Week :

Money

Definition, Functions and measurement of Money

The Equation of Exchange
Assumptions of the Quantity Theory and it’s criticism
The Role of Financial Institutions
The Monetary Policy

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 Money and Banking and financial market

Definition and functions of money

Money is the stock of assets that can be readily used to make
transactions.
The main three (3) functions of Money
I. Store of value-money is a way to transfer purchasing power
from the present to the future.
• Although not the best store of value but it works a store of
purchasing power
II. Unit of account-money provides the terms in which prices are
quoted and debts are recorded.
• Money is the yardstick with which we measure economic
transaction.
• If you owe someone, he wont quote you in terms of another good
III. Medium of exchange-legal tender for all debts, public and
Private.
• It is what we use to buy goods and services- acceptable by all in
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 Money and Banking and financial market

Nature, type and functions of money

The ease with which money is converted into other goods and
services sometimes called money’s liquidity.
The Types of Money
A. Fiat money -Money that has no intrinsic value because it is
established as money by government decree or fiat.(Bank
notes)
B. Commodity money-Commodity with some intrinsic value
that is used as medium of exchange e.g. gold.
Money supply- Is the quantity of money available in an
economy.
In an economy that uses commodity money or fiat money, the
money supply is the quantity of that commodity or fiat ,
respectively.
• The government controls the supply of money: legal
restrictions give the government a monopoly on the
printing of money.
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 Money and Banking and financial market

Measure of quantity of money

1. Currency-The sum of outstanding paper money and coins(Most day-
to-day transactions use currency as the medium of exchange).
• Demand deposits- funds people hold in checking accounts.
(checking account are almost as convenient as currency hence
counted as one)
2. M1 - Currency plus demand deposits, traveler’s checks, and other
checkable deposits
3. M2 - M1 plus retail money market mutual fund balances, saving
deposits (including money market deposit accounts) and small
time deposits
4. M3- M2 plus large time deposits, repurchase agreements, Eurodollars,
and institution-only money market mutual fund balances
Monetary policy refers to the actions undertaken by a nation's central
bank to control money supply or/and interest rates and achieve
macroeconomic goals that promote sustainable economic growth

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 THE LABOUR MARKET AND INFLATION

The theory that increasing the supply of money in an economy

increases the price levels is known as the quantity theory of
money or Equation of Exchange
In mathematical terms, the quantity theory of money is based upon
the following relationship: M x V = P x Q;
where M is the money supply, V is the velocity of money, P is the
price level, and Q is total output.
In the long run, the velocity of money (that is, how quickly money
flows through the economy) and total output (that is, an
economy’s Gross Domestic Product) are exogenous.
If all other factors are held constant, an increase in M will require an increase
in P. Thus, an increase in the money supply requires an increase in the
price level (inflation).
John Maynard Keynes, however, disagreed with this view and argued that V and
Q in the quantity theory of money are exogenous and stable in the short
run. Therefore, changes in Money supply may no produce proportional
change in price levels but raise total output or cause velocity to fall.
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 Money and Banking and financial market

The Role of Financial Institutions

Financial markets are those in which funds are transferred
from people who have an excess of available funds to
people who have a shortage. Financial markets such as
credit, bond and stock markets
Financial markets have the following types of private sector
financial institutions, including banks, insurance companies,
mutual funds, finance companies, and investment banks, all
of which are heavily regulated by the government.
They are also called financial intermediaries, because they
facilitate borrowing funds from people who have saved and
in turn make loans to others.
Term “banks” refers to firms such as commercial banks, savings
and loan associations, mutual savings banks, and credit
unions.
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 Financial system

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 Money and Banking and financial market

Government regulate the Banks through the Central bank(

partially independent institution, headed by Central Bank
Governor with the following functions :
I. Manage Monetary policy: setting interest rate and
controlling the money supply;
II. Financial stability: acting as banker of government and as
the bankers' bank (lender of last resort);
III. Reserve management: managing a country's foreign-
exchange and gold reserves and government bonds;
IV. Banking supervision: regulating and supervising the
banking industry;
V. Payments system: managing or supervising means of
payments and inter-banking clearing systems;
VI. Coins and notes issuance;

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 Money and Banking and financial market

Introduction to monetary policy

The Central bank through the monetary policy achieve
macroeconomic goals such as stabilizing nation‘s exchange
rate, keep unemployment low, and reduce inflation which
eventually promote sustainable economic growth.
Types of Monetary policy:
I. Expansionary(inflationary)-Increase money supply and
decrease in interest rates.
• During recession, Increased money supply in the market aims to boost
investment and consumer spending. Lower interest rates mean that businesses
and individuals can secure loans on convenient terms to expand productive
activities and spend more on big-ticket consumer goods.
II. Contractionary(Tight) - Increase interest rate and reduce
money supply.
• Overheat economy-higher inflation: cost of living and cost of doing business,
Contractionary monetary policy, aims to bring down inflation. This slows
economic growth and increase unemployment, but is necessary to keep
economy in check.
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 Money and Banking and financial market

Tools of monetary policy:

A.Open Market Operation- central bank buying and selling of
short-term bonds using newly created bank reserves.
•Buying(selling) bonds increases (reduces) liquidity or quantity of money leading
to lower(higher) interest rates in economy. Target in this tool is interest rates
B. Reserve Requirements: refer to the funds that banks must
retain with central bank as a proportion of the deposits
made by their customers in order to ensure that they are
able to meet their liabilities.
•Increasing the reserve requirement, curtails commercial bank lending and
slowing growth of the money supply.
C. Need for Collateral and use of discount rate as central bank
act a lender of last resort.
•Higher discount rate at which central bank lends to Commercial banks so as to
meet reserve requirements, reduces liquidity, leading to higher interest rates and
lower risky loans among commercial banks.
D. Central bank statements and policy announcements influence Money supply
by markets, and investors expectations.
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 Money

References
Olivier Blanchard, David R. Johnson, (2013) Macroeconomics, (6th Ed), Prentice
Hall
Collins, M., (2012). Money and Banking in the UK: A History (Vol. 6). Routledge
Wright, R., (2012). Money and banking.
Sivramkrishna, S., (2016). In Search of Stability: Economics of Money,
History of the Rupee. Taylor & Francis.
Jacoud, G., (2013). Money and banking in Jean-Baptiste Say's economic
thought. Routledge.

Mankiw N.G.,(2013). Principles of Economics, 7th Edn. Cengage Learning

Mankiw N.G. and Taylor, M.P. (2011), Economic, Cengage Learning.

Lumen learning,(2019), Defining-measuring-and-assessing-inflation,

[Online].Avail. at
https://courses.lumenlearning.com/boundless-economics/chapter/defining-
measuring-and-assessing-inflation/.(Accessed: 8 April 2021)

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