1 Economics
Chapter 18 Banking, Money and Interest Rates
18.1 The meaning and functions of money
The functions of money
o Medium of exchange --> a general accepted means of payment for goods and services and as a means of payement for
labout and other factor services.
o Means of storing wealth --> people want to save to purchase things in the future
o A means of evolution --> allows to value goods, services or assets to be compared.
o A means of establishing the value of future claims and payements --> can agree on the price of a future payement.
The meaning and functions of money:
The ideal attributes of money
Durability --> 'coins last a long time'
Divisbility --> 'you want something you can divide into pieces' - must come in a number of denominations (large and
small)
Transportability --> 'how easy is it to carry it around'
Non-counterfietability -->'you can't reproduce it'
What should count as money?
- Narrow money - liquid; cash!
- Broad money - less liquid
- What is "Fiat" money? --> has no intrinsic value
18.2 The financial system
Role the central bank
- Note issue (the central bank is in charge of printing them)
- Lender of last resort to commercial banks (gives the confidence to the people, helps the commercial banks)
- Provider of liquidity to banks (they make sure that banks have enough cash)
- Oversees the activities of banks and other financial institutions (they check if banks behave in a certain way and follow
the standard that are set up, the police of the ordinary banks)
- Manages the government’s borrowing programme
- Operates monetary policy (money supply and interest rates, they look after them) (page 567)
- Controls inflation (<2%)
- Operates exchange rate policy and manages reserves (reserves from banks and government, but also oversea central
banks)
Government Bonds
Governments (G) raise money from taxes and the sale of governments bonds (treasury bills, these are due in one year)
- When they want to inject money into the economy they buy bonds; they also lowers interest rates.
- When they want reduce the amount of money in the economy they sell bonds; this also raises interest rates
Bonds and the interest rates
There is an inverse relationship between the price of bonds and the rate of interest (if the price of bonds goes up, the rate of
interest goes down):
FixedPayment = interest rate
Bond price
FixedPayment = bond price
Interest rate
FixedPayment = bond price x interest rate
Bond price = the price of the government bond the government is selling. FixedPayment = ????.
Open market operations
If the government wish to reduce the money supply (MS)
- Central Bank (CB) sell TBs in finance markets
- Financial institutions (e.g. commercial banks) buy them using money
- CB need to reduce the price of the TB to make them more attractive
- Hence a reduction in MS causes interest rates (I) to rise
Chapter 18 Banking, Money and Interest Rates
18.1 The meaning and functions of money
The functions of money
o Medium of exchange --> a general accepted means of payment for goods and services and as a means of payement for
labout and other factor services.
o Means of storing wealth --> people want to save to purchase things in the future
o A means of evolution --> allows to value goods, services or assets to be compared.
o A means of establishing the value of future claims and payements --> can agree on the price of a future payement.
The meaning and functions of money:
The ideal attributes of money
Durability --> 'coins last a long time'
Divisbility --> 'you want something you can divide into pieces' - must come in a number of denominations (large and
small)
Transportability --> 'how easy is it to carry it around'
Non-counterfietability -->'you can't reproduce it'
What should count as money?
- Narrow money - liquid; cash!
- Broad money - less liquid
- What is "Fiat" money? --> has no intrinsic value
18.2 The financial system
Role the central bank
- Note issue (the central bank is in charge of printing them)
- Lender of last resort to commercial banks (gives the confidence to the people, helps the commercial banks)
- Provider of liquidity to banks (they make sure that banks have enough cash)
- Oversees the activities of banks and other financial institutions (they check if banks behave in a certain way and follow
the standard that are set up, the police of the ordinary banks)
- Manages the government’s borrowing programme
- Operates monetary policy (money supply and interest rates, they look after them) (page 567)
- Controls inflation (<2%)
- Operates exchange rate policy and manages reserves (reserves from banks and government, but also oversea central
banks)
Government Bonds
Governments (G) raise money from taxes and the sale of governments bonds (treasury bills, these are due in one year)
- When they want to inject money into the economy they buy bonds; they also lowers interest rates.
- When they want reduce the amount of money in the economy they sell bonds; this also raises interest rates
Bonds and the interest rates
There is an inverse relationship between the price of bonds and the rate of interest (if the price of bonds goes up, the rate of
interest goes down):
FixedPayment = interest rate
Bond price
FixedPayment = bond price
Interest rate
FixedPayment = bond price x interest rate
Bond price = the price of the government bond the government is selling. FixedPayment = ????.
Open market operations
If the government wish to reduce the money supply (MS)
- Central Bank (CB) sell TBs in finance markets
- Financial institutions (e.g. commercial banks) buy them using money
- CB need to reduce the price of the TB to make them more attractive
- Hence a reduction in MS causes interest rates (I) to rise
