Chapter 23 Money and modern banking David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,...
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Transcript of Chapter 23 Money and modern banking David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,...
Chapter 23Money and modern banking
David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,
6th Edition, McGraw-Hill, 2000
Power Point presentation by Peter Smith
23.2
Some key questions
Why does society need money? Why do governments wish to
influence money supply? How do financial markets interact
with the “real” economy? What is the relationship between
money and interest rates?
23.3
Money
Any generally accepted means of payment for delivery of goods or the settlement of debt
Legal money– notes and coins
Customary money– IOU money based on private debt of the
individual e.g. bank deposit.
23.4
Money and its functions
Medium of exchange– money provides a medium for the exchange of goods and
services which is more efficient than barter
Unit of account– a unit in which prices are quoted and accounts are kept
Store of value– money can be used to make purchases in the future
Standard of deferred payment– a unit of account over time: this enables borrowing and
lending
23.5
Modern banking
A financial intermediary– an institution that specializes in bringing lenders
and borrowers together e.g. a commercial bank, which has a government licence
to make loans and issue deposits
including deposits against which cheques can be written
Clearing system– a set of arrangements in which debts between
banks are settled
23.6
A beginner’s guide to the financial markets
Financial asset– a piece of paper entitling the owner to a specified
stream of interest payments over a specified period Cash
– Notes and coin, paying no interest– the most liquid of all assets.
Bills– financial assets with less than one year until the
known date at which they will be repurchased by the original owner
– highly liquid
23.7
A beginner’s guide to the financial markets(continued)
Bonds– longer term financial assets – less liquid because there is more
uncertainty about the future income stream
Perpetuities– an extreme form of bond, never repurchased by the original issuer,
who pays interest forever e.g. Consols
Gilt-edged securities– government bonds in the UK
Industrial shares (equities)– entitlements to receive corporate dividends
– not very liquid
23.8
Credit creation by banks
Commercial banks need to hold only a proportion of assets as cash reserves– this enables them to create credit by
lending EXAMPLE:
– suppose the public needs a fixed £10m for transactions
– and the commercial bank maintains a 10% cash reserve
23.9
Credit creation – example
Commercial bank :Liabilities Assets
Deposits Cash Loans Total
Cashratio
%
Publiccash
holding
Moneysupply
Initial position:100 10 90 100
Central bank issues £10m extra; the public deposits it10 10 110
110 20 90 1101 18.2 10 120
110 11 99 1102 10 19 129
119 20 99 1193 16.8 10 129
200 20 180 200n 10 10 210
23.10
The monetary base and the money multiplier The monetary base or stock of high-
powered money– the quantity of notes and coin in private
circulation plus the quantity held by the banking system
The money multiplier– the change in the money stock for a £1
change in the quantity of the monetary base
23.11
The money multiplier
Suppose the banks wish to hold cash reserves R asas fraction (cb) of deposits (D), and the private sectorwish to hold cash (C) as a fraction (cp) of bank deposits (D).
Then R = cbD and C = cp D
Monetary base H = C + R = (cb + cp) D
Money supply = C + D = (cp + 1) D
So M = (cp + 1)
(cp + cb)H
Money supply = money multiplier × monetary base