Lecture 10 summary

Lecture 10
Economic analysis

Financial indictors of interest to economists:
Money and credit

- Money
o Money is not income or wealth
▪ Income → reward earned by the factors of production (labour,
capital, natural resources and enterneurship) in the production
process (wages, rent, interest and profit)
▪ Wealth → assets that have been accumulated over time minus
liabilities
o Generally accepted payment for goods and services, or clearing of debt
▪ Therefore, functions of money are:
• Medium of exchange
• Store of value/unit of account
o Stock variable, measured on last day of each month
o Monetarists: strong link between money & price movements
o Financial analysts: money = good indicator of interest rate movements
o Monerary aggregates
▪ Published on S-23 and S-148
▪ M1A = coins and banknotes in circulation + cheque and transmission
accounts from domestic private sector with monetary institutions
• Coins and banknotes → 14% of M1A and 3% of total M3
▪ M1 = M1A + demand deposits held by the domestic private sector
• Comprises about 1/3 of the money supply
▪ M2 = M1 + short-term and medium-term deposits
• Comprises about 1/2 of the money supply
▪ M3 = M2 + long-term deposits
• Less suscpetble to changes in indivudal portfolios due to
financial innovations or changes to expectations and
structure of interest rates

NOTE! Periods:

Short term → 1 – 31 days, Meduim term → 32 – 180 days, Long term → longer than 180
days

- Credit extention
o Link to future interest rate movements
o Credit extended to the non-financial private sector: funds production,
consumption and capital formation
o Published on S-22
o Mortgage advances (to firms and households) make up +/-50% of total
credit to domestic private sector




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, - Graph indicates a strong correlation between money supply and public sector
credit extension
M3 and PSCE growth
30
M3 PSCE
25




Year-on-year per cent
20

15

10

5

0

-5
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15



Interest rates

- Interest = payment by borrower to lender for use of funds
- Interest rate = amount of interest payable over certain period, as percentage of
amount borrowed = ‘price’ of money
- Simple interest:
o Calculated on principal sum (PV) only
o Interest payment: i = PV(present value) x r (interest rate) x n (number of
periods)
▪ E.g. R5000 borrowed at 12% for 2 years.
o Simple interest = 5000 x 0.12 x 2 = R1200 (or R600 per year)
- Compound interest:
o Calculated on principal sum plus any interest due (r x PV) which is added to
the outstanding loan amount after each period (instead of being paid
across at the time)
o Can be compounded at intervals shorter than 1 year:
interest payment = higher
𝑟 𝑛𝑡
o 𝐹𝑉 = 𝑃𝑉 (1 + 𝑛)
▪ n = number of times per year the interest is compounded
▪ t = length of deposit / loan (years)
▪ FV = future value
▪ E.g Borrow R5000 at 12% for 2 years, compounded monthly:
0.12 12∗2
𝐹𝑉 = 5000 (1 + 12
) = 5000(1.01)24 = R6348.67 → interest payment
= R6349 – R5000 = R1349
▪ Previous example, but annual compounding:
0.12 1∗2
𝐹𝑉 = 5000 (1 + 1
) = 5000(1.12)2 = R6272 → interest payment =
R6272 – R5000 = R1272
o Calculation can be reversed to obtain PV (this is called discounting →
opposite of compounding)
𝐹𝑉
▪ PV = 𝑟 𝑛𝑡
(1+ )
𝑛




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