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Introduction to Money

Lecture # 01

Barter System Of Exchange


Barter is the direct exchange of
goods and services for other goods
and services.
Drawbacks of barter System
double coincidence of wants
Lack of Common Measure of Value
Indivisibility of certain articles
Lack of store of Value i.e
perishable products
Difficulties in transportation

Evolution of Money
Metallic Money
Standard Metallic Money
Token Metallic Money

Paper Money
Convertible Paper Money: Issued by SBP convertible to Gold
or Silver on demand i.e 5, 10, 50,100, 500, 1000 Notes
issued by SBP
Inconvertible Paper Money: Issued by Govt: without keeping
in reserve Gold and Silver i.e Rs. 1 in Pakistan

Credit Money
Amount of money borrowed or loaned out to a person
i.e Cheques, DD, Pay orders, Credit Card, Govt Bonds

An Overview of Money
Money is anything that is
generally accepted as a medium
of exchange.
Money as a means of payment,
or medium of exchange, is more
efficient than barter.
Money is not income, and money
is not wealth. Money is:
a means of payment,
a store of value, and
a unit of account.

An Overview of Money
Money as a store of value refers to
money as an asset that can be used to
transport purchasing power from one
time period to another.
Money is easily portable, and easily
exchanged for goods at all times. The
liquidity property of money makes
money a good medium of exchange as
well as a store of value.
i.e currency notes vs diamonds or
paintings

An Overview of Money
Money also serves as a unit of account,
or a standard unit that provides a
consistent way of quoting prices.
Commodity monies are items used as
money that also have intrinsic value in
some other use. Gold is one form of
commodity money.
Fiat, or token, money is money that is
intrinsically worthless.
Legal tender is money that a
government has required to be accepted
in settlement of debts.

Measuring the Supply of Money


in the United States
The two most common measures of money
are M1 and M2.
M1, or transactions money is money
that can be directly used for transactions.
It includes currency held outside banks,
plus demand deposits, plus travelers
checks, plus other checkable deposits
M1 is a stock measureit is measured at a
point in timeon a specific day. On June
26, 2000, M1 was $1,103.3 billion.

Measuring the Supply of Money


in the United States
M2, or broad money, includes near
monies, or close substitutes for
transactions money.
M2 = M1 + savings accounts + money
market accounts + other near monies

On June 26, 2000, M2 was $4,778.2


billion.
The main advantage of looking at M2
instead of M1 is that M2 is
sometimes more stable.

The Private Banking System


Most of the money in the
United States today is bank
money, or money held in
checking accounts rather than
currency.
Financial intermediaries
are banks and other financial
institutions that act as a link
between those who have
money to lend and those who
want to borrow money.

How Banks Create Money


To see how banks create money, consider
the origins of the modern banking system:
Goldsmiths functioned as warehouses where
people stored gold for safekeeping.
Upon receiving the gold, a goldsmith would issue
a receipt to the depositor. After a time, these
receipts themselves, rather than the gold that
they represented, began to be traded for goods.
At this point, all the receipts issued were backed
100 percent by gold.

How Banks Create Money


Goldsmiths realized that people did not
come often to withdraw gold and, as a
result, they had a large stock of gold
continuously on hand. They could lend
out some of this gold without any fear of
running out.
There were thus more claims than there
were ounces of gold.

How Banks Create Money


Knowing there were more receipts
outstanding than there were ounces of
gold, people might start to demand gold
for receipts.
A run on a goldsmith (or a modern-day
bank) occurs when many people present
their claims at the same time.

The Modern Banking System


A brief review of accounting:
Assets liabilities = Net Worth, or
Assets = Liabilities + Net Worth
A banks most important assets are its loans.
Other assets include cash on hand (or vault cash)
and deposits with the Fed.
The Federal Reserve System (the Fed) is the
central bank of the United States.
A banks liabilities are the promises to pay that it
has issued. A banks most important liabilities
are its deposits.

T-Account for a Typical Bank


The balance sheet of a bank must
always balance, so that the sum of
assets (reserves and loans) equals
theT-Account
sum of
liabilities (deposits and
for a Typical Bank (millions of dollars)
net worth). ASSETS LIABILITIES
Reserves

20

100

Deposits

Loans

90

10

Net worth

110

110

Total

Total

The Creation of Money


Banks usually make loans up to the
point where they can no longer do so
because of the reserve requirement
restriction (or up to the point where
their excess reserves are zero).
e x c e s s re s e rv e s a c tu a l re s e rv e s re q u ire d re s e rv e s

The Creation of Money


When someone deposits $100, and the bank
deposits the $100 with the central bank, it has
$100 in reserves.
If the required reserve ratio is 20%, the bank has
excess reserves of $80.
With $80 of excess
reserves, the bank can lend $400 and have up to
$400 of additional deposits. The $100 in reserves
plus $400 in loans equal $500 in deposits.
Increase in MS= Excess reserves * Money
Multiplier
80 * 5 = 400

The Creation of Money


Balance Sheets of a Bank in a Single-Bank Economy
Panel 1
ASSETS

LIABILITIES

Reserves 0

0 Deposits

Panel 2
ASSETS

LIABILITIES

Reserves 100 100 Deposits

Panel 3
ASSETS

LIABILITIES

Reserves 100 500 Deposits


Loans 400

The Creation of Money


The Creation of Money: Balance Sheets of Three Banks
Panel 1
ASSETS

ASSETS

LIABILITIES

Panel 3
ASSETS

LIABILITIES

Reserves 100

100 Deposits

Reserves 100
Loans 80

180 Deposits

Reserves 20
Loans 80

100 Deposits

Reserves 80

80 Deposits

Reserves 80
Loans 64

144 Deposits

Reserves 16
Loans 64

80 Deposits

Reserves 64

64 Deposits

Reserves 64

115.20 Deposits

Reserves 12.80 64 Deposits

Summary:
Bank 1

Deposits
100

Bank 2

80

Bank 3

64

Bank 4
.
.
.
Total

LIABILITIES

Panel 2

51.20
.
.
.
500.00

The Money Multiplier


The money multiplier is the
multiple by which deposits can
increase for every dollar
1
increase
in
reserves.
M o n e y m u ltip lie r =
R e q u ire d re s e rv e ra tio

If the required reserve ratio is 10%, then


an increase in reserves of $1 could cause
an increase in deposits of $10 if there
were no leakage out of the system.

Find M1 & M2

Simple Balance Sheet of bank,


RRR = 20%
Assets
Reserves
Securities
Loans
Property

$1200
750
3500
550

Liabilities and net worth


Checkable
deposits
$5000
Stock shares
1000

Required Reserves&Currently excess


reserves
bank lends fully its excess reserves. Modify
the B.S to reflect the creation of the loan
Increase in MS as result of above loan
creation

Borrower of the new loan writes a


check for the amount of the loan to
purchase
new
equipment
for
business. seller then deposits the
check in an other bank. Show the
new B.S for this bank once the check
has cleared.
Find excess reserves when check is
cleared

Customer
has
deposited
$30,000 in the local bank. Prior
to this deposit, bank was just
meeting its RR. RRR is 25%
Find required increase in required
reserve A/c.
Find excess in reserve A/c if all this
deposit is placed in reserves A/c
Find Money Multiplier
Increase in the MS with this new
deposit
Money Multiplier * Increase in

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