the money held for transactions and precautionary motive as active
balances, and that which is held for speculative motive as idle balances. The total demand for
money is found by the summation of transactions, precautionary, and speculative demands.
THE QUANTITY THEORY OF MONEY
This theory suggests the existence of a direct relationship between money supply and the average
price level in the macro economy. Specifically the quantity theory of money states that the price
level is strictly proportional to the money supply.
The quantity theory of money which was pioneered by the 18th century economists including
Adam Smith and David Hume, was modified and popularized in 1911 bythe American
Economist, Irvin Fisher (1867 – 1947) in what is known as equation of exchange:
MV = PQ
where M = Total money supply
V = velocity of circulation of each unit of money
P = average price level
Q = real national output or real GNP
The assumptions of the theory are that:
(i) The velocity of money circulation (V) is fixed.
(ii) The real GNP denoted (Q) is fixed in the short – run.
(iii) The money stock (M) is determined from time to time by the country`s monetary authorities.
(iv) The economy is at full employment level.
NOTE: in realty it is necessary for the government to ensure consistency between the quantity of
money and the amount of goods and services available in the economy in order to promote price
stability and rapid economic growth.
BANKING:
Financial institutions may be broadly divided into two groups – banking and non-banking
financial institutions. The banking institutions include commercial and merchant banks,
development banks, and the Central Bank. On the other hand, the non-banking institutions
include insurance companies, equipment – leasing companies, hire – purchase companies,
building societies, discount houses, etc.
COMMERCIAL BANKING
The commercial banks are profit – making enterprises, as well as the major financial
intermediaries through which the monetary authorities facilitate effective distribution of money
in the economy
.
Functions of Commercial Banks
The commercial banks offer a range of services which include the following:
Accepting deposits of money
Granting loans and advances
Acting as agents of payment
Creating demand – deposit money
Providing international trade service
Providing brokerage services
Foreign exchange services:
Safekeeping of valuable items.
Equipment leasing
Creation of Money by Commercial Banks
Creation of money by commercial banks reflects the view that by granting loans and advances,
an initial deposit with a commercial bank can yield a greater cumulative demand deposits in the
entire commercial banking system. When a commercial bank advances a loan, it opens an
account in the name of the customer creating a claim against itself and in favour of the customer
(borrower). Note that the loan is made, not by physically handing over claims, but by creating a
book - keeping entry. The same procedure is followed by other banks – each keeping small cash
in reverse and lending the remaining amount. The entire commercial banking system thus creates
demand deposit money and the economy is reflated.
CENTRAL BANK
A Central Bank is the apex institution of the monetary and banking system of every country. It is
owned by the government but the responsibility of its management is usually rested in the Board
of Directors whose members are appointed by the government. The Bank of Ghana (BOG) and
the Central Bank of Nigeria (CBN) are among the earliest Central Banks established in the West
African sub-region.
Traditional Functions of the Central Bank
In both developed and developing economies, the following are performed by the Central Bank:
Currency issue and distribution
The bankers’ bank
Banker to the government
Promotion of monetary stability
Foreign exchange management
Supervision of finance houses through monetary policy.
MONETARY POLICY
Monetary Policy Defined
Monetary policy refers to the combination of measures designed to regulate the value, supply
and cost of money in the economy in consonance with the expected level of economic activity.
An expansionary monetary policy is that which is designed to increase money supply, while a
contractionary or restrictive monetary policy is that which is intended to reduce money
supply.
Instruments of Monetary Policy
i. Open market operations (OMO): This refers to purchases and sales of securities in the open
market by Central Bank in order to achieve the desired level of money stock in the economy. To
reduce money supply, the Central Bank will sell securities in the open market. Conversely, to
increase money supply, it will require the purchase of government securities.
ii. Reserve requirements: This refers to the proportion of the total deposit liabilities of the
commercial and merchant banks which they are required by law to keep as reserve with the
Central Bank. The reserve requirements (i.e cash reserve ratio and liquidity ratio) will be
increased to reduce money supply or reduced to increase money supply.
iii. Discount rate: It is the minimum lending rate of the Central Bank at which it rediscounts bills
and government securities, or the rate charged by the Central Bank on its loans to the
commercial and merchant banks as a lender of last resort. It is used to regulate credit conditions
and availability in the economy because other rates depend on it.
iv. Moral suasion: It is the use of persuasion rather than compulsion by the Central Bank to get
other financial institutions to adopt a pattern of behaviour that is favourable to effective conduct
of the monetary policy.
v. Special deposits: Sometimes, commercial and merchant banks are required by law to hold a
non-interest bearing special deposit with the Central Bank to complement other contractionary
monetary policy measures.
vi. Selective credit control: It involves issuance of credit guidelines to commercial and
merchant banks to direct their credit facilities to the so-called favoured or preferred sectors of the
economy.
vii. Credit ceiling: It is a directive by the Central Bank prescribing the growth rate of credit
expansion by the commercial and merchant banks. This is to ensure stability in both the domestic
and external sectors of the economy.
PRACTICE QUESTIONS
1. A situation where goods are directly exchanged for goods is described as
A. The functions of money
B. The barter system
C. The focus of exchange
D. A medium of exchange
2. Which of the following statements is not true of the functions of money?
A. Ability to last for a long time without losing its value
B. Facilitating the exchange of goods and services
C. A unit in terms of which the value of a good is determined
D. Providing purchasing power to meet future needs of goods and services
E. A standard of deferred payment
3. Money whose face value is greater than the actual value of the materials of which it is made is
referred to as
A. Legal tender
B. Quasi – money
C. Fiat money
D. Token money
4. Money should be ....... so as not to lose its value a)divisible b) durable c)relatively scarce
5. Having #50,#100,#200,#500,#1000 of Nigerian currency result from a quality of money
knownas...... a) portability b) divisibility c) acceptability
6. The motives for holding money are.... a)transactionary,precautionary,emergency b)
transactionary,precautionary,speculative c) transactionary,savings,precautionary
7......... is the total amount of money all the people in an economy desire to hold a) supply of
moneyb) currency c) demand for money
8. ...... is the total stock of money available for use in an economy at a given period of time a)
supply of money b) currency c) demand for money
9. The quantity theory of money was improved by a) Irvying Fisher b) Irvin Fisher c) Irving
Fishering d) Ololade Joel Fisher
10. MV= PQ where Q means a) quantity of money b) equilibrium of output c) real output
11. ......... is the average number of times unit of money is put into use during a period a) velocity
of money b) GDP c) money supply
12. Which of the following is not a function of commercial banks?
A. Accepting deposits of money
B. Issuing and distributing currency notes and coins
C. Providing foreign exchange services
D. Granting loans and advances
E. Safe keeping of valuable items
13. Which of the following controls money supply in the economy to promote economic growth
and development?
A. Commercial banks
B. Development banks
C. Finance companies
D. Discount houses
E. Central Bank
15. Creation of money by commercial bank is done by.... a) lending to borrowers b) issuing
cheques c)printing money
16. If a sum of #100 is deposited in the bank and the reserve requirements is 10%. How much
money will be created by the bank a) #10 b) #90 c) #1000
17. The apex bank in a country is.... a) commercial bank b) financial institutions c) central bank
18. The sales and purchases of securities from and to the commercial banks to control the
circulation of money is called...... a) fiscal policy b) open market operation c) public finance
19. The certain percentage required by the commercial banks to have as deposit with the central
bank is known as..... a) liquidity ratio b) bank rate c) special deposit
20. If the central bank increases the bank rate, this will discourage... a) lenders b) spenders c)
borrowers
Suggested Solutions
1.B
2A
3B
4C
5B
6B
7C
8A
9B
10A
11A
12B
13E
14A
15A
16. C..Money creation = amount deposited / reserve ratio Money creation= 100/10% = 100/0.1 =
#1000
17.C
18.B
19A
20C
WESTMINSTER
