Money and Monetary policy

Soumaya Hamdouni Hind Wahbi Aymane Moussaid Ayoub Faiz

Business Management 1 Sunderland

Introduction:
The key aim of monetary policy for most central banks is to keep inflation low and steady. However in a market-oriented economy, central banks cannot control inflation directly. They have to use instruments such as interest rates, the effects of which on the economy are uncertain. And they have to rely on incomplete information about the economy and its prospects. Some central banks use money growth or the exchange rate as intermediate targets to guide policy decisions. Others take a more eclectic approach and consider a range of factors. Monetary policy has occupied much time of the worlds most distinguished economists over the years. This Handbook provides an introductory overview to the subject.

Table of content:
The meaning of money: Clarifying a misunderstanding The functions of money The kinds of money Measuring money

The supply of money: Banks and the creation of money What causes the money supply to rise?

The demand of money: The monetary policy: The meaning of monetary policy Macroeconomic stability How monetary policy works? Tools of monetary policy Problems in controlling money supply The impact of monetary policy on business

Morocco: The banking system S.W.O.T Analysis Of the financial system The Moroccan financial system

Moroccos economy:

Conclusion: References:

The meaning of money: Clarifying a misunderstanding:

In our everyday lives, we often refer to money as one of three things: 1.coins and paper money (currency). 2.a person's wealth. 3.a person's income. When economists refer to money they have a different connotation in mind: "money is anything that is generally accepted in payments of goods and services or in the repayment of debts"
Mishkin, F. The Economics of Money, Banking and Financial Markets, p. 44

before going any further we must define precisely what we mean by money. Money is more than just notes and coins. In fact the main component of a country's money supply is not cash, but deposits in banks and other financial institutions. The bulk of the deposits appear merely as bookkeeping entries in the banks' accounts. People can access and use this money in their accounts through cheques, debit cards, standing orders, direct debits, etc. without the need for cash. Only a very small proportion of these deposits, therefore, needs to be kept by the banks in their safes or tills in the form of cash. Thee functions of money: Money has three functions in the economy, that distinguish it from other assets, such as stocks, bonds, real estate, art and even football cards. These functions are:

Medium of exchange: is an item that buyers give to sellers when they want to purchase goods and services. For example; when you buy a shirt at a clothing store, the store gives you the shirt, and you give the store your money. This transfer of money from buyer to seller allows the transaction to take place.

Unit of account: a way of expressing value, allows us to compare different goods and services in other way, it is the yardstick people use to post prices and record debts. For example; you might observe that a shirt costs 20 and a hamburger that costs 2. Even though it would be accurate to say to say that the price of a shirt is 10 hamburgers and the price of a hamburger is 1/10 of a shirt, prices are never quoted in this way. Similarly, if you take a loan from a bank, the size of your future loan repayment will be measured in , not in a quantity of goods and services. When we want to measure and record economic value, we use money as the unit of account.

Store of value: a way of holding wealth or an item that people can use to transfer purchasing power from the present to the future. When a seller accepts money today in exchange for good or service, that seller can hold the money and become a buyer of another good or service at another time. Of course, money is

not the only store of value in the economy, for a person can also transfer purchasing power from the present to the future by holding other assets. Economists use the term liquidity to describe the ease with which an asset can be converted into the economy's medium of exchange. Because money is the economy's medium of exchange, it is the most liquid asset available.

The kinds of money: When money takes the role of commodity with intrinsic value, it is called commodity money. The term intrinsic value means that the item would have value even if it were not used as money. One example of commodity money is gold. Gold has intrinsic value because it is used in industry and in the making of jewelry. Although today we no longer use gold as money, historically gold has been a common form of money because it is relatively easy to carry, measure, and verify for impurities. Another example of commodity money is cigarettes. In prisoner-of-war camps during World War II, prisoners traded goods and services with one another using cigarettes as the store of value, unit of account, and medium of exchange. Money without intrinsic value is called fiat money. A fiat money is simply an order or decree, and fiat money is established as money by the government decree. For example, compare the paper in your wallet printed by the government, and the paper from a game. Why can you use the first to pay your bill at a restaurant but not the second? The answer is that the government has decreed it's currency to be valid money. Each paper money in your wallet reads: " this note is legal tender for all debts, public and private". Measuring money: In the definition of the monetary aggregates issued by the Fed, there was given the common measures of the money stock, but lastly this definition has been frequently revised. However, there are three common aggregates of money labeled M1, M2 and M3.

The M oney Supply

M easu g m ey rin on
Na rrowest definition and m easure of m oney supply A ts used prim sse arily for transa ctions

M 1

C urrency (coins & paper m oney) C heckable accounts Traveler s C hecks M plus 1 Savings deposits, including M oney M arket deposit accounts S mall tim deposits e M oney M arket M utual Funds M plus 2 Large Tim D e eposits

M easu g m ey rin on
B roade m r easure of m oney sto ck Includes item used a sto of s s re

M 2

value M + 1

M easu g m ey rin on
E ven B roader definition of m oney

M 3

supply Include item that se s s rve a a unit s of a ccount M + 2

} }
}
M 1 M 2 M 3

The supply of money:

Banks and the creation of credit By far the largest element of money supply (cash outside the banks plus all bank and building society deposits) is bank deposits. It is not surprising then that banks play an absolutely crucial role in the monetary system. Banks are able to create additional money by increasing the amount of bank deposits. They do this by lending to people: granting people overdrafts or loans. When these loans are spent, the shops deposits the money in their bank accounts, or have it directly transferred when debit cards are swiped across their tills. Thus the additional loans granted by the banks have become deposits in the shops' banks. These deposits can be used as the basis for further loans. These in turn create further deposits and so on. The process is known as the ' creation of credit'. Can this process go on indefinitely? The answer is no, banks must keep a certain proportion of their deposits in the form of cash, then non-cash deposits of cash to meet the demands of their customers for cash. Let us say that 10% of bank's deposits have to be in the form of cash, then non-cash deposits would account for the remaining 90%. So it additional cash of 10 million were deposited in the banking system, banks could create non-cash deposits of an additional 90 million but no more. Of the total new deposits of 100 million, cash would be 10% and non- cash deposits would be 90%. This effect is known as the bank multiplier. What causes the money supply to rise? The money supply might rise as a result of banks responding to an increased demand for credit. They may be prepared to operate with a lower liquidity ratio to meet this demand. Another source of extra money is from abroad. One of the main reasons for an increase in money supply is government borrowing. If the government spends more than it receives in tax revenues, it will have to borrow to make up the difference. This difference is known as the public sector net cash requirement (PSNCR). The government borrows by selling interest-bearing securities. these can be short term securities in the form of treasury bills, or longer-term securities in the form of bonds, also known as ' gilts'.

The demand of money:

The demand for money refers to the desire to hold money: to keep your wealth in the form of money, rather than spending it on goods and services or using it to purchase financial assets such as bonds or shares. But why should people want to hold on money, rather than n spending it or buying some sort of security such as bonds or shares? There are two main reasons: The 1st is that people receive money only at intervals and not continuously. They thus require to hold balances of money in cash or in current accounts ready for spending later in the week or month. The 2nd: is as a form of saving. Money in a bank account earns a relatively small but safe rate of return. Some assets, such as company shares or bonds, may earn you more on average, but there is a chance that their price will fall. In other words, they are risky.

The monetary policy:

What Does Monetary Policy Mean? The actions of a central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates. Monetary policy is maintained through actions such as increasing the interest rate, or changing the amount of money banks need to keep in the vault (bank reserves). Investopedia explains Monetary Policy The monetary policy is one of the ways the government attempts to control the economy. If the money supply grows too fast inflation will be too high if it is too slow economic growth slows which affects the gross domestic product GDP. Macroeconomic stability implies: 1. Economic growth 2. Low inflation 3. Exchange rate stability 4. Financial sector stability.

1. Monetary policy affects economic growth through influencing aggregate supply and
aggregate demand which is The quantity of goods and services that households, firms and the government are willing to buy at each price level.

A ge a D m n ( g r g te e a d
Pric e Lvl ee A D
P1 P2

A ) = C +I + G + X - M D

N wA e D

Y1

Y2

N wY e

Y (G P) D
7

Aggregate Supply The quantity of goods and services that firms are willing to produce at each price level.

P rice Level

AS

New AS

Y1

Y2

Y (GDP)
9

A g g te D m n g re a e ad a d S p ly n up to e e g th r d te in th le e o p e a do tp t in th e o o y e rm e e v l f ric s n u u e cnm

Price Level
P 1

New AD AD

AS

P0

Y0

Y 1

Y
1 0

2. Inflation means sustained increase in prices. High inflation is a problem, since it Discourages saving; Encourages speculation, dollarization, capital flight; Hurts the poor, and Raises uncertainty. How monetary policy works? Monetary policy pursues its objectives by Managing level of money, Influencing interest rates, and Affecting volume of lending. The central bank achieves its objectives by influencing Reserve money, The money multiplier, and Broad money.

Tools of monetary policy: There are four ways in which the central bank affect the money supply; these are: 1. open-market operations. 2. reserve requirement. 3. discount rate 4. selective credit control. 1. open-market operations. The Process of buying and selling government bonds in the financial market is called Open market operations. This process can be divided into to cases: A. Open Market Purchase. B. Open Market Sale.

A. Open Market Purchase. The central bank buys government bonds from firms or households. The central bank pays for these bonds with check drawn on itself and payable to the seller. The seller deposits the check in a commercial bank. The commercial bank present the check to the central bank for payment. The central bank make a book entry increasing the deposit of the commercial bank at the central bank and thus, adds to the commercial banks reserves. This will Creates excess reserves to commercial banks and enables commercial banks to create more loans . The increase in loans will create more deposits by the banking system , and that will increase the money supply. B. Open Market Sale. The central bank sells government bonds and receive a check drawn on commercial banks. The value of the check will be deducted from the deposit of the commercial bank. This decreases the reserves available to commercial banks which will decrease the loans made by commercial banks. This decreases the deposit created by banks which in turn decreases the money supply. 2. reserve requirement. An increase in the required reserve ratio forces the banks with no excess reserves to decrease its loans, which in turn, decreases the deposits and that will decrease the money supply. 3. discount rate. It is the interest rate at which the central bank will lend funds to commercial banks whose reserves are temporarily below the required level. These loans help banks to meet their reserve requirements when open market sales by the central bank cause a sudden fall of commercial banks reserves. A fall in the discount rate encourages more borrowing by commercial banks and that increases the reserves of the banks , which in turn, increases loans and deposits in the banking system. This will lead to an increase the money supply. When the discount rate increases, commercial banks are likely to increase their reserves so as to avoid the costs associated with an unexpected cash drain. Changes in the discount rate provide a signal of the central bank intention. 4. Selective credit control. Examples: margin requirements, mortgage controls, and maximum interest rates. Margin Requirement: It is the fraction of the price of stock that must be put in cash by the purchaser and the balance can be borrowed from the brokerage firm. If the central bank would like to increase the money supply, it will reduce the margin requirement and the opposite is also true. Problems in controlling money supply:

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The monetary policy tools have powerful effects on the money supply, yet the central bank control of the money supply is not precise. The central bank must wrestle with two problems: The 1st problem is that the central bank does not control the amount of money that households choose to hold as deposits in banks. The more money households deposit, the more reserves banks have, and the more money the banking system can create. And the less money households deposit, the less reserves banks have, and the less money the banking system can create. To see why this is a problem, suppose that one day people begin to lose confidence in the banking system and, therefore, decide to withdraw deposits and hold more currency. When this happens, the banking system loses reserves and creates less money. The money supply falls, even without any central bank action. The 2nd problem with monetary control is that the central bank does not control the amount that bankers choose to lend. When money is deposited in a bank it creates more money only when the bank loans it out. Because banks can choose to hold excess reserves instead, the central bank can not be sure how much money the banking system will create. For instance, suppose that one day bankers become more cautious about economic conditions and decide to make fewer loans and hold greater reserves. In this case the banking system creates less money than it otherwise would. Because of the bankers' decision the money supply falls. The impact of monetary policy on business: How much will a change in interest rates affect the level of business activity and/or inflation? This depends on the nature of the demand for loans. If this demand is unresponsive to interest rate changes or (b) unstable because it is significantly affected by other determinats ( such as anticipated income or foreign interest rates), then it will be very difficult to control by controlling the rate of interest. Problem of an inelastic demand for loans. If the demand for loans is inelastic, any attempt to reduce demand will involve large rises in interest rates. The problem will be compounded if the demand curve shifts to the right, due, say, to a consumer spending boom. High interest rates lead to the following problems: They may discourage business investment and hence long-term economic growth. They add to the costs of production, to the costs of house purchase and generally to the cost of living. They are thus cost innationary. They are politically unpopular, since the general public do not like paying higher interest rates on overdrafts, credit cards and mortgages. High interest rates encourage inflows of money from abroad. This drives up the exchange rate. A higher interest exchange rate makes domestically produced goods expensive relative to goods made abroad. This can be very damaging for export industries and industries competing with imports. Evidence suggests that the demand for loans may indeed be quit inelastic. Especially in the short run, many firms and individuals simply cannot reduce their borrowing commitments. In fact, higher interest rates may force some people and firms to borrow more in order to finance the higher interest rate payments. Problem of an unstable demand. Accurate monetary policy control requires the authorities to be able to predict the demand curve for money. Only then can they set the appropriate level of interest rates. Unfortunately, the demand curve may shift unpredictably, making control very difficult. The major reason is speculation. For example, if people think interest rates will rise and bond prices fall, in the meantime they will demand to hold their assets in liquid form. The demand for money

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will rise. Similarly, if people think exchange rates will rise, they will demand sterling while it is still relatively cheap. The demand for money will rise. It is very difficult for the authorities to predict what people's expectations will be. Speculation depends so much on world political events. If the demand curve shifts very much, and if it is inelastic, then monetary control will be very difficult. Furthermore, the authorities will have to make frequent and sizeable adjustments to interest rates. These fluctuations can be very damaging to business confidence and may discourage long-term investment. The net result of an inelastic and unstable demand for money is that substantial interest rate may be necessary to bring about the required change in aggregate demand.

Morocco:

Basic information:
Population Population: 34,343,220 (July 2008 est.) Age structure: 0-14 years: 30.5%; 15-64 years: 64.3%; 65 years and over: 5.2% Birth rate: 21.31 births / 1,000 population Life expectancy at birth: 71.52 years Ethnic Groups: ArabBerber (99.1%), other (0.7%), Jewish (0.1%) Religious Groups: Muslims (98.7%), Christian (1.1%), Jewish (0.25%)

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GDP

GDP (PPP): 137.4 billion (2008 est.) GDP real growth rate: 5.3% (2008 est.) GDP per capita (PPP): $4,000 (2008 est.) GDP per sector: Agriculture: 14.7%; Industry: 38.9%; Services: 46.5% (2008 est.) Industries Phosphate Rock mining and processing Food processing Leather goods Textiles Construction Tourism Agriculture

Major

Macroeconomic Data Inflation rate (consumer prices): 4.6% (2008 est.) Labor force: 11.5 million (2008 est.) Labor force by occupation: Agriculture: 44.6%; Industry: 19.8%; Services: 35.5% (2006 est.) Unemployment rate: 9.1% (Q2 2008, State High Planning Commission estimate); Budget: Revenues: $26.09 billion; Expenditures: $28.41 billion (2008 est.) Public debt: 60.2% of GDP (2008 est.) Banking System 16 commercial banks with $60.2 billion in Assets. The Big 3 share $38.4 billion in Assets and account for 63.8% of the market. Attijariwafa Bank ($16.3 billion in Assets) 27.1% share Banque Centrale Populaire (BCP) ($14.1 billion in Assets) 23.4% share Banque Marocaine du Commerce Extrieur (BMCE) ($8.0 billion in Assets) 13.3% Share 13 small to mid-sized players with $19.3 billion in Assets garner 36.2% market share Credit Populaire du Maroc (CPM) Bank Al Amal Crdit Agricole du Maroc (CAM) Fonds dEquipement Communal Crdit Immobilier et Hotelier (CIH) Union Marocaine de Banques Mdia Finance Crdit Foncier du Maroc (CFM) Socit Gnrale Marocaine de Banques (SG) Crdit du Maroc (CDM) Citibank Maroc Arab Bank Maroc Foreign Versus Domestic Ownership 5 of the 16 commercial banks are dominated by foreign ownership Citibank (100% owned by Citibank) Arab Bank Maroc (100% owned by Arab Bank)

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BMCI (65% stake owned by BNPParibas) Crdit du Maroc (52.6% stake owned by Crdit Agricole), SG (51.9% stake owned by Socit Gnrale)

Majority foreign-owned banks hold 21% of Assets at end2006. In addition, several banks have minority stakes in Moroccos Big 3: Santander (14.6% of Attijariwafa Bank) CIC (10% of BMCE holding) CAM (5% of BMCE holding) Source of funds Deposits (82%) Debt and other liabilities (13%) Loans (5%) Privatizations: partial versus full Government ownership stands at 23% of Assets in 2006, down from 40% in 2002 The former specialized public banks (Bank Al Amal, Crdit Agricole du Maroc (CAM), Fonds dEquipement Communal, Crdit Immobilier et Hotelier (CIH) now account for only 7 percent of total bank assets. Interest Spread (Lending Rate Minus Deposit Rate)

The interest spread is large especially by comparison with US figures. The range is quite wide but seems to average 800 to 1200 bps above the deposit rate currently hovering around 1100 bps. Bank Credit to the Private Sector Since 2006, credit to the private sector has been increasing rapidly, growing by almost 30 percent year-on-year in 2007, while its ratio to nonagricultural GDP jumped by more than 10 percentage points between 2006 and 2007, to reach almost 80 percent. Bank Credit to the Public Sector: $640 million as of September 2008 Size and Structure of Insurance Companies: Though the largest in the Maghreb and second largest in Africa, the Moroccan insurance sector is still relatively underdeveloped relative to other emerging nations With 109.5 billion MAD (~$12.9 billion) in assets (2007), the sector accounts for less than 10% of total financial system assets. Premiums stand at MAD 17.7 billion in premium (2007), or around 3% of the countrys GDP. This amounts to only $65 per capita. There are 17 insurance companies and a single domestic reinsurance company (the Central Reinsurance Company, or SCR). However, the sector is fairly concentrated, with 3 players owning a +50% market share Insurance companies do not generally maintain ties with commercial banks Moroccos economy:

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The Moroccan economy has been characterized by macroeconomic stability, with generally low inflation and sustained, moderately high growth rates over the past several years. Morocco's primary economic challenge is to accelerate growth and sustain that improved performance in order to reduce high levels of unemployment and underemployment. While overall unemployment stands at 8.6% (2010 est.), this figure masks significantly higher urban unemployment, as high as 31% among young urban males. The Moroccan financial system

1. The macroeconomic stability:

2. Capital account restrictions apply to residents, but transactions for nonresidents are mostly free. 3. There is an absence of benchmarks. 4. International agreements are transforming the formerly closed nature of the economy. 5. Macroeconomic conditions were strong in 2001-2002

S.W.O.T Analysis Of the financial system

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Weeknesses: :strenghts
Robust health of the large commercial banks Precarious solvency and liquidity situation of two large state-owned specialized banks. The level of nonbank financial institutions and sectors.

The financial system could contribute to economic growth. Increased openess would bring benefits and opportunities to Moroccos financial institutions and other economic agents.
The banking system

Opportunities:

Fiscal problems. The inefficiency of the legal and judicial systems remains an impediment to the development of the financial sector.

:Threats

Morocco's banking sector is fairly well developed and modern. The banking system is made up of the Central Bank, Bank al-Maghreb, 16 commercial banks (partially owned by or working in partnership with European banks such as BNP Paribas), several development banks, and 36 financing companies. Seven banks control the market and the principal actor is the Banque Populaires network, followed by Attijariwafa, the BNPE and banks controlled mainly by foreign shareholders, including the BMCI (a subsidiary of BNP-Paribas) and the Credit du Maroc (a subsidiary of the Crdit Lyonnais-Crdit Agricole Group). The Caisse des Dpts is extremely active in real estate and tourism, funding public interest projects as well as more modest initiatives.

Conclusion:

Monetary policies are demand macro economic policies. They work by stimulating or discouraging spending on goods/ services . Monetary policies tries to eliminate those fluctuations. Central bank have no handle on productivity and real economic growth.

References:

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Mishkin, F. The Economics of Money, Banking and Financial Markets, p. 44 Economic - Principles of Macroeconomics Slomar,J. The economic envoronment of business ,p.227-258 Morocco: finacial system stability assessment. 2003 Morocco Final: M,El Hajoui-A,Marrache-R,Rosenberg-K,Spriggs R,Christiansen, IMF Resident Representative in Georgia.ppt, July 2005 IB Economics, 3.4 Addison,wesley losman, chapter 29 IMF,Morocco Financial Stability Assessment (2008).pdf, and The Report: Emerging Morocco 2007 Borrowing Rates,1983-2009.pdf http://web.worldbank.org/WBSITE/EXTERNAL/ACCUEILEXTN/PAYSEXTN/M ENAINFRENC HEXT/MOROCCOINFRENCHEXTN/0,,contentMDK:20149674~pagePK:141 137~piPK:1411 27~theSitePK:468145,00.html http://ocw.mit.edu www.investopedia.com www.BKAM.ma

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