Component (Faculty/Institute): FDEG

Field: Economics and Management

Year of graduation: L2
course_title Monetary economy
Teacher: Abdourahman Ahmed Waliyeh
Number of course hours: 24 hours
Number of tutorial hours: 10 sessions

Skills: to generally understand monetary economics, monetary policy, and the system
banking. But also, to serve as a springboard for students to understand the financial system in the
market finance course.
Possible prerequisites:
Learning Outcomes Sessions Contents Teaching methods
Chapter 1
order the genesis The theory
theory of money classic of the
money
The theory
1- Define and master mimetic of the
the history of the currency
currency Chapter 2 Course,
-explain what is Meaning of Power point
the currency. term TD
currency
The functions of
the currency,
The evolution of
system of
payment.

Chapter 3
analysis of the request Theory
of currency quantitative of the
currency
Keynes: the
theory from the
preference for the
liquidity
Friedman : the
theory Course
quantitative TD
2- Study, the offer and the modern of the
request for change currency
The differences
Keynes/Friedman
 Chapter 4
present the mechanism The functions of
The money supply and the banks and
banking sector creation
monetary
The determinants
of the offerof
currency

Chapter 5
3- Present the
monetary policy analysis of politics The objectives of the
monetary politics
monetary Course
The instruments TD
of politics
monetary
The channels of
transmission

Teaching methods:
PowerPoint presentation
courses in digital format
tutorials

Assessment methods for knowledge:

written exams 100%
- continuous assessment during the semester 40%
end of semester exam 60%

BIBLIOGRAPHY
F. Mishkin, C. Bordes, P-C. Hautcoeur, D. Lacoue-Labarthe, X. Ragot, Money, Bank and Markets
financiers9eNEW HORIZONS edition, 2010

MILTON FRIEDMAN, Money and its Pitfalls, 1992, French edition, Dunod.

Marie Delaplace, Currency and Financing of the Economy, 5andedition, Dunod, 2017

Monetary Economics Course. Higher Institute of Management of Tunis.

 Chapter 2: What is money

I. Meaning of the term 'currency'

The word currency has varied uses, but it has a precise meaning for economists. To avoid any
confusion, we must specify how this meaning differs from the common usage.

Economists define money (also the money supply) as anything that is

generally accepted in payment for goods and services or for the repayment of debts. The
currency (commonly referred to as cash) consists of coins and bills. But, for
For economists, currency represents only a part of money. As checks are
generally accepted as payment, the deposit to a checking or postal account are
also considered as money. An even broader definition is also used because
Deposits in savings accounts can also serve as money if they can be converted.
quickly and easily in cash or transferred to current accounts. The practical definition of
The money supply is therefore not, even for economists.

Money is therefore broader than currency, but more limited than wealth where the
Wealth is different from income, even though common expressions sometimes mix them.
Thus, 'he has a lot of money' refers to wealth and not just the bank account; the wealth
understand the currency owned but also all the other assets which are movable property
(cars, furniture, artworks, letters such as stocks and bonds) and real estate
(land and buildings that is, house or apartment). As for the word money in the expression
She makes a lot of money, he aims for an income, that is, a flow of monetary gains per unit of.
time, while money is a stock. Speaking of an income of 1000 euros makes no sense if one does not
does not know the unit of time (the day, the week, the month, the year), than to have 1000 euros at a
specific meaning.

In summary, money includes everything that is generally accepted in payment for goods and
services or reimbursement of debts, and is distinguished from assets as well as from income.

II. The functions of money:

Economists almost agree in assigning three essential functions to money:

The intermediate currency of exchanges:

Money facilitates the circulation of goods among economic agents and also facilitates the
development of exchanges. She acts as an intermediary for exchanges in almost all the
market transactions in modern economies. Money therefore contributes indirectly to
economic development, since exchange is one of the engines of economic activity.
The intervention of money remedies the insufficiencies of barter: complementarity problems
of intent exchanging partners, problems of equivalence of values of the exchanged goods.

However, for a good to effectively function as money, it must nonetheless

to gather several qualities :
It must be easily standardized, so that its value can be easily assessed;

it must be widely accepted;

It must be divisible so that we can easily 'give change';

It must be easy to transport;

it must not deteriorate quickly.

2. Unit of account
The second function of money is to provide a unit of account, that is to say, to serve
of a unit of measurement of value in the economy. The value of goods is usually measured by
services in terms of currency, just as weight is measured in grams and distances in
meters.

The fact that the prices of goods are expressed in currency allows for a comparison of the
value of goods relative to each other.

Price Relative prices

monetary
1 A = 20 FDj 1A=1B+2C
1 B = 10 FDj 1B=2C
1 C = 5 FDj 1C=¼AC

3. Store of value
Money also serves as a store of value: it is purchasing power set aside and
transformable over time. A store of value serves to save purchasing power between the
the moment when income is received and the moment when it is spent.

As a consumable good, money allows its holder to choose between total use
and the partial use of its current purchasing power. The reserved currency allows for dealing with
risks and uncertainties of the future. However, during a period of inflation, the purchasing power of money
reserve deprived. To address this problem, economic agents substitute for the
currency in their assets of real assets (land, jewelry, works of art, ... and in assets
Financiers). Currency still has the advantage of being perfectly liquid, and therefore always
available to seize the opportunities that may arise.

III. Evolution of the payment system

Throughout human history, money has taken on successive different forms: money
merchandise, metallic money, fiduciary money, scriptural money, and money
electronics. We better understand the different functions of money and the forms it takes.
taken in history by examining the evolution of the payment system, that is to say the entire
means enabling transactions in an economy.

1. The commodity and metallic money

i. The commodity money

To address the problems of barter, men have used in each region of the world a
merchandise as money (salt, tea, dried fish, shells, cattle...). The phase of
The commodity money was relatively short-lived. Indeed, it had several limitations; The
merchandise is not always divisible, not always preservable, not easy to transport and to
user, and is not homogeneous. Due to these shortcomings, men will evolve towards the
metallic currency.

ii. Metallic currency

Initially, non-precious metals (bronze, copper,...) were used, but quickly, we evolved towards
precious metals (gold and silver).

These two metals have a double value:

An objective value: they are perfectly divisible, eternally preservable, easy to use and
to transport (high value under low volume), and homogeneous.

A subjective value: these two metals are beautiful and rare.

Gold and silver have undergone an evolution in three stages in the way they are used:

- The stage of weighed money: the price is announced in weight, and the metal is weighed each time.
transaction.
- The stage of counted money: manufacturing of artisanal coins.
- The stage of minted currency: this 3rd stage is by far the most important, the richest in
events and in economic teaching, it lasted several dozen centuries
(until the 19th century).
Initially, the minting of coins is ensured by the church (trust and wealth); by the
Next, the minting is ensured by the feudal lords, and in the Middle Ages, the minting of coins will be
monopolized by the princes to ensure their prestige and consolidate their power. Some countries have
used bimetallism: minted coins made from gold and silver, others have
utilized monometallism: minting of coins from a single metal. 'When two
currencies are in circulation, one considered good, the other considered bad,
bad money drives out good

2. Fiat money
The banknote as we know it today appeared in 1656 in Sweden, when the
the director of the Stockholm bank, he was called Palmstruck, decided to issue to the discount brokers
banknotes instead of precious metal coins. It is evident that paper money,
was accepted as a means of payment by economic agents, only because it was
convertible into gold. Convertibility itself went through several stages:
1thereTotal convertibility:

During this first stage, precious metal coins were still in circulation despite the emergence of banknotes.
From the bank, the convertibility was done in the form of notes against coins, and the metal coverage.
was total.

The metallic standard divided economists in the 19th century; A school of thought driven by
Ricardo suggested tying the creation of money to the available gold stock, the reason
being to avoid inflation. Another school of thought driven by Toock suggested a creation of
currency, depending on the needs of an economy, to avoid the blockage of economic activity.

2. Partial convertibility:

Over the years, banks have created a quantity of banknotes, the total value of which is greater
in the available gold stock. Therefore, it was not possible to maintain the convertibility of banknotes against coins, we are
thus passed to partial convertibility: bills for gold bars.

Under these conditions, convertibility is only possible for affluent economic agents.
metallic coverage is no longer total.

3. Non-convertibility:

The beginning of the 20th century was characterized by wars, economic crises, the emergence of a
socialist regime... The main countries of this time (England, France, USA) decided after the
The 1929 crisis definitively suspended the internal convertibility of their currencies into gold: gold
should be kept for state and national needs. In 1944, and following the conference of
Bretton Woods, it was decided that currencies are convertible to US dollars, and this is
convertible into gold, but solely for the benefit of central banks. In 1971, the American president
Richard Nixon suspended the convertibility of the dollar into gold: definitive end of the convertibility of the
gold currency.

3. The scriptural money

Even though its appearance is older than that of banknotes, the generalization of the
scriptural money, in England first and then in other countries, dates only from the 19th century, it
it concerns all monetary sight deposits (DVM) made by economic agents with
from banks, they are said to be 'on demand' because these deposits are available immediately at no cost
and without any delay; they are called 'monetary' because their circulation results from a simple accounting entry.
hence the name of scriptural money. The creation of this form of money has made it possible to remedy
certain disadvantages of cash: Risk of loss, theft or destruction and
difficulty in handling the settlement of large transactions. Note: it should not be
confusing scriptural money (DVM) with the instruments and techniques that ensure its
circulation such as check, transfer or credit card. Indeed, if the agents' accounts do not
are not sufficiently supplied, or if their holders have not been able to obtain an opening of a
credit by their bank, the check or credit card cannot make a payment.

4. Money and the State

In the euro area, monetary integration is achieved while there is no political integration.
Is a money without a state viable? This question falls within the broader framework of the connections
which unite money and the State. A close parallel can be observed between them in history. But
Is it the currency that needs the state or the other way around? The value of fiat currency.
Does it come from the guarantee granted by the State? We are trying to answer these questions starting from
a review of the history of money.

Trade exchanges have occurred since at least the third millennium before our era.
Mesopotamia, made easier by the use of precious metals; essentially silver. It is then
of a commodity money that has two real uses and not just monetary ones and that must
verify the weight and quality to ensure its value. This currency is not provided by a State,
which does not prevent it from circulating. Similar cases are not rare in large-scale trade.
distance to the modern era, since even the coins minted by the states were often
used for their metal weight only. A similar situation is found in the camps of
prisoners during World War II, where cigarettes (among other things) have a use
monetary that will extend to all of Germany until the monetary reform of 1948. these currencies
are held because they have a known intrinsic value, even if it is not for everyone
holder: the non-smoker knows that there are enough smokers to be sure that the value of cigarettes
He remains relatively stable and will therefore be able to buy whatever he wants in exchange for cigarettes.

Why the intervention of the State? Nevertheless, these commodity currencies were never able to
spread widely due to the importance of the verification costs that they incurred. Some
Economic agents proposed to issue currency by providing guarantees on its
quality. This is how emission banks once promised the convertibility of their
bills in precious metals, and that the banks promise it today in 'bank currency'
central." However, three reasons quickly led to a state control of this activity, to
less when the money supply of the population was concerned.

First of all, the risks of abuse were significant. This will be observed in the United States where, in the middle
of the 19thecentury,
a regime of 'free banking' prevailed in which any bank could issue to
ticket willingness: if the abuses were few in number, they were loud, and led to
the regulatory intervention of the State. Even today, the regulation of the banking system is without
doubt a condition of trust in the currency, which allows us to say that the value of the
money comes partially from the surveillance of the state exerted on banks (if the state itself
trustworthy).

Moreover, the production of money is an activity with increasing returns to scale, because the
money is a good for which network effects are significant, like the telephone:
the importance for each user to have

5. Measure the currency

Central banks are seeking to measure as accurately as possible the amount of money in circulation. For
they use different monetary aggregates. Their definition has become more difficult since the
1980s due to numerous financial innovations. Starting from the 1980s, most of the
central banks have modified, sometimes repeatedly, their measures of money. France
has not escaped this movement. Moreover, the creation of the Monetary Union has imposed a
The prior harmonization of national monetary aggregates has subsequently made it possible to define the battery.
of monetary aggregates used by the ECB.

The criteria used to define official monetary aggregates are of an economic nature, namely
institutional nature. In France, institutional criteria have long prevailed. During
In the 1980s, economic criteria become increasingly important to the point of becoming
dominant since 1986. In 1994, the construction of monetary aggregates is entirely
justified by economic arguments highlighting the functions of money.

Traditional financial environment: a definition of money based on criteria

institutional.

Traditionally, the official definition of money included in France, in addition to the means of
Payments held by non-financial agents 'their liquid or short-term placements recorded
in the passive of the financial institutions that ensured their immediate conversion into means of
payment without the risk of capital loss (the only penalty being the reduction of interest received)
and without drawing on the payment methods of another economic agent.1

The consideration of an institutional criterion in this definition was justified by the fact that only
financial institutions offered liquid investments. Other possible investments
were composed of medium and long-term stocks and bonds carrying a risk
In capital. There were no negotiable short-term investments on a secondary market.
One distinguishes investments with financial institutions according to whether they were managed by
banking financial institutions or by non-banking financial institutions: Caisse des Dépôts
and Consignments and the network of Savings Banks; Real Estate Credit; National Credit; Cooperative Credit.

New financial environment: a definition of money based on criteria

economic.

In the second half of the 1980s, the changes experienced by the financial sphere are
undermine the confidence that authorities could have in traditional broad aggregates.
We have witnessed a spectacular development of collective investment schemes in securities.
investment funds (UCITS) that offered investment opportunities costs - shares of SICAV (investment companies)
investment in variable capital), shares of mutual funds (FCP) - well compensated and
comes from a limited capital risk. Furthermore, the existing gaps traditionally for certain
deadlines were met by the emergence of new negotiable debt securities (certificates of
deposit, treasury bills, negotiable treasury bonds, and bonds from financial institutions
specialized; bonds from financial companies and debt issuance houses). From now on, there was a
true continuum of debts within which it became much more difficult to draw a
clear boundary between monetary investments and non-monetary investments.

In response to these transformations, the Banque de France has undertaken a redefinition of the aggregates.
monetary. Therefore, the new official definition of money adopted in France eliminates any
institutional concern. It includes 'in addition to the means of payment, all the
placements that non-financial agents consider as a reserve of purchasing power
The Monetary Aggregates, Information Notes No. 75, Bank of France, April 1988, p. 1.
1
immediately available because they can be easily and quickly converted into means
of payment, without significant risk of capital loss2

This new definition of money simultaneously refers to the three essential functions.
of money (we emphasized). It no longer establishes a division between money and other assets at
part of the nature of the managing entity. Monetary aggregates can now also be found in
many investments made with credit institutions and investments made on
the distressed markets.

The creation of the European Monetary Union required prior harmonization of

national monetary statistics so that the European Central Bank has aggregates
consistent and quality European currencies.

Currently, the measures of the money supply used at the European level, usually
monetary aggregates, there are three, from the narrowest (M1) to the broadest (M3),
constructed by successive interlocks. These aggregates are measured based on assets of a characteristic nature
monetary liabilities of monetary financial institutions.

The narrowest measure of money, M1, includes cash (coins and notes) and demand deposits.
in monetary financial institutions. These assets are clearly money because they are
directly payment instruments.

The intermediate aggregate M2 includes (1) M1, (2) investments available at any time but which do not
can be used directly to make payments (and must therefore be converted beforehand
on demand deposits) and (3) term deposits with a term of less than 2 years (or 3 years if
repayable within a fixed period). These investments include, in particular in France, the accounts.
on regulated savings accounts such as Livret A, blue passbooks, housing savings accounts
(CEL), the accounts for industrial development (CODEVI), the popular savings accounts (LEP).

The broad aggregate M3 includes (1) M2, (2) the negotiable instruments issued by financial institutions.
monetary: buyback agreements, money market letters, and debt instruments representing investment
on the money market (especially in France the money market funds) and (3) the bonds with less
issued by IFM for 2 years.

Fiat currency + Demand deposits Total M1

M2 = M1 + Time deposits with a duration ≤ 2 years + Deposits redeemable with a notice period ≤ 3 months

TOTAL M2

M3= M2+ pensions3UCITS short-term debt securities with a duration ≤2 years Total M3

The reform of money aggregates and the new framework for cyclical analysis of developments
2

monetary and financial", Quarterly Bulletin of the Bank of France, January-February 1991, pp 41-43
3
We speak of assumption to refer to the temporary transfer of ownership of a debt.
from its holder to the one who
 Chapter 3. The Demand for Money

The study of the demand for money returns to examining the reasons why agents
non-financial economic entities hold money.
The theoretical developments related to this question do not have unanimous support among economists.
To this effect, this chapter first addresses classical theories, then Keynesian theories.
of the demand for money and finally mentions Milton Friedman's modern quantitative theory.

The demand for money among the classics

Classical economists consider that money is a good like any other whose utility is to be
the intermediary of exchanges. The quantitative theory of money explains the quantity of money
detained for a given level of total income. The essence of this theory is based on the absence
effects of interest rates on the demand for money.

Velocity of circulation of money and equation of exchanges

The velocity of money circulation is the number of times a monetary unit is used for
the purchase of goods and services during a given period, usually a year.

V = (P x Y) / M

With:

amount of money in circulation

V: velocity of circulation of money
the general level of prices
the overall product

For example, for a nominal GDP (P x Y) of 6000 billion euros annually and a quantity of
with a money supply of 1.2 trillion euros, the velocity of circulation is therefore 5; this means that a coin
On average, one euro is spent five times on the purchase of services and final goods.

The equation of exchanges

Irving Fisher (1907) established the quantitative equation of money as it is today according to
The classics in multiplying both sides of the equation by M, we thus obtain the identity.
next "called exchange equation" which links nominal income to the quantity of money and to
its speed of circulation.
MxV=PxY

The quantitative equation of money becomes: MV = PY where Y is measured by real GDP.

Building the quantitative equation in theory requires taking into account certain assumptions:
 the money supply is exogenous, it is determined by the monetary authorities (the bank
central.
The speed of money circulation is constant (it depends on the preferences of the agents)
economic and payment techniques in use.

Thus, by dividing both sides of the exchange equation by V, we obtain: M = 1/V x P

x Y is rewritten PY. At the equilibrium of the money market, the quantity of money M held by the agents
is equal to the quantity of money demanded Mdwho can therefore substitute for Mr. With k called
sometimes "liquidity rate" representing the constant ratio 1/V (since V is constant), this
the equation can be reformulated as follows:

Md= k x PY

This expression expresses the demand for real cash and k>0.

According to this report, we see that the demand for real cash is an increasing function of
income. The higher the income, the greater the demand for money. The latter is
detained only for reasons of transactions.

C. The demand for money from the Cambridge school

For A. Marsall (1842-1924) and A.C. Pigou (1877-1959), the demand for money arises from the desire of
individuals to hold cash allowing them to make transactions. Therefore, we find
always the idea that money is exclusively transactional.

In this analysis, the demand for money M is a function of real GDP Y and the level.
prices P as well as a coefficient k.

Let Md = k.P.Y or =k.Y

defined by Pigou as real balances. These real balances depend on Y and of the

coefficient k.

Real cash holdings represent cash holdings deflated by the general price level, that is to say the
purchasing power of these cash holdings.

Pigou will show that if the price level increases, agents will seek to maintain their
real encashments so that their purchasing power does not change, the demand for money will therefore
grow. The agents will thus increase the share of their income that they hold in cash.
monetary: it is the effect of real cash balances or the Pigou effect. These rational agents are victims of the
the monetary illusion.

The monetary illusion is a behavior that consists of confusing the increase in cash holdings.
monetary and increase in purchasing power. Indeed, during periods of rising prices,
The increase in monetary reserves does not imply an increase in purchasing power.
In the same way, if the amount of money increases and the general price level remains unchanged,
purchasing power is increasing. Agents therefore have additional funds to their holdings
equilibrium initials. They will therefore increase their demand. But in a state of equilibrium, i.e. full
If the factors of production are not used, the supply cannot increase. In these conditions, prices rise.
This rise in prices reduces the value of real cash holdings down to the level they were at.
initially. Thus, the money supply must be strictly controlled so that there is
no increase in the general price level.

From the previous equation, it follows that k =

Finally, the coefficient expresses the ratio between the quantity of money demanded and the
value of goods and services existing in the economy. It therefore measures the number of units
monetary to create a unit of exchange. Therefore, it is equal to the inverse of the
speed of money circulation.

Example

Sik=0.5, it means that the quantity of money demanded will be equal to half of the
value of goods and services exchanged over a given period. This means that
1 euro will allow you to buy 2 euros worth of goods and services; this euro will therefore be used twice.
times.

So we have Md = . P.Y which is

We say this equation reflects that the demand for cash in real terms

and a decreasing function of the speed of money circulation.

In other words, the higher the speed, the less it is necessary to hold money.
is an increasing function of the volume of activity Y.

Since the traffic speed is stable in the short term, then depends on the volume

of activity Y.
In the General Theory of Employment, Interest and Money published in 1936, Keynes (1883-
1946) and oppose this vision by showing that money can be desired for itself and
subject to a specific request.

Keynes: the theory of reference for liquidity

Keynes believes that the demand function for money in real terms among the classics remains
incomplete. The nominal interest rate is another determinant of the demand for money in terms of
real.
Keynes considers that economic agents hold money for three reasons:
 The reason for the transaction
This word results from the fact that the revenues and expenses of economic agents are not
synchronized. If it were the opposite, economic agents would not need to hold any
currency to finance transactions. The volume of transactions to be carried out depends on income.
The higher the income, the higher the volume of transactions to be made, the higher the demand
The cash reserves needed to ensure this volume of transactions are high.

At the national level, the national demand for transaction money (Md) is a direct
T function
of national income or national product. It varies in the same direction as national income. So:
Y = National Income

MdT= L1(Y+)

Example: MdT= 0.5 Y, if Y = 1000 um so Md= 500

T um

Therefore, the demand for money for the purpose of transaction is an increasing function of income.

The precautionary principle

In addition to the means of transaction, money can be held to meet expenses.
unpredictable futures. This term would not exist if the flows of future expenses were anticipated.
certainly. It follows that the demand for money for precautionary motives will be all the more
more important than future expenses are uncertain.

The determinants of the precautionary cash balance are not explicitly stated by Keynes. He merely settles for
combine the transaction and precaution funds into a single function of

MdP= Md=TL1(Y+)

Thus, if money is demanded for its liquidity, i.e., its availability in payments (and
No for its function as a store of value), the demand for money then responds solely to the reasons of
transaction and precaution. The reserves created by an economic agent for the purposes of
Caution and transaction vary according to his income.

Speculation motif
The demand for money for speculative reasons (MdTranslate the S behavior of the agents

economic to build a cash reserve in order to profit from fluctuations in asset prices
scholarships. It reflects the preference for liquidity of economic agents: (PPL) The demand for
speculative currency (Md) isS a decreasing function of the interest rate level or vice versa
of the interest rate:

Mds=L(i-1)
When interest rates rise, the price of fixed-rate bonds decreases and vice versa.

Example:t0a bond of 100 yielding a coupon4of 10

=0.1 so = =100

Hypothesis 1: (t) increases:

tIThe new bonds of 100 yield a coupon of 12

-t==0.12

course of old obligations = =83.33

Hypothesis 2: (t) decreases:

The new bonds yield a coupon of 8

i= =0.08

course of old bonds = =125.

If interest rates (t) are high:

⇒ Economic agents anticipate their declines.
⇒ Anticipation of an increase in bond prices
⇒ Purchase of bonds
⇒ Decrease in speculative holdings
The money demand model proposed by Keynes has a major implication: the velocity of
circulation is not constant; it varies with interest rates, and those are recorded
significant fluctuations.

Friedman: the modern quantitative theory of money

M. Friedman is the leading figure of what is called monetarism, also known as

The Chicago School. The starting point of Mr. Friedman's analysis is relatively close to that
from Keynes. Money is indeed considered as an asset held by an agent based on the
service that she renders to him. However, the analysis differs profoundly.
Unlike Keynes, whose analysis is of a macroeconomic nature and focuses on the short term.
period, Friedman reasons in the long term and seeks, by extending neoclassical analyses,
found microeconomically the demand for money by applying the theory of
consumer. Then it is me, according to neoclassical analysis, that all agents
can be represented by a type agent (representative agent whose function is to consume),

a received coupon (Income): C = i x P

4
as far as the repair of cash is concerned. Friedman then extends this analysis to
producer.
The question is therefore to identify how the rational agent determines its cash.
Unlike Keynes, who only considered income, Friedman incorporates into the analysis.
heritage and its long-term translation, permanent income.

The wealth of an agent is the value of the asset corresponding to the income that the agent will receive during
his entire life and which is, in a way, his long-term average income, his income.
permanent.

Friedman thus assumes that this agent has a clear idea of the average income they will earn throughout their life.
The agent will therefore determine their money holdings based on their permanent income and the
expected returns of competing monetary assets. Thus, it is within this portfolio
who is a constraint and who generates a permanent income that the agent will arbitrate between
different acts.

This heritage can be composed of different assets among which Friedman distinguishes assets.
non-humans and human actors.

Non-human assets consist of monetary assets, real assets, and financial assets.

Monetary assets (holding of monetary cash) are possible choices in the constitution
of heritage. However, currency does not provide a return but a service related to its
utilization in transactions. This service depends on how the agent appreciates it, but also on the
general price level. The agent therefore reasons in real terms and is not subject to illusion
monetary. What matters to him is the ability of these monetary reserves to purchase goods.
Thus, as Keynes distinguished, we have seen, a motive of transaction, a motive of precaution.
And a word of speculation, Mr. Friedman will reunify these three words. An economic agent does not
the holding of money only in view of transactions. The holding of money is justified
only by the fact that it provides a service in exchange.

Heritage can also be held in the form of human assets (his work, referred to as his capital)
human). Each individual is more or less competent and has the ability to offer their services in exchange for
compensation. It is therefore a creator of income.

The agent will then compare the returns of the different assets. Satisfaction is maximal when
the marginal utility, i.e. the utility of the last unit of money is equal to the marginal returns
competing assets. In other words, when the marginal returns of the different assets
the components of its heritage are equivalent.

Thus, for Friedman, money competes with all the assets that make up wealth.
and generating an income and not just, as with Keynes, letters for the motf of
speculation. For example, if the yields on bonds or stocks decrease, the demand
currency increases. If there is a decrease in inflation, the agent is encouraged to hold more.
of money.
The demand for money in real terms therefore depends on the volume of permanent income,
service rendered by money, which itself depends on the general price level, in relation to the
returns of competing assets.

In conclusion, while for Keynes, the demand for money constantly varies due to the
agents' expectations, for Friedman, if the short-term demand for money can be unstable,
On the other hand, it is stable in the long term.

The differences between the theories of Friedman and Keynes

Friedman is often opposed to Keynes, and it is true that they have quite a few differing positions.
radically opposed. But one must see where the opposition lies.

The first difference is that Friedman takes more actions into account than Keynes, who groups all.
the assets, except for money, into one large category (letters), assuming that their
yield generally varies in the same direction.

Secondly, unlike Keynes, Friedman considers real assets and money as

substitutes: agents make a choice between the two when determining their detention
of receipts. Hence the presence of the gap between the anticipated yield of real assets and that of the
money in its function as a demand for money. If real money assets are substitutable,
Variations in the quantity of money can have a direct effect on overall spending.

Thirdly, contrary to Keynes, Friedman does not assume that the return of money is
constant, especially since it includes the yield from use. As a result, an increase in rates
interest implies that loans become more profitable for banks, which leads to
seek to attract more depositors to increase the volume of these loans (see the principles of
banking system). So, they can increase the financial return of money, that is to say
the rate of remuneration for depositors, thus improving the yield of use by enhancing quality
of the banking service. Finally, rb- rmremains constant. Thus, for Friedman, one can consider that
The demand for money is only a function of permanent income.Md
f(Yp)
P

Lastly, to truly align with this theory while taking into account the
Empirical information, for him, is about showing that the speed of circulation of money is
not stable but at least easily predictable because the money demand function is, it
stable. We arrive at the following equation for the speed of circulation:

To remember
Economic theories clash concerning the demand for money. For the classics and the
neoclassicals, the demand for money is exclusively transactional. In contrast, the
money competes with letters for Keynesians, and with all the assets that make up
the agent's wealth for monetarists. If this demand for money is unstable among the
Keynesians due to the agents' anticipations, on the other hand, in the long term, it is stable for the
monetarists

Chapter 4: The Money Supply and the Banking System

As with all goods and services in an economy, money is subject to an offer. The offer of
Currency is created by monetary institutions.

I. The functions of banks and monetary creation

A. The functions of banks
The banking system is essentially composed of the Central Bank and banks.
commercials.

The Central Bank is positioned at the top of the banking system, it is an institution that
benefits from great independence from political power. It ensures several
functions to know:

hold the monopoly on the issuance of fiduciary currency (banknotes) and creates, in
a measure, of scriptural money when it grants credit to banks and the State.
It is the bank of banks because it has supplied banks with liquidity, but
also because it exerts control over banks as part of the policy
monetary.
To assist the State through the advances it grants to the Public Treasury
Set the key interest rate
Etc.

Regarding commercial banks, their main functions are:

The management of payment methods in the economy, which essentially are found under
sight deposits in banks; cashier services include the maintenance of
client accounts and investment advice, the circulation of money, exchanges of
devices etc...
The financing of economic activity through credits granted to businesses and
to households.

More generally, the role of banks is to finance the economy and to mediate.
financial between the different economic agents.
 B. The creation of money
Monetary creation is ensured by two series of agents: commercial banks or second-tier banks
ranking for scriptural money, the Central Bank for equal money or bank money
central (tickets but also scriptural recorded in the central bank accounts).

Today, a small share of monetary creation is directly the responsibility of the Central Bank and
in the Treasury: for example, the ECB issues banknotes based on the needs of the economy,
The Treasury puts coins into circulation. However, the majority of the creation
Monetary policy is carried out by second-tier banks in the form of scriptural money.

Banks of Bank Public Treasury

second rank Central

Currency Currency
scriptural legal

The techniques of money creation

We will present these techniques through an example that will offer in the first part, a
Economy with a single bank (The Bank for All) and a single currency (the currency
scriptural; in a second part, a central bank (CB) and fiat money will be
introduced.

Initially, the balance sheet of the BTP is as follows:

Actf Liabilities Amounts Amounts

A to Z accounts receivable 10,000 Client Deposits A to Z 10,000

Let's start from the fact that the money supply is the sum of the banks' liabilities. We deduce from this balance sheet
that the money supply is equal to 10,000.

This is an industrial company 'EI' that requests and obtains a loan of 20,000.
give the following writings:

Actf Liabilities Amounts Amounts

Accounts Receivable A to Z 10,000 Client deposit A to Z 10,000
Claim on EI 2,000 EI deposit 2,000
It is observed that following the loan granted by the BPT to the EI, the money supply increases and goes from
10000 to 12000.

EI requested a loan to, for example, pay its suppliers who are among the clients.
from A to Z. She signs them checks for an amount of 1900 which gives the entries
following:

Actf Liabilities Amounts Amounts

Receivables from clients A to Z 10,000 Customer Deposit A to Z 11 900
Claim on EI 2,000 Deposit of EI 100

It is noted that following this settlement operation, the money supply does not change. There is
just a transfer of funds from one account to another.

Suppose now that the Treasury issues a treasury bond of a

amount of 5,000 and fully subscribed by the BPT.

Actf Liabilities Amounts Amounts

Customer Receivables A to Z 10,000 Client Deposit A to Z 11,900
Claim on EI 2,000 EI Deposit 100
Claim on the Public Treasury 5,000 Public Treasury Deposit 5000

This operation increases the money supply which becomes 17,000, the credit of the State granted by the BPT
therefore creates a monetary creation.

Let there be an exporting company EX that receives an amount of currency from abroad, whose
The value in national currency is 3000. The currencies are deposited at the BTP, which
give the following writings :

Actf Liabilities Amounts Amounts

Accounts receivable from clients A to Z 10,000 Client deposits A to Z 11,900
Receivable from EI 2,000 EI deposit 100
Claim on the Public Treasury 5,000 Public Treasury Deposit 5000
Claim on the foreigner 3,000 Deposit EX 3,000

It is noted that this net foreign exchange entry causes a creation of money and is a
increase in the money supply which reaches 20,000.

This example demonstrates that money creation occurs in 3 situations: credits to

the economy, (business + household), state credits and when there is a net inflow of currency.

We introduce in the example the Central Bank BC and fiat money. Let's assume that
Company EX decides to withdraw its account with BPT 2,000 in cash. BPT does not
 cannot create fiat money, must turn to the Central Bank by giving it a
part of his act.

BPT
Actf Liabilities Amounts Amounts
Receivables from customers A to Z 10,000 Customer Deposit A to Z 11,900
Claim on EI 1,500 EI Deposit 100
Claim on the Public Treasury 3,800 Public Treasury Deposit 5,000
Claim against a foreign entity 2,700 Deposit EX 1,000

Actf Liabilities Amounts Amounts

Receivable from EI 500 Banknotes put into circulation 2,000
Claim on the Public Treasury 1,200
Claim on foreign country 300
BC

The intervention of BC through a refinancing operation does not increase the

money supply, but it causes a modification of the structure of the mass
monetary since there is a substitution of a quantity of fiduciary money for a quantity of
book money.
The issuance of money by the central bank in the event of an advance to the state translates into a
increase in the money supply.
It emerges through these elements that the counterparts of the money supply are
today: claims on the economy, claims on the State, and claims on foreign countries
(or and currency).
Economic agents demand short-term loans to meet their needs.
short-term financing:
The companies; the current operational needs (payment of salaries, materials
first, the different invoices...)
These needs result from the time lag between receipts and
disbursements.
Households; consumption needs
The State; operational needs.
Generally, the creation of money takes place during short-term loans for
finance the needs mentioned above. However, it happens that banks create money to
financing the investment (the equipment). This type of financing is inflationary in nature.

II. The limits of monetary creation

A. One must beware of inflation and deflation.

Formally, the amount of money that a banking system can create should not
exceed the value of the volume of the production that will be presented for exchange,

If the creation of money is excessive

 The purchasing power of each monetary unit collapses (inflation). This inflation
particularly penalizes holders of fixed incomes who cannot renegotiate
their contract: landlords of housing or commerce, long-term lenders, retirees
etc., on the other hand, the actors who can pass on price increases are doing well
Good. We are therefore witnessing a modification of the distribution of added value.
as was the case in the 70s. But inflation brings other
consequences: it can deter entrepreneurs from developing their tools
production and potential lenders to lend since there is uncertainty about the
real profitability of their operation (inflation deducted)

If the creation of money is insufficient

If there is a lack of currency, sellers of goods and services will have to lower their prices.
(deflation). The consumer might initially rejoice at this, but he
would quickly notice that deflation leads to a slowdown in activity
economic even faster than inflation. Indeed, rather than accepting a
decrease in the profitability of their capital, companies would give up production,
would reduce the salaries of their employees, would cut the workforce, etc.

There is therefore a need for a joint and corresponding growth of these two
variables: the production of goods and services and the money supply.
That this principle must be applied rigidly, come what may, like the
would the liberals or in a more flexible manner, to stimulate growth
as proposed by Keynesians, it is one of the points of the debate when discussing
monetary policy.

B. The mechanisms that regulate the pace of monetary creation

Even if it is enough for a bank to credit a customer account to create money, that does not
does not mean that we are in total arbitrariness...

Mandatory reserves
First, it must be a bank to which this power has been granted, then the
the monetary creation power of this bank is limited by the necessity to maintain
on its account central bank reserves (required reserves) of which the
volume will mechanically increase with the increase of the credits it sells to
its clients: thus the more a bank distributes loans, the more it must deposit with
from the BC of receivables and see an interest rate deducted that reduces a portion of
the interest that she herself has collected.

Prudential rules
Other devices should, in principle, protect against the risk of seeing banks
to embark on a spiral of credit development until reaching a level
so that they would no longer be able to mitigate the repayment defaults
of insolvent borrowers: This is the goal of the 'prudential rules' established by the
 Basel Committee: thus the 'Cooke ratio' makes the total amount of loans dependent on
can grant a bank the amount of its equity (its capital).

III. Monetary base and monetary multiplier

To understand the mechanism of the monetary multiplier, it is necessary to present

the concept of monetary base and explain the mechanism of monetary expansion.

A. Monetary base

The monetary base is the currency issued by the central bank. It consists of the
sum of banknotes in circulation and central money, that is to say, the holdings held
by account holders, mainly credit institutions, on the books of
the Issuing Institute. Regarding the current accounts of Credit Institutions,
it is possible to break down this account into two:
The amount of required reserves (RO) and the amount of excess reserves
(RE).
Central bank money appears on the liabilities side of the central bank's balance sheet. On the assets side of this balance sheet are

represented the sources of the creation of the monetary base, that is to say, the counterparts of
the base.

B. The credit multiplier

In the multiplier perspective, the central bank, by controlling the revenues of banks, the
constraints in their credit distribution, it thus determines, a priori, the quality of
currency in circulation which will be according to a phenomenon of 'monetary duplication', a
multiple of the monetary base initially created by it; any deposit in a bank will
involve a succession of credits that will in turn generate new deposits in the
remainder of the banking system.
However, this power of monetary creation must take into account the risks of
capital flight from central bank currency that banks must face, and which are
two orders :
Banknote leaks related to user habits (preference for banknotes
of banks) which corresponds to a coefficient 'b'

b = (banknotes / scriptural money) * 100

The reserve leaks, because the central bank imposes reserves on banks
mandatory in the form of non-interest-bearing accounts, which correspond to
coefficient 'r'.
r = (required reserves / deposits) * 100

As a result, the multiplier 'k' is then expressed as follows:

k = 1 / (b + r - b * r)
Example: if b=10%, r=20% therefore k=1/(0.1+0.2-0.2*0.1)= 3.571

Thus, all new deposits in central bank money (or increase in the base
monetary) of 100 will generate a monetary creation of of 100*3.571 that is
357.1
One can conclude that the money supply is influenced by the amount that banks...
kept in reserve and the amount they lend.
When the bank lends money, it increases the amount of money in circulation.

Attention!!! Banks do not create any additional wealth because banks, because when they
they create an asset (that is to say liquidity), they also create a liability (that is to say a debt)
to the bank). Monetary creation increases the liquidity of the economy but not its wealth.