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MEC152 Tutorial session 3

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13 views

MEC152 Tutorial session 3

Uploaded by

Ofentse Racodi
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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MEC152 Tutorial session 3

Topic 3: Money, Interest rates and exchange rates


Money and its primary functions

• money is defined as a widely accepted medium of exchange that is used to facilitate


transactions, store value, and serve as a unit of account within an economy.
• Money serves as a means for individuals, businesses, and governments to buy and sell
goods and services, settle debts, and measure the value of various economic activities.
Fuctions
Functions of Money

Primary functions Secondary functions

i. Medium of exchange: Money must be readily a. Unit of account: Money provides a


accepted as a form of payment for goods and standardised unit for measuring and
services. comparing the value of different goods and
services.
ii. Store of value: Money should be able to hold b. Standard of deferred payment: Money allows
its value over time. People should be confident for transactions to be conducted with the
that the money they hold today will still have value understanding that payments can be postponed to
when they decide to spend it in the future. a later date.
c. Divisibility: Money should be easily divisible
into smaller units without losing its value.
Monetary aggregates

- help assess the amount of money available for transactions and economic activities.

i. M1 (narrow money): Includes currency (coins and banknotes) held by the public and

demand deposits (cheque accounts) at banks.

ii. M2 (broad money): Includes M1 plus savings deposits, time deposits, and other near

money assets.

iii. M3 (comprehensive): Includes M2 plus large time deposits and other larger liquid

assets.
Motives for holding money

i. Transactional motive: people hold money is to facilitate day-to-day transactions. For


example, buying goods and services, paying bills, and meeting immediate financial
obligations.
ii. Precautionary motive: measure to meet unexpected expenses or emergencies. Money
serves as a buffer against unforeseen financial needs, providing a sense of security. For
example, medical reasons, puncture etc.
iii. Speculative motive: The speculative motive for holding money is related to the desire to
take advantage of potential investment opportunities. When individuals expect interest rates
to rise in the future, they might choose to hold more money instead of investing it in assets
that would yield lower returns in a rising-rate environment.
Money demand curve

Money demand curve

- Downward sloping showing that there is an


inverse/ negative relationship between money
demand and interest rates
- whenever there is a decrease in the interest rate,
the quantity of money demanded increases.
- On the other hand, the quantity of money
demanded drops as the interest rate rises.
Shifts in the money demand curve

Factors that shift the money demand curve

- Changes in the aggregate price level


(i.e.,inflation or deflation)
- Changes in real GDP
- Expectations
The supply of money

• refers to the total amount of money circulating in an economy at a given point in time. It
includes all forms of money held by the public and in financial institutions that can be used
for transactions, as well as for storing value.
• An economy’s money supply is controlled by its central bank.
• The central bank directly regulates the amount of currency in existence and also has
indirect control over the amount of checking deposits issued by private banks.
The money supply curve

- the supply of money is represented by a vertical


line at the quantity of money that the central
bank decides to put out into the economy.
- the supply curve for money will shift to the right
if the central bank increases the money supply,
and to the left if the money supply is reduced
Shifts in the money supply curve

Factors that shift the supply curve

- monetary policy

- Banking system

- Currency in circulation

- Consumer and business behaviour

- Government activities

- Foreign trade
The central bank's main tools for controlling the money supply

i. Open market operations (OMO): It involves the buying and selling of government securities (bonds) in
the open market. Increase money supply by buying government securities from commercial banks;
decrease money supply by selling government securities to commercial banks
ii. Reserve requirements: Central banks require commercial banks to hold a certain percentage of their
deposits as reserves. If the central bank reduces reserve requirements, banks can lend more,
increasing the money supply. If it raises reserve requirements, banks can lend less, decreasing the
money supply.
iii. Repo (or repurchase) rate: This is the interest rate at which the central bank lends money to
commercial banks for the short term, typically overnight. It is a tool used by central banks to manage
liquidity in the banking system and influence short-term interest rates in the broader financial market.
Increase in repo rate decreases money supply while a decrease in the repo rate increases money
supply
Tools continued…

• Discount rate: The discount rate is the interest rate at which commercial banks can borrow
money directly from the central bank.
• Forward guidance: Central banks can guide financial markets and the public about their
future monetary policy intentions.
• Quantitative easing (QE): This involves the central bank purchasing financial assets, such
as government bonds and other securities, directly from the market.
Equilibrium in the money market

- equilibrium in the money market occurs when the


quantity supplied is equal to the quantity demanded
Shifts in money demand

Decrease in money supply Increase in Money supply


Shifts in money demand

Decrease in money demand curve Increase in money demand curve


Q &A

Thank you

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