Chapter 01 VVI

Q: What is money? Functions of money?

Money is a generally accepted medium of exchange used to acquire goods and services. It
serves as a store of value, a unit of account, and a standard of deferred payment.

Functions of Money:

1. Medium of Exchange: Money facilitates transactions by providing a commonly

accepted means of payment.
2. Store of Value: Money allows individuals and businesses to store wealth over time.
3. Unit of Account: Money provides a common standard for measuring the value of
goods and services.
4. Standard of Deferred Payment: Money can be used to settle debts at a future date.

Money is any item or medium that is widely accepted as a method of payment for goods and
services, or for the repayment of debts. It serves as a foundation for the economy, facilitating
trade and value exchange. Money can come in various forms, such as coins, banknotes, and
digital currency.

Functions of Money:
Here are the primary functions of money, along with easy-to-understand examples for each:
1. Medium of Exchange
• Definition: Money is used to facilitate the buying and selling of goods and services.
• Example: When you buy a coffee at a café, you use cash or a debit card. The money
serves as a medium that allows you to exchange it for the coffee instead of bartering
(e.g., trading a book for a coffee).
2. Unit of Account
• Definition: Money provides a standard measurement of value, allowing people to
compare the value of different goods and services.
• Example: A loaf of bread costs $2, and a sandwich costs $5. Money allows you to
easily see that the sandwich is more expensive than the bread.
3. Store of Value
• Definition: Money can be saved and retrieved in the future, maintaining its value over
time.
• Example: If you save $100 in your savings account, you can use that money later to
buy groceries, a car, or anything else without losing its value (assuming inflation is
controlled).

4. Standard of Deferred Payment

• Definition: Money is accepted for settling debts that are to be paid in the future.

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 • Example: If you borrow $1,000 to buy a car, you agree to pay back the loan in
monthly installments. The loan amount is expressed in money, making it clear how
much you owe.

Summary Table
Function Definition Example
Medium of Facilitates buying and selling Buying coffee with cash or a card
Exchange
Unit of Account Standard measurement of Comparing the price of a loaf of
value bread ($2) to a sandwich ($5)
Store of Value Can be saved and retrieved in Saving $100 in a savings account
the future
Standard of Accepted for future debt Borrowing $1,000 for a car and
Deferred Payment payments agreeing to pay it back

These functions illustrate how money plays a crucial role in our everyday transactions and
economic activities.

Q: What is money supply? Does money supply include interbank deposits? Why?

Money supply refers to the total amount of money available in an economy at a particular
time. It includes cash (coins and banknotes) and various types of deposits held by the public at
commercial banks and other financial institutions.
Components of Money Supply:
• Narrow money (M1): Currency in circulation and demand deposits (checking
accounts).
• Broad money (M2, M3, etc.): Includes M1 plus savings deposits, time deposits, and
other near-money assets.
Does Money Supply Include Interbank Deposits?
No, interbank deposits (funds deposited by one bank into another) are not included in the
money supply. This is because money supply measures the amount of money available to the
public for spending and investment. Interbank deposits are internal banking reserves, which
help banks manage liquidity but do not directly affect the money available to consumers and
businesses.

Q: What are the monetary aggregates? How narrow money (MI) is different from broad
money (M2)?

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Monetary aggregates are broad categories that measure the money supply within an economy.
They represent different forms of money used in an economy, classified based on their liquidity
(how easily they can be converted into cash for transactions). The most common monetary
aggregates are: Narrow Money (M1) and Broad Money (M2).

Category Narrow Money (M1) Broad Money (M2)

Definition Most liquid forms of money. M1 plus less liquid assets like savings
deposits.
Components Currency, demand deposits, M1 + savings deposits, time deposits, and
checkable deposits. money market funds.
Liquidity Highly liquid, used for daily Less liquid, used for savings and
transactions. investment.
Use Day-to-day transactions. Broader money supply for
savings/investment.
Examples Cash, checking accounts. Savings accounts, fixed deposits.

Q: How money supply is measured?

The money supply is measured using various monetary aggregates, which categorize money
based on liquidity.

Q: Kinds of money

In Bangladesh, the monetary system includes various forms of money, such as coins, paper
currency, and deposit money (cheques). Here’s an overview of each:

1. Coins

• Description: Coins are small, flat, round pieces of metal used as currency. In
Bangladesh, coins are issued in various denominations.
• Denominations: Commonly used coins include 1, 2, 5, and 10 taka.
• Usage: Coins are typically used for small transactions, such as purchasing snacks or
paying for public transport.

2. Paper Currency

• Description: Paper currency refers to banknotes issued by the central bank, which is
the Bangladesh Bank. These are used for larger transactions compared to coins.
• Denominations: Available in denominations of 2, 5, 10, 20, 50, 100, 500, and 1,000
taka.
• Features: Bangladeshi banknotes often feature images of national leaders, historical
events, and cultural symbols, and they include security features to prevent
counterfeiting.

3. Deposit Money (Cheques)

• Description: Deposit money refers to funds held in bank accounts that can be
accessed through various means, including cheques, debit cards, or electronic
transfers.

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 • Cheques: A cheque is a written order directing a bank to pay a specific amount from
the account holder’s funds to the person named on the cheque. Cheques are
commonly used for larger transactions or business payments.
• Usage: While cash is widely used, cheques are often employed for significant
payments, such as salaries, utility bills, or real estate transactions.

Summary Table
Form of Money Description Denominations/Usage
Coins Metal currency for small 1, 2, 5, 10 taka; used for snacks and
transactions transport
Paper Currency Banknotes issued by the 2, 5, 10, 20, 50, 100, 500, 1,000 taka;
Bangladesh Bank used for larger purchases
Deposit Money Funds held in bank Used for larger transactions, often in
(Cheques) accounts; payment method business and utility payments

These forms of money are integral to the economy of Bangladesh, facilitating various
transactions in everyday life.

Here’s an overview of legal tender (fiat money) and nonlegal tender (credit money
proper):

(a) Legal Tender (Fiat Money)

• Definition: Legal tender refers to money that is recognized by law as an acceptable

form of payment for debts and financial obligations. It is not backed by a physical
commodity (like gold or silver) but derives its value from the trust and confidence of
the people and government.
• Characteristics:
o Government Issued: Only the government (or central bank) has the authority
to issue legal tender.
o Compulsory Acceptance: It must be accepted if offered in payment of a debt.
For example, in Bangladesh, the Bangladeshi Taka (৳) is legal tender.
o Value: The value is determined by supply and demand in the economy, as
well as government policy.
• Examples:
o Banknotes: The 2, 5, 10, 20, 50-, 100-, 500-, and 1,000-taka notes in
Bangladesh.
o Coins: Coins in denominations of 1, 2, 5, and 10 taka.

(b) Nonlegal Tender (Credit Money Proper)

• Definition: Nonlegal tender, also known as credit money, refers to money that is not
recognized by law as a means of payment for debts but is accepted based on mutual
agreement between parties. This form of money derives its value from the
creditworthiness of the issuer.
• Characteristics:
o Not Government Issued: It can be issued by private entities, banks, or
organizations.

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 oConditional Acceptance: Acceptance of a nonlegal tender is based on trust or
agreement between the parties involved in a transaction.
o Value Dependent on Credit: Its value is influenced by the trust and
confidence in the issuer's ability to repay or fulfill obligations.
• Examples:
o Cheques: Written orders directing a bank to pay money from the account
holder's funds, accepted based on the trust in the issuer's account balance.
o Promissory Notes: Written promises to pay a specified amount at a future
date, accepted by the lender based on the borrower's creditworthiness.
o Credit Cards: Although not physical money, credit cards allow users to make
purchases on credit, with the understanding that they will pay back the amount
owed.

Summary Table

Type Definition Characteristics Examples

Legal Tender Money recognized Government issued, Banknotes and
(Fiat Money) by law for payment compulsory acceptance, coins (Taka in
of debts value from trust Bangladesh)
Nonlegal Money not Not government issued, Cheques,
Tender (Credit recognized by law, conditional acceptance, promissory notes,
Money accepted by mutual value from creditworthiness credit cards
Proper) agreement

These distinctions clarify how different forms of money operate within the economy,
influencing transactions and trust among parties involved.

Q: Why is the unit-of-account function of money crucial to the operation of an

economy?

The unit-of-account function of money is essential for an economy because it:

1. Standardizes Value: Allows comparison of prices for informed consumer choices.
2. Facilitates Pricing: Enables businesses to set clear and consistent prices.
3. Simplified Calculations: Aids in assessing costs, revenues, and profits.
4. Enhances Communication: Provides clear price signals for better purchasing
decisions.
5. Promotes Resource Allocation: Directs resources to their most valued uses based on
price.
6. Supports Stability: Fosters trust, encouraging long-term contracts and investments.
Summary
Overall, this function ensures efficient transactions, informed decision-making, and economic
stability.

Q: Explain how money functions as a standard of deferred payments.

Money acts as a standard of deferred payments by:

1. Facilitating Credit: Enables borrowing and future repayment.
2. Clarifying Obligations: Specifies amounts owed clearly.
3. Ensuring Stability: Maintains value, fostering trust.

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 4. Legal Recognition: Legally accepted for settling debts.
5. Encouraging Economic Activity: Allows purchases without full upfront payment.
Summary
This function supports credit use and economic growth by ensuring clear and reliable
financial obligations.

Q: (a) Explain how money functions as a store of value. (b) Is money the only store of
value? (c) What is the difference between money as a store of value and the other assets
(d) Are long-term bonds a store of value?

Here’s a more concise version:

(a) Money as a Store of Value
• Definition: Money allows individuals to save and use it later without significant loss of
value.
• Mechanism: It maintains purchasing power over time, assuming controlled inflation.
(b) Is Money the Only Store of Value?
• No: Other stores of value include real estate, precious metals, stocks, bonds, and
collectibles.
(c) Difference Between Money and Other Assets
• Liquidity: Money is the most liquid, easily converted to goods/services; other assets
may require time to sell.
• Volatility: Money usually maintains stable value, while other assets can fluctuate.
• Purpose: Money facilitates transactions, while other assets serve as investments.
(d) Are Long-Term Bonds a Store of Value?
• Yes: Long-term bonds can preserve value and provide fixed returns, though they may
fluctuate in value due to interest rate changes.
Summary
Money effectively serves as a store of value but is not the only option; it differs from other
assets in liquidity, volatility, and purpose, with long-term bonds also serving as a store of value.

Q: What effect does inflation have on the use of money as a unit of account, a medium
of exchange, a standard for deferred payment, and a store of value?

Effects of Inflation on Money's Functions:

1. Unit of Account: Inflation distorts price comparisons, making it harder to measure
value.
2. Medium of Exchange: Reduced purchasing power discourages holding money,
leading to faster spending or alternative currencies.
3. Standard of Deferred Payment: Inflation lowers the real value of future payments,
benefiting borrowers and hurting lenders.
4. Store of Value: Inflation erodes money’s value, pushing people to invest in assets like
real estate or stocks.
Summary
Inflation undermines money’s effectiveness in all its key functions by reducing its purchasing
power and stability.

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Q: Which of the Central Bank measures of the monetary aggregates – M1 or M2 – is
composed of the most liquid assets? Which is the larger measure?

M1 is the most liquid, while M2 is larger as it encompasses both M1 and additional less
liquid assets.

Q: Why general people will have demand for money? Which sort of demand for
money is influenced by income and which by rate of interest?

Why People Demand Money:

1. Transactions: To pay for goods and services.
2. Precautionary: For emergencies or unexpected needs.
3. Speculative: To seize future investment opportunities.
Demand Influenced by Income:
• Transactions and Precautionary Demand increase with income—higher income
means more spending and saving for emergencies.
Demand Influenced by Interest Rates:
• Speculative Demand is influenced by the interest rate—low rates lead to holding
more cash, while high rates encourage investment.

Q: What is a monetary standard? Why are demand deposits included in the M1

definition of money?
What is a Monetary Standard?
A monetary standard is the system a country uses to define, manage, and back its currency,
such as the gold standard or fiat money.
Why Are Demand Deposits Included in M1?
Demand deposits (e.g., checking accounts) are part of M1 because they are highly liquid and
can be immediately used for transactions, functioning just like cash.

Q: How banks can create money? To what extent a single bank can create money? A
banking system as a whole?
How Banks Create Money:
Banks create money by lending out excess reserves through fractional reserve banking,
which increases deposits and the money supply.
Extent a Single Bank Can Create Money:
A single bank can only create money based on its excess reserves. Once loaned out, it can’t
create more directly.
Extent a Banking System Can Create Money:
The entire banking system can multiply money through repeated lending, known as the
money multiplier:
• Money Multiplier = 1 / Reserve Ratio. For example, with a 10% reserve ratio, the
system can expand money up to 10 times the initial deposit.
Summary:
A single bank is limited by its reserves, but the whole banking system can significantly
increase the money supply through the money multiplier effect.

Q: Differentiate between Real and Nominal interest rate?

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Here’s a concise comparison between Real Interest Rate and Nominal Interest Rate in
tabular form:

Aspect Real Interest Rate Nominal Interest Rate

Definition Adjusted for inflation; reflects The stated or advertised interest rate,
true purchasing power without adjustment for inflation
Formula Real Interest Rate = Nominal Nominal Interest Rate = Real Rate +
Rate - Inflation Rate Expected Inflation
Impact of Shows the actual cost/return Does not account for inflation; can
Inflation after accounting for inflation overstate actual returns or costs
Reflects The real earning power or cost The advertised rate without considering
of borrowing changes in purchasing power
Example If nominal rate is 6% and A loan offers a 6% nominal interest
inflation is 3%, real rate is 3% rate, but inflation erodes its true value
Q: How to you define monetary system? What are the constituents of monetary
system? How come it is different from the financial system?

Definition of Monetary System

A monetary system is the framework for managing a country’s currency and money supply,
facilitating transactions in the economy.
Constituents of a Monetary System
1. Currency: Coins and banknotes.
2. Banking System: Institutions that accept deposits and make loans.
3. Central Bank: Regulates the monetary system and implements monetary policy.
4. Monetary Policy Tools: Instruments to control money supply and interest rates.
5. Payment Systems: Mechanisms for facilitating transactions (e.g., electronic
payments).
Difference from Financial System
• Scope: The monetary system focuses on currency and money supply, while the
financial system includes a broader range of financial instruments, markets, and
institutions (e.g., stocks, bonds).
• Functions: The monetary system ensures stability and management of money, while
the financial system facilitates resource allocation and investment.
Summary
The monetary system manages currency and money supply, while the financial system
encompasses a wider range of financial activities and instruments.

Q: Write down Keynesian money demand function and explain.

Keynesian Money Demand Function

The Keynesian money demand function can be expressed as:
Md=L(Y,i)M_d = L(Y, i)Md=L(Y,i)
Where:
• MdM_dMd = Demand for money
• LLL = Liquidity preference (demand for money)
• YYY = Real income
• iii = Nominal interest rate
Key Components
1. Liquidity Preference:

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 o People hold money for:
▪ Transaction Motive: More money is needed for everyday transactions
as income rises.
▪ Precautionary Motive: Increased income leads to a higher buffer
against unexpected expenses.
▪ Speculative Motive: When interest rates are low, people hold cash
rather than investing.
2. Real Income (Y):
o Higher real income increases the demand for money.
3. Interest Rate (i):
o Higher interest rates decrease money demand since people prefer to invest
rather than hold cash.
Summary
The Keynesian money demand function indicates that money demand is positively related to
real income and negatively related to interest rates. This relationship is vital for understanding
how monetary policy influences economic activity. Lower interest rates can increase money
supply and stimulate spending, while higher income levels boost money demand for
transactions and precautionary savings.

Q: Does slow growth of demand and time deposit indicates bad/good signal for economy?
Explain

Slow Growth of Demand and Time Deposits: Good or Bad Signal?

Demand Deposits:
• Slow Growth:
o Bad Signal: Indicates weak consumer confidence and reduced spending,
potentially reflecting economic stagnation.
o Good Signal: May suggest increased savings for financial security during
uncertain times.
Time Deposits:
• Slow Growth:
o Bad Signal: Suggests low investment activity and uncertainty about the
economy, which could hinder growth.
o Good Signal: If consumers prefer liquidity, it might indicate readiness to
spend or invest when opportunities arise.
Conclusion
Overall, slow growth in both types of deposits is often a bad signal for the economy,
pointing to weak confidence and reduced activity. However, the context matters; if it reflects
a preference for savings due to uncertainty, it might not be entirely negative. Analyzing
alongside other economic indicators is essential for a complete picture.

Q: Draw a relation between nominal rate of interest, real rate of interest and inflation

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Q: Recently BB issued digital banking license. Do you think digital banks will open the
opportunity to enhance financial inclusion?

Yes, digital banking licenses from Bangladesh Bank (BB) can boost financial inclusion:

Key Benefits:

1. Accessibility: Digital banks can reach remote areas and provide 24/7 access to
services.
2. Lower Costs: Reduced operational costs can lead to lower fees and better rates.
3. Innovative Products: They can offer tailored services like microloans for low-
income individuals.
4. Financial Literacy: Many provide resources to improve financial understanding.
5. Data Insights: Enhanced credit assessment allows broader access to loans.

Conclusion:

Digital banks can make banking more accessible and affordable, empowering underserved
populations and promoting economic growth.

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//Here are the main kinds of money in concise terms:

1. Commodity Money: Has intrinsic value (e.g., gold, silver).

2. Fiat Money: Value is based on government trust, no intrinsic value (e.g., US Dollar,
Euro).
3. Representative Money: Represents a claim on a commodity (e.g., gold certificates).
4. Bank Money: Created by banks, exists as electronic records (e.g., checking account
balances).
5. Electronic Money (E-money): Digital representation of fiat currency (e.g., digital
wallets, online banking).
6. Cryptocurrency: Digital, decentralized money using blockchain technology (e.g.,
Bitcoin, Ethereum).
7. Commodity-backed Money: Money linked to a commodity, often with a reserve
backing (e.g., historical gold-backed currency).
8. Token Money: Value is not based on the material but on its designation (e.g., coins
with nominal value).

//The demand for money is driven by three primary motives:

1. Transactions motive: People demand money to facilitate everyday transactions, such

as buying groceries, paying bills, or purchasing goods and services.
2. Precautionary motive: Individuals and businesses hold money as a precautionary
measure to cover unexpected expenses or to maintain liquidity.
3. Speculative motive: People may demand money to speculate on future price changes,
such as anticipating a rise in asset prices or a decline in interest rates.

Step 1. Introduction
Money supply can be defined as the volume of money available in the economy at a point. M1,
M2, M3, and M4 are different measures of money supply. M1 measure includes currency in
circulation, traveler's checks, and demand deposits. M2 includes M1, money market deposit
accounts and money market mutual fund shares, savings deposits, and small-denomination time
deposits.

Step 2. Explanation
a. The table given below shows different components of M1 and M2.
Particulars 2019 2020 2021 2022

Currency 880 895 900 906

Traveler's
5 5 4 3
Check

Demand and
Checkable 1000 972 980 993
deposits

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 M1 1,885 1,872 1,884 1,902

Saving account
5,500 5,780 5,968 6,105
deposits

Money market
680 685 683 692
mutual funds

money market
deposit 1,214 1,245 1,274 1,329
accounts

Small time
840 871 1,133 1,576
deposit

M2 10,119 10,453 10,942 11,604

The growth in M1 and M2 has been obtained in the table given below.
Year M1 growth rate M2 growth rate

2019 1,885 10,119

2020 1,872 -0.68966 10,453 3.300721

2021 1,884 0.641026 10,942 4.678083

2022 1,902 0.955414 11,604 6.050082

This growth rate can be obtained using the following formula.

((Current Money Supply-Money Supply in Previous Period) / Money Supply in Previous
Period) ×100
Example= ((2020-2019)/2019) *100
b. M1 and M2 have different growth rates because M1 is a more liquid measure of money supply.
M2 contains some components that are not so liquid.

(i) M1 and M2 Calculations

Components:

• Currency Outside Bank

• Demand Deposits
• Current Deposits
• Savings Deposits
• Time Deposits

M1 and M2 Calculations:

Formulas:

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 • M1 = Currency OB + Demand Deposits + Current Deposits + Traveler’s Cheque
• M2 = M1 + Savings Deposits + Time Deposits + Mutual Funds

Yearly Calculations:

2020:

• M1 = 1840 + 1944 + 1362 = 4146

• M2 = 4146 + 5780 + 4212 = 14138

2021:

• M1 = 1850 + 1960 + 1358 = 4168

• M2 = 4168 + 5968 + 4794 = 15130

2022:

• M1 = 1865 + 1986 + 1376 = 4227

• M2 = 4227 + 6105 + 5790 = 12122

Summary of M1 and M2:

Year M1 M2
2020 4146 14138
2021 4168 15130
2022 4227 12122

Growth Rates:

Growth Rate Formula:

Growth Rate=(Current Year−Previous YearPrevious Year)×100\text{Growth Rate} =

\left(\frac{\text{Current Year} - \text{Previous Year}}{\text{Previous Year}}\right) \times
100Growth Rate=(Previous YearCurrent Year−Previous Year)×100

M1 Growth Rates:

• 2021: (4168−41464146)×100≈0.53%\left(\frac{4168 - 4146}{4146}\right) \times 100

\approx 0.53\%(41464168−4146)×100≈0.53%
• 2022: (4227−41684168)×100≈1.42%\left(\frac{4227 - 4168}{4168}\right) \times 100
\approx 1.42\%(41684227−4168)×100≈1.42%

M2 Growth Rates:

• 2021: (15130−1413814138)×100≈6.96%\left(\frac{15130 - 14138}{14138}\right)

\times 100 \approx 6.96\%(1413815130−14138)×100≈6.96%
• 2022: (12122−1513015130)×100≈−19.89%\left(\frac{12122 - 15130}{15130}\right)
\times 100 \approx -19.89\%(1513012122−15130)×100≈−19.89%

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Summary of Growth Rates:

Year M1 Growth Rate M2 Growth Rate

2021 0.53% 6.96%
2022 1.42% -19.89%

(ii) Reasons for Different Growth Rates:

1. Component Differences:
o M1 (cash and checking accounts) is for immediate transactions, while M2
includes savings and time deposits, which are influenced by different financial
behaviors.
2. Economic Conditions:
o In uncertain times, people may prefer holding cash (boosting M1), while
savings may not grow as quickly.
3. Interest Rates:
o Rising rates can lead to a shift from checking accounts (M1) to savings
accounts or time deposits (M2), impacting their growth rates.
4. Behavioral Factors:
o Changes in consumer preferences for liquidity versus savings can lead to
differing growth in M1 and M2.

In summary, the different compositions of M1 and M2, alongside varying economic contexts,
contribute to their distinct growth rates.

𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡
Discount Yield = Face Value X Time to Maturity 𝑋 100

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