Money and Banking’ Lecture

15 - 3 - 2020

Dr. Eid Ashry

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 What Is Money?
• Meaning of money
• Economists define money as anything that is
generally accepted in payment for goods or
services or in the repayment of debts.
• Currency, consisting of dollar bills and coins,
clearly fits this definition and is one type of
money.

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 Money and Bank accounts
• To define money merely as currency is much too
narrow for economists. Because cheques are also
accepted as payment for purchases, chequing
account deposits are considered money as well.
• An even broader definition of money is often
needed because other items such as savings
deposits can in effect function as money if they
can be quickly and easily converted into currency
or chequing account deposits. As you can see,
there is no single, precise definition of money or
the money supply, even for economists.

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 Money and wealth
• To complicate matters further, the word money is
frequently used synonymously with wealth.
• Economists make a distinction between money in
the form of currency, demand deposits, and other
items that are used to make purchases, and
wealth, the total collection of pieces of property
that serve to store value.
• Wealth includes not only money but also other
assets such as bonds, common stock, art, land,
furniture, cars, and houses.
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 Money and Income
• People also use the word money to describe what
economists call income.
• Income is a flow of earnings per unit of time.
Money, by contrast, is a stock: it is a certain
amount at a given point in time.
• Keep in mind that the money discussed in this
book refers to anything that is generally accepted
in payment for goods and services or in the
repayment of debts and is distinct from income
and wealth.
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 Function of Money
• Money has three primary functions in any
economy: as a medium of exchange, as a unit
of account, and as a store of value.
• its function as a medium of exchange is what
distinguishes money from other assets such as
stocks, bonds, and houses.
• Money is a class of assets that serves as an
economy’s medium of exchange

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 Medium of Exchange
• In almost all market transactions in our
economy, money in the form of currency or
cheques 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 efficiency by eliminating
much of the time spent in exchanging goods
and services.

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 Medium of exchange and barter
economy
• To see why, let s look at a barter economy, one
without money, in which goods and services
are exchanged directly for other goods and
services.
• Barter economy is a system of exchange in
which goods and services are traded directly,
with no money involved.
• Medium of exchange is whatever people use
to purchase goods and services

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 Double coincidence of wants
• 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 wants they have to find
someone who has a good or service they want
and who also wants the good or service they
have to offer.

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 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
kilometres.
• Unit of account is a measure in which prices
and salaries are quoted

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 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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 Money and liquidity
• Store of value is a form in which wealth can be
held .
• Money is not unique as a store of value; any asset,
whether money, stocks, bonds, land, houses, art,
or jewellery, can be used to store wealth.
• Liquidity is the relative ease and speed with
which an asset can be converted into a medium
of exchange. Liquidity is highly desirable.

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 Money and liquidity
• Liquidity is 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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 Money value and price level
• How good a store of value money is depends
on the price level, because its value is fixed in
terms of the price level.
• A doubling of all prices, for example, means
that the value of money has dropped by half;
conversely, a halving of all prices means that
the value of money has doubled.

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 Types of Money
• The payments system has been evolving over
centuries and with it the form of money. At one
point, precious metals such as gold were used
as the principal means of payment and were
the main form of money. Later, paper assets
such as cheques and currency began to be used
in the payments system and viewed as money.

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 Commodity Money
• An object that clearly has value to everyone is a
likely candidate to serve as money, and a natural
choice is a precious metal such as gold or silver.
• Money made up of precious metals or another
valuable commodity is called commodity money.
• Commodity money is an object in use as a
medium of exchange that also has a substantial
value in alternative (non-monetary) uses.

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 Fiat Money
• Fiat money is money that is decreed as such by
the government. It is of little value as a
commodity, but it maintains its value as a
medium of exchange because people have faith
that the issuer will stand behind the pieces of
printed paper and limit their production.

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 Cheques
• A cheque is an instrument from you to your
bank used to transfer money from your
account to someone else’s account when she
deposits the cheque.
• Cheques allow transactions to take place
without the need to carry around large amounts
of currency.

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 Electronic Payment
• The development of inexpensive computers
and the spread of the Internet now make it
cheap to pay bills electronically.
• now banks provide websites that allow you to
log on, make a few clicks, and thereby transmit
your payment electronically .

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 E-Money
• Electronic payment technology can not only
substitute for cheques, but can substitute for
cash, as well, in the form of electronic money
(or e-money), money that exists only in
electronic form.

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 Debit cards
• The first form of e-money was the debit card.
Debit cards, which look like credit cards,
enable customers to purchase goods and
services by electronically transferring funds
directly from their bank accounts to a
merchant s account.

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 Stored-value card
• A more advanced form of e-money is the
stored-value card. The simplest form of stored-
value card is purchased for a preset dollar
amount that the consumer pays up front, like a
prepaid phone card.
• Stored-value card is a card issued with a
prepaid balance that can be used for purchases.

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 Dollarization
• In some countries, the national currency is
replaced by foreign currency. Most often this
currency is the U.S. dollar, so this phenomenon is
called dollarization.
• Dollarization is the use of foreign currency
(often U.S. dollars) as money.
• Dollarization sometimes arises informally,
without any action by the government. People and
businesses decide to use dollars rather than the
local money. Usually the reason is high inflation,
which makes local currency lose value rapidly.

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 How the Quantity of Money is
Measured?
• The definition of money as anything that is
generally accepted in payment for goods and
services tells us that money is defined by
people s behaviour. What makes an asset
money is that people believe it will be
accepted by others when making payment.

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 Money supply
• Money supply is the total amount of money in
the economy.
• The narrowly defined money supply, usually
abbreviated M1, is the sum of all coins and
paper money in circulation, plus certain
checkable deposit balances at banks and
savings institutions.

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 Money supply 2
• The broadly defined money supply, usually
abbreviated M2, is the sum of all coins and
paper money in circulation, plus all types of
checking account balances, plus most forms
of savings account balances, plus shares in
money market mutual funds.

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 Money and liquidity
• Near moneys are liquid assets that are close
substitutes for money.
• An asset’s liquidity refers to the ease with
which it can be converted into cash.

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 Liquidity and Money Supply
• The Need for Liquidity:
• Degrees of Liquidity :The liquidity of assets varies
widely. the most liquid assets are money that people
can spend directly, including currency and checking
deposits. Some other kinds of bank deposits, such as
savings deposits, are almost as liquid. Securities are
less liquid than saving. Still, securities are more liquid
than many assets. Real estate, for example, is illiquid. A
house can be traded for money, but the process is time
consuming and expensive.
• gs deposits.

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Returns on assets and their liquidity
• Sometimes a trade-off exists between the
returns on assets and their liquidity. For
example, checking deposits earn less interest
than savings deposits, or even no interest, but
they are more liquid. Savings deposits earn
less interest than bonds. Given this trade-off,
many people hold a mixture of assets with
different degrees of liquidity.

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Functions of Central Banks and Money
Supply
• A central bank has many roles in the economy.
Let’s outline the most important functions.

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 Central Bank and clearing Payments
• Every private bank has an account at the
Central Bank for its region. Banks use these
accounts to clear checks and process electronic
payments. Because banks have accounts there,
the Central Bank is sometimes called the
“banks’ bank.”

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Central Bank and Monetary Policy
• The best-known function of central banks is
monetary policy, or management of the money
supply. These policy decisions, which we
discuss at many points in the book, have strong
effects on the economy.
• Monetary policy is the central banks’
management of the money supply.

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 Emergency Lending
• Central banks have long lent money to private
banks. This lending occurs primarily during
financial crises, which threaten banks with
failure. During crises, banks need loans to
survive, and they cannot get funds from private
sources. So the central bank steps in as the
lender of last resort.
• Lender of last resort is the central bank’s role
as emergency lender to financial institutions

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