Monetary_Theory_FINC 402.pdf

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Introduction: Overview of the Course Overview of The Financial System and Some Basic Concepts

Tools of Monetary Policy Demand for Money

FINC 402: MONETARY THEORY

Dr. Edward Asiedu

University of Ghana Business School,Department of Finance

Oce Hours: Wednesdays 11:00am - 12:00 noon (UGBS Graduate Campus, First Floor 1W10)

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Introduction: Overview of the Course Overview of The Financial System and Some Basic Concepts

Tools of Monetary Policy Demand for Money

Outline

1 Introduction: Overview of the Course

Introduction

Role and Nature of Money Functions of Money

Evolution of Payment System Measuring Money

2 Overview of The Financial System and Some Basic Concepts

Financial Market

Central Banking and the Conduct of Monetary Policy Money Supply

3 Tools of Monetary Policy

Tools of Monetary Policy

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Introduction: Overview of the Course

Overview of The Financial System and Some Basic Concepts Tools of Monetary Policy

Demand for Money

Introduction

Role and Nature of Money Functions of Money Evolution of Payment System Measuring Money

Outline

Introduction

Role and Nature of Money Functions of Money

2 Overview of The Financial System and Some Basic Concepts Financial Market

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Demand for Money

Introduction

Why should Accountants and Financial Analysts be

interested in Monetary Theory

Majority of us are going to be working with nancial institutions (Financial intermediaries, banks, insurance companies, pension funds, mutual funds etc.).

Financial intermediaries: institutions that borrow funds from people and give loans to others.

Banks: institutions that accept deposits and make loans. And therefore it is important to understand how nancial institutions work.

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Demand for Money

Introduction

Why should Accountants and Financial Analysts be

interested in Monetary Theory

Banks: institutions that accept deposits and make loans. And therefore it is important to understand how nancial institutions work.

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Demand for Money

Introduction

Why should Accountants and Financial Analysts be

interested in Monetary Theory

Banks: institutions that accept deposits and make loans.

And therefore it is important to understand how nancial institutions work.

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Demand for Money

Introduction

Why should Accountants and Financial Analysts be

interested in Monetary Theory

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Demand for Money

Introduction

Why should Accountants and Financial Analysts be

interested in Monetary Theory

Also, importantly, to understand the role of money in the economy.

Money, also referred to as the money supply, is dened as anything that is generally accepted in payment for goods or services or in the repayment of debts.

Money plays a key role in generating business Cycles (recessions and booms).

Business Cycles are upward and downward movement of aggregate output produced in the economy

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Demand for Money

Introduction

Why should Accountants and Financial Analysts be

interested in Monetary Theory

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Demand for Money

Introduction

Why should Accountants and Financial Analysts be

interested in Monetary Theory

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Demand for Money

Introduction

Why should Accountants and Financial Analysts be

interested in Monetary Theory

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Demand for Money

Introduction

Why should Accountants and Financial Analysts be

interested in Monetary Theory

Business cycles aect all of us in immediate and important ways. When output is rising, for example, it is easier to nd a good job; when output is falling, nding a good job might be dicult.

Thus, recession (unemployment) and economic booms aect all of us.

Changes in the money supply impacts changes in aggregate economic activity and ination.

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Demand for Money

Introduction

Why should Accountants and Financial Analysts be

interested in Monetary Theory

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Demand for Money

Introduction

Why should Accountants and Financial Analysts be

interested in Monetary Theory

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Demand for Money

Introduction

Aims of the course

The three main aims of the course are:

To enhance students understanding of the role and nature of money.

To enhance students understanding of the monetary and nancial system.

To equip students with the knowledge to understand the impact of monetary policy on an economy

Students should be able at the end to evaluate alternative monetary policy rules.

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Demand for Money

Introduction

Aims of the course

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Demand for Money

Introduction

Aims of the course

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Demand for Money

Introduction

Aims of the course

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Demand for Money

Introduction

Outline of the course

Introduction:

Barter and Early Exchange Systems

Denition and Nature, Functions and Value of Money Introduction of Financial Institutions in Ghana

Central Banking and the Conduct of Monetary Policy

Structure of Central Banks and the Reserve System Bank Reserves and the Money Supply

Determinants of the Money Supply Tools of Monetary Policy

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Demand for Money

Introduction

Outline of the course

Introduction:

Denition and Nature, Functions and Value of Money

Introduction of Financial Institutions in Ghana

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Demand for Money

Introduction

Outline of the course

Introduction:

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Demand for Money

Introduction

Outline of the course

Introduction:

Structure of Central Banks and the Reserve System

Bank Reserves and the Money Supply Determinants of the Money Supply Tools of Monetary Policy

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Demand for Money

Introduction

Outline of the course

Introduction:

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Demand for Money

Introduction

Outline of the course

Introduction:

Determinants of the Money Supply

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Demand for Money

Introduction

Outline of the course

Introduction:

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Demand for Money

Introduction

Outline of the course

Demand for Money

Keynesian Theories Precautionary,

Transaction and Speculative Demand

Income Velocity and the Quantity Theory of Money Monetarism

Supply of Money

Monetary and Fiscal policy in the Macroeconomy Interest Rates

Monetary and Targeting and Money Control Ination and Money

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Demand for Money

Introduction

Outline of the course

Demand for Money

Keynesian Theories Precautionary, Transaction and Speculative Demand

Supply of Money

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Demand for Money

Introduction

Outline of the course

Demand for Money

Income Velocity and the Quantity Theory of Money

Monetarism

Supply of Money

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Demand for Money

Introduction

Outline of the course

Demand for Money

Supply of Money

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Demand for Money

Introduction

Outline of the course

Demand for Money

Supply of Money

Monetary and Fiscal policy in the Macroeconomy

Interest Rates

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Demand for Money

Introduction

Outline of the course

Demand for Money

Supply of Money

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Demand for Money

Introduction

Outline of the course

Demand for Money

Supply of Money

Monetary and Targeting and Money Control

Ination and Money

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Demand for Money

Introduction

Outline of the course

Demand for Money

Supply of Money

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Demand for Money

Introduction

Outline of the course

Demand for Money

Supply of Money

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Demand for Money

Introduction

Background readings

Frederic S. Mishkin, The Economics of Money, Banking, and Financial Markets, 7th or 9th edition (Addison Wesley: New York).

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Demand for Money

Introduction

Background readings

Frederic S. Mishkin, The Economics of Money, Banking, and Financial Markets, 7th or 9th edition (Addison Wesley: New York).

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Demand for Money

Introduction

Role and Nature of Money

Functions of Money Evolution of Payment System Measuring Money

Outline

Introduction

Functions of Money

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Demand for Money

Introduction

Role and Nature of Money

What Is Money?

Money has been dierent things at dierent times; however, it has always been important to people and to the economy. To understand the eects of money on the economy, we must understand exactly what money is.

We will explore the functions of money, looking at why and how it promotes economic eciency.

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Demand for Money

Introduction

Role and Nature of Money

What Is Money?

Money has been dierent things at dierent times; however, it has always been important to people and to the economy.

To understand the eects of money on the economy, we must understand exactly what money is.

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Demand for Money

Introduction

Role and Nature of Money

What Is Money?

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Demand for Money

Introduction

Role and Nature of Money

What Is Money?

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Demand for Money

Introduction

Role and Nature of Money

Meaning of Money?

As the word money is used in everyday conversation, it can mean many things, but to economists, it has a very specic meaning.

Economists dene money (also referred to as the money supply) as anything that is generally accepted in payment for goods or services or in the repayment of debts.

Currency, consisting of cedi bills, euro bills, dollar bills and coins, clearly ts this denition and is one type of money. When most people talk about money, they're talking about currency (paper money and coins).

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Demand for Money

Introduction

Role and Nature of Money

Meaning of Money?

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Demand for Money

Introduction

Role and Nature of Money

Meaning of Money?

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Demand for Money

Introduction

Role and Nature of Money

Meaning of Money?

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Demand for Money

Introduction

Role and Nature of Money

Meaning of Money?

To dene money merely as currency is much too narrow for economists.

Because cheques are also accepted as payment for purchases, checking/current account deposits are considered money as well.

An even broader denition of money is often needed, because other items such as savings deposits can in eect function as money if they can be quickly and easily converted into currency or checking/current account deposits.

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Demand for Money

Introduction

Role and Nature of Money

Meaning of Money?

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Demand for Money

Introduction

Role and Nature of Money

Meaning of Money?

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Demand for Money

Introduction

Role and Nature of Money

Meaning of Money?

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Demand for Money

Introduction

Role and Nature of Money

Meaning of Money?

To complicate matters further, the word money is frequently used synonymously with wealth. When people say, Mike is richhe has an awful lot of money, they probably mean that Mike has not only a lot of currency and a high balance in his checking account but has also stocks, bonds, four cars, three houses, and a yacht.

Thus while currency is too narrow a denition of money, this other popular usage is much too broad.

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Demand for Money

Introduction

Role and Nature of Money

Meaning of Money?

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Demand for Money

Introduction

Role and Nature of Money

Meaning of Money?

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Demand for Money

Introduction

Role and Nature of Money

Functions of Money

Whether money is kola or shells or rocks or gold or paper, it has three primary functions in any economy:

Medium of Exchange Unit of account Store of value

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Demand for Money

Introduction

Role and Nature of Money

Functions of Money

Medium of Exchange

Unit of account Store of value

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Demand for Money

Introduction

Role and Nature of Money

Functions of Money

Medium of Exchange Unit of account

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Demand for Money

Introduction

Role and Nature of Money

Functions of Money

Medium of Exchange Unit of account Store of value

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Demand for Money

Introduction

Functions of Money

Outline

Introduction

Functions of Money

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

In almost all market transactions in our economy, money in the form of currency or checks is a medium of exchange; it is used to pay for goods and services.

The use of money as a medium of exchange promotes economic eciency by minimizing the time spent in exchanging goods and services.

HOW??

Use the scenario of a Finance/Economics Professor, who can do just one thing well: give brilliant monetary theory lectures.

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

HOW??

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

HOW??

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

HOW??

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

In a barter economy, if the Professor wants to eat, she must nd a farmer who not only produces the food he likes but also wants to learn economics. As you might expect, this search will be dicult and time-consuming, and Ellen might spend more time looking for such an economics-hungry farmer than she will be teaching.

It is even possible that she will have to quit lecturing and go into farming herself. Even so, she may still starve to death.

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

It is even possible that she will have to quit lecturing and go into farming herself. Even so, she may still starve to death.

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

The time spent trying to exchange goods or services is called a transaction cost.

In a barter economy, transaction costs are high because people have to satisfy a double coincidence of wantsthey have to nd someone who has a good or service they want and who also wants the good or service they have to oer.

The use of money as a medium of exchange there promotes economic eciency by minimizing the time spent in

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

For a commodity to function eectively as money, it has to meet several criteria:

It must be easily standardized, making it simple to ascertain its value;

It must be widely accepted;

It must be divisible, so that it is easy to make change; It must be easy to carry; and

It must not deteriorate quickly.

Examples of money (in history): Tobacco, whiskey, cigarettes used in prisoner-of-war camps, beads etc.

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

It must be divisible, so that it is easy to make change;

It must be easy to carry; and It must not deteriorate quickly.

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

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Demand for Money

Introduction

Functions of Money

Medium of Exchange

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Demand for Money

Introduction

Functions of Money

Unit of Account

The second role of money is to provide a unit of account; that is, it is used to measure value in the economy. We measure the value of goods and services in terms of money.

Just as we measure weight in terms of kilograms or distance in terms of kilometers.

To see why this function is important, let's look again at a barter economy where money does not perform this function.

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Demand for Money

Introduction

Functions of Money

Unit of Account

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Demand for Money

Introduction

Functions of Money

Unit of Account

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Demand for Money

Introduction

Functions of Money

Unit of Account

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Demand for Money

Introduction

Functions of Money

Unit of Account

If the economy has only three goodssay, Plantain, books, and pensthen we need to know the price (value) of a kilo of plantain in terms of books or pens. In other words, how many kilos of plantain you have to pay for a book or penor how many books (exercise book, textbook etc.) you have to pay for a pen.

This will indeed become more complicated with more than three goods.

The solution to the problem is to introduce money into the economy and have all prices quoted in terms of units of that money

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Demand for Money

Introduction

Functions of Money

Unit of Account

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Demand for Money

Introduction

Functions of Money

Unit of Account

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Demand for Money

Introduction

Functions of Money

Unit of Account

The solution to the problem is to introduce money into the economy and have all prices quoted in terms of units of that

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Demand for Money

Introduction

Functions of Money

Unit of Account

We can see that using money as a unit of account reduces transaction cost

The benets of this function of money grow as the economy becomes more complex.

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Demand for Money

Introduction

Functions of Money

Unit of Account

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Demand for Money

Introduction

Functions of Money

Unit of Account

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Demand for Money

Introduction

Functions of Money

Store of Value

Money also functions as a store of value; it is a repository of purchasing power over time.

A store of value is used to save purchasing power from the time income is received until the time it is spent.

This function of money is useful, because most of us do not want to spend our income immediately upon receiving it, but rather prefer to wait until we have the time or the desire to shop.

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Demand for Money

Introduction

Functions of Money

Store of Value

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Demand for Money

Introduction

Functions of Money

Store of Value

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Demand for Money

Introduction

Functions of Money

Store of Value

This function of money is useful, because most of us do not want to spend our income immediately upon receiving it, but

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Demand for Money

Introduction

Functions of Money

Store of Value

Money is not unique as a store of value; any assetwhether money, stocks, bonds, land, houses, art, or jewelrycan be used to store wealth.

Many such assets have advantages over money as a store of value: They often pay the owner a higher interest rate than money, experience price appreciation, and deliver services such as providing a roof over one's head.

Question: If these assets are a more desirable store of value than money, why do people hold money at all?

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Demand for Money

Introduction

Functions of Money

Store of Value

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Demand for Money

Introduction

Functions of Money

Store of Value

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Demand for Money

Introduction

Functions of Money

Store of Value

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Demand for Money

Introduction

Functions of Money

Store of Value

The answer to this question relates to the important economic concept of liquidity, the relative ease and speed with which an asset can be converted into a medium of exchange.

Liquidity is highly desirable. Money is the most liquid asset of all because it is the medium of exchange; it does not have to be converted into anything else in order to make purchases. Other assets involve transaction costs when they are converted into money.

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Demand for Money

Introduction

Functions of Money

Store of Value

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Demand for Money

Introduction

Functions of Money

Store of Value

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Demand for Money

Introduction

Functions of Money

Store of Value

Liquidity is highly desirable. Money is the most liquid asset of all because it is the medium of exchange; it does not have to be converted into anything else in order to make purchases. Other assets involve transaction costs when they are converted