MONETARY POLICY AND INTERNATIONAL FINANCE
Central Banks and the Money Supply Process
Chapter 3
3.1 Describe what money is
Money (‘money supply’) is anything that is generally accepted as payment
for goods/services or repayment of debt.
3.2 List and summarise the functions of money
1. Medium of Exchange = eliminates the trouble of finding a double
coincidence of needs (reduces transaction costs)
- Promotes specialisation
- Must be easily standardised & widely accepted.
2. Unit of Account = used to measure value in the economy.
- Reduces transaction costs.
3. Store of Value = used to save purchasing power over time.
‘Money retains value over time’
Money = most liquid asset BUT loses value during inflation.
3.3 Identify different types of payment systems.
- Commodity Money = valuable, easily standardised, and divisible
commodities (precious metals, cigarettes).
- Fiat Money = paper money ordered by governments as legal tender.
- Checks = an instruction to your bank to transfer money from your
account.
- Electronic Payment (online bill pay)
- E-Money (electronic money) = debit card, stored-value card (smart
card), E-cash.
,3.4 Compare and contrast the M1 and M2 money supplies.
Money is typically measured and categorised into different types of
monetary aggregates, which reflect the level of liquidity and ease of
conversion into other assets.
M1 = includes the most liquid assets that can be easily converted into cash.
- Currency (coins and banknotes)
- Traveler's checks
- Demand deposits (checking accounts)
- Other checkable deposits (savings accounts)
M2 = adds to M1 other assets that are slightly less liquid.
- Small denomination time deposits (short-term deposits)
- Savings deposits and money market deposit accounts
- Money market mutual fund shares
M3 = even more comprehensive measure that includes large time deposits
and other larger liquid assets.
(not as commonly used due to the decreased trackability of some
country-specific assets)
- Longer-term deposits (3-6 months)
- Certificates of deposit (CDs)
- Other larger liquid assets (commercial paper, treasury bills)
Monetary aggregates are NB tools for policymakers to understand the
money supply and track the economy's performance. By analysing changes
they can gain insights into factors such as inflation, employment, and
economic growth.
(2023 6.1) Explain how cigarettes could be called "money" in
prisoner-of-war camps of World War II? (6)
see answer 3.1 and 3.2
,Chapter 14
14.1 Recognise the historical context of the development of the
central banking system.
The Sverige Riksbank (Bank of Sweden) was the first central bank,
primarily to lend money to the government.
The rise of global trade led to the need for more central banks throughout
Europe.
- founding of the Bank of England = de facto origin of central banking.
Over time, central banks evolved to focus on maintaining monetary stability.
In response to concerns about power concentration, the Federal Reserve
System was designed as a decentralised system with 122 regional Federal
Reserve banks, remaining privately owned by its member banks.
After World War II, many emerging market economies established their
central banks, which began to adopt similar structures to those of the
European Central Banks (ECBs).
The functions of central banks have expanded globally to include:
- Regulating the value of the national currency
- Financing governments
- Acting as a "lender of last resort" to banks facing liquidity and/or
credit crises.
, 14.2 Describe the key features and functions of a central bank.
Key Features of a Central Bank:
1. Independence: Central banks are generally designed to be
independent from political influence, allowing them to make long-term
decisions to maintain economic stability.
2. Monopoly on Issuing Currency: Central banks are the only
institutions authorised to issue the nation’s currency.
3. Lender of Last Resort: They provide financial support to banks
during times of crisis to maintain stability in the banking system.
Functions of a Central Bank:
1. Monetary Policy Implementation: Central banks use tools like open
market operations, reserve requirements, and interest rates to control
money supply and maintain price stability.
2. Financial Stability: They oversee and regulate the financial system
to prevent and manage systemic risks.
3. Foreign Exchange Management: They manage foreign exchange
reserves and may intervene in the foreign exchange market to
stabilise the national currency.
4. Banker to the Government: Central banks manage government
accounts, including issuing and servicing government debt.
Central Banks and the Money Supply Process
Chapter 3
3.1 Describe what money is
Money (‘money supply’) is anything that is generally accepted as payment
for goods/services or repayment of debt.
3.2 List and summarise the functions of money
1. Medium of Exchange = eliminates the trouble of finding a double
coincidence of needs (reduces transaction costs)
- Promotes specialisation
- Must be easily standardised & widely accepted.
2. Unit of Account = used to measure value in the economy.
- Reduces transaction costs.
3. Store of Value = used to save purchasing power over time.
‘Money retains value over time’
Money = most liquid asset BUT loses value during inflation.
3.3 Identify different types of payment systems.
- Commodity Money = valuable, easily standardised, and divisible
commodities (precious metals, cigarettes).
- Fiat Money = paper money ordered by governments as legal tender.
- Checks = an instruction to your bank to transfer money from your
account.
- Electronic Payment (online bill pay)
- E-Money (electronic money) = debit card, stored-value card (smart
card), E-cash.
,3.4 Compare and contrast the M1 and M2 money supplies.
Money is typically measured and categorised into different types of
monetary aggregates, which reflect the level of liquidity and ease of
conversion into other assets.
M1 = includes the most liquid assets that can be easily converted into cash.
- Currency (coins and banknotes)
- Traveler's checks
- Demand deposits (checking accounts)
- Other checkable deposits (savings accounts)
M2 = adds to M1 other assets that are slightly less liquid.
- Small denomination time deposits (short-term deposits)
- Savings deposits and money market deposit accounts
- Money market mutual fund shares
M3 = even more comprehensive measure that includes large time deposits
and other larger liquid assets.
(not as commonly used due to the decreased trackability of some
country-specific assets)
- Longer-term deposits (3-6 months)
- Certificates of deposit (CDs)
- Other larger liquid assets (commercial paper, treasury bills)
Monetary aggregates are NB tools for policymakers to understand the
money supply and track the economy's performance. By analysing changes
they can gain insights into factors such as inflation, employment, and
economic growth.
(2023 6.1) Explain how cigarettes could be called "money" in
prisoner-of-war camps of World War II? (6)
see answer 3.1 and 3.2
,Chapter 14
14.1 Recognise the historical context of the development of the
central banking system.
The Sverige Riksbank (Bank of Sweden) was the first central bank,
primarily to lend money to the government.
The rise of global trade led to the need for more central banks throughout
Europe.
- founding of the Bank of England = de facto origin of central banking.
Over time, central banks evolved to focus on maintaining monetary stability.
In response to concerns about power concentration, the Federal Reserve
System was designed as a decentralised system with 122 regional Federal
Reserve banks, remaining privately owned by its member banks.
After World War II, many emerging market economies established their
central banks, which began to adopt similar structures to those of the
European Central Banks (ECBs).
The functions of central banks have expanded globally to include:
- Regulating the value of the national currency
- Financing governments
- Acting as a "lender of last resort" to banks facing liquidity and/or
credit crises.
, 14.2 Describe the key features and functions of a central bank.
Key Features of a Central Bank:
1. Independence: Central banks are generally designed to be
independent from political influence, allowing them to make long-term
decisions to maintain economic stability.
2. Monopoly on Issuing Currency: Central banks are the only
institutions authorised to issue the nation’s currency.
3. Lender of Last Resort: They provide financial support to banks
during times of crisis to maintain stability in the banking system.
Functions of a Central Bank:
1. Monetary Policy Implementation: Central banks use tools like open
market operations, reserve requirements, and interest rates to control
money supply and maintain price stability.
2. Financial Stability: They oversee and regulate the financial system
to prevent and manage systemic risks.
3. Foreign Exchange Management: They manage foreign exchange
reserves and may intervene in the foreign exchange market to
stabilise the national currency.
4. Banker to the Government: Central banks manage government
accounts, including issuing and servicing government debt.
