Economics Slide Ch14

Chapter 14:
The monetary sector
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Master ECONOMICS FOR SOUTH AFRICAN STUDENTS
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CHAPTER 14: THE MONETARY SECTOR
CHAPTER OUTLINE
LEARNING OUTCOMES
14.1 THE FUNCTIONS OF MONEY
14.2 DIFFERENT KINDS OF MONEY
14.3 MONEY IN SOUTH AFRICA
14.4 FINANCIAL INTERMEDIARIES
14.5 THE SOUTH AFRICAN RESERVE BANK
14.6 THE DEMAND FOR MONEY
14.7 THE STOCK OF MONEY: HOW IS MONEY CREATED?
14.8 MONETARY POLICY
14.9 BANK SUPERVISION
IMPORTANT CONCEPTS
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LEARNING OUTCOMES
Once you have studied this chapter you should be able to
• describe the functions of money
• define money
• describe the main functions of the South African Reserve Bank
• explain the demand for money
• explain how money is created
• explain the basic instruments of monetary policy
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LO: describe the functions of money
LO: define money
14.1 THE FUNCTIONS OF MONEY
WHAT IS MONEY?
Money is anything that is generally
accepted as payment for goods and
services or that is accepted in settlement
of debt.
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LO: describe the functions of money
THE FUNCTIONS OF MONEY
LO: define money
The three functions of money

Money is NOT
1 Money
Moneyasas
a medium
a storeofofof
medium
unit exchange
value
of exchange
account • Income
servesasasaasstore
Money serves
functions ananintermediary
of value
agreed ∵ it to
measure cansmooth
held the
be stating
for and process
theexchangedof
The reward earned in theprices
exchange
later
goodsfor
Money and
as aand
goods to make
and
services.
unit of it more efficient.
services.
account
2 production process
Money
The
We need is aanything
store ofcommon that
value functionis generally
measurealso the acceptable
of means that
cost in exchange
of money
various serves
goods as fora
and
3 Money
goods as
and
standard
services a be
toof store
ableof
services.
deferred value
toThe
payment.
decide • By
how Wealth
alternative toto
this
best using
we money
mean
spend that
our inmoney
exchange
income. is
is the
the directofexchange
measure value foroffuture
goodspaymentsConsists
for goods of barter.
. called assets that have
been accumulated over time
• A factor of production
What money is not
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LO: define money
14.2 DIFFERENT KINDS OF MONEY
See Box 14-1 Cheques and EFTs, debit cards and credit cards (Textbook page 258)
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LO: define money
14.3 MONEY IN SOUTH AFRICA

Three different methods SARB use to measure the quantity of money:
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1 The conventional measure (M1)
2 A broader definition
M1 includes ofnotes
coins and money(in (M2)
circulation outside the monetary sector) as
well as all demand deposits (including cheque and transmission deposits) of
3 The
themost comprehensive
domestic private sectormeasure of money
with monetary (M3)
institutions.
M2 is equal to M1 plus all other short-term and medium-term
deposits
This
M3 is of the
definition
equal domestic
toofM2
money
pluscan allprivate
be written
long-term sector in with
the monetary
form
deposits ofofthe institutions
an domestic
equality, asprivate
follows:
M = Cmonetary
sector with + D .....................................(14-1)
institutions.
where
M2 canM be=defined
quantity asof money
money plus quasi money
Regarded C =as best
cash measure
(coins and notes of developments in the the
in circulation outside monetary
monetary sector.
sector)
D = demand deposits
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14.4 FINANCIAL INTERMEDIARIES
Financial intermediaries
Institutions that specialise in purely financial transactions, in which no
goods or non-financial services are involved. The main function of financial
intermediaries is to act as go-betweens (intermediaries) between the
surplus units and the deficit units in the monetary economy.
Securities
Paper certificates or electronic records that provide evidence of ownership
of equity (stocks), debt obligations (bonds) or related financial
instruments. Tradable financial assets.
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Box 14-2: More about financial intermediaries
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LO: describe the main functions of the South African Reserve Bank
14.5 THE SOUTH AFRICAN R ESERVE BANK

The SARB regards financial
The Reserve Bank is the monetary authoritystability
in South(particularly
Africa andprices
its current
functions can be grouped into the following 4stability) as itsof
major areas most important
responsibility:
objective. In pursuit of this
Three services provided by the
1) Formulation and implementation of monetaryobjective the Bank plays a
policy
SARB:
pivotal role in the following
• Banker and advisor
2) Service to the government areas:
• Custodian of gold and foreign
• Bank supervision
exchange reserves
3) Provision of economic and statistical services
• The National Payment System
• Administration of exchange
• Banker to other bankers
4) Maintaining financial stability control
• Banknotes and coins
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LO: explain the demand for money
14.6 THE DEMAND FOR MONEY

See Box 14-3: Bonds, the bond market and the capital market
The amount of money that various participants in the economy plan to

hold in the form of money balances. Relates to the choices made by
participants who earn an income or who possess wealth. The demand for
money does not relate to the amounts of money that people want, as
demand is not the same as want.
Why do households, firms and government hold money?
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THE DEMAND FOR MONEY LO: explain the demand for money
Cost of holding money

• Opportunity cost
• Interest forgone
• Impact of inflation
Two basic components of the demand for money:

• Transactions demand
• Demand for money as an asset
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Motives for holding money

• Transactions motive (money as means of payment/medium of exchange)
• Speculative motive (money as an asset; store of value)
See Appendix 14-1: Keynes’s speculative demand for money

(Textbook page 272)
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Figure 14-1 The demand for money (Textbook page 265)
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• Summarised in table below
Table 14-1 The demand for money (or liquidity preference): a summary (Textbook page 263)
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The interest rate
The amount of interest payable over a certain period (usually a year)

expressed as a percentage of the amount borrowed. The interest rate is,
therefore, the price a borrower has to pay to enjoy the use of funds which
he or she does not own, and the return that a lender enjoys for deferring
his or her consumption or parting with liquidity. May be defined as the
price of money.
See Box 14-4 The inverse relationship between interest rates and bond prices
(Textbook page 266)
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LO: explain how money is created
14.7 THE STOCK OF MONEY: HOW IS MONEY

CREATED?
See Box 14-5 Money creation: an example (Textbook page 267)
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THE STOCK OF MONEY: HOW IS MONEY CREATED? LO: explain how money is created
• Many misconceptions
• Money created by banks, not by mint or printing press
• Banks create deposits (money) by granting loans
• Banks limited only by:

– demand for loans
– actions of central bank (SARB), by varying repo rate
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Figure 14-2 The determination of the quantity of money (Textbook page 268)
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Box 14-6 The traditional approach to the “supply” of money and

equilibrium in the money market (Textbook page 269)
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LO: explain the basic instruments of monetary policy
14.8 MONETARY POLICY

The measures taken by the monetary authorities to influence the
quantity of money or the rate of interest with a view to achieving stable
prices, full employment and economic growth. Monetary policy entails
the manipulation of interest rates and is conducted by the central bank.
Should be applied in harmony with fiscal policy.
• Responsibility of SARB
• Monetary Policy Committee (MPC)
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MONETARY POLICY LO: explain the basic instruments of monetary policy
The monetary policy framework in South Africa
See Box 14-7 Inflation targeting as a framework for monetary policy

(Textbook page 270)
Main features:
• Ultimate objective (balanced and sustained economic growth)
• Intermediate objective (pre-announced inflation target)
• Operational variable (repo rate)
• Monetary control system (classical reserve system)
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MONETARY POLICY LO: explain the basic instruments of monetary policy
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The instruments of monetary policy
Key instruments:
Accommodation policy
Other instruments
These
A systeminclude non-market-oriented
whereby private banks tender
Accommodation policy measures for such
Open-market
weekly South as credit Reserve
policy
African ceilings and
Bank
deposit
funds rate control
through (whichagreements.
repurchase were
the sale orin South
discontinued purchase of
Africawhereby
some domestic
time
Open-market policy Repos are the main means
financial
ago), changesassets (mainly Treasury
in exchange control bills
banks can obtain funds in order to
and government
regulations, bonds) by the central
comply with central bank
their cash intervention
reserve in
bank
foreignin exchange
order to exert a specific
markets, publicinfluence
debt
Other instruments requirements.
on interest rates
management and theand the quantity
informal measure of
money, via its influence on the cash
of moral suasion.
reserves of the banks.
See Box 14-8 Repurchase agreements (REPOS) (Textbook page 271)
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14.9 BANK SUPERVISION
• Capital asset holdings
• Liquid asset holdings
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IMPORTANT CONCEPTS
• Medium of exchange • Stock (quantity) of money • Passive balances
• Barter economy • Repurchase tender • Interest rate
• Unit of account system • Monetary policy
• Store of value • Repo rate • Monetary policy
• Commodity money • Classical cash reserve framework
system • Monetary growth
• Credit money
• Bonds targeting
• Notes and coins in
circulation • Demand for money • Inflation targeting
• Demand deposits • Liquidity preference • Cash reserve
• Liquidity requirement requirement
• Monetary aggregates
(shortage) • Accommodation policy
• Financial intermediaries
• Transactions demand • Open-market policy
• Securities
• Precautionary demand • Interest rates and
• Monetary authority
• Speculative demand bond prices
• South African Reserve
• Active balances • Bank supervision
Bank
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Chapter 14:

The monetary sector

14.1 THE FUNCTIONS OF MONEY

The three functions of money

14.2 DIFFERENT KINDS OF MONEY

14.3 MONEY IN SOUTH AFRICA

14.5 THE SOUTH AFRICAN R ESERVE BANK

14.6 THE DEMAND FOR MONEY

The amount of money that various participants in the economy plan to

Why do households, firms and government hold money?

Cost of holding money

Two basic components of the demand for money:

Motives for holding money

See Appendix 14-1: Keynes’s speculative demand for money

Figure 14-1 The demand for money (Textbook page 265)

• Summarised in table below

The interest rate

The amount of interest payable over a certain period (usually a year)

14.7 THE STOCK OF MONEY: HOW IS MONEY

See Box 14-5 Money creation: an example (Textbook page 267)

• Money created by banks, not by mint or printing press

• Banks create deposits (money) by granting loans

• Banks limited only by:

– actions of central bank (SARB), by varying repo rate

Box 14-6 The traditional approach to the “supply” of money and

14.8 MONETARY POLICY

• Monetary Policy Committee (MPC)

The monetary policy framework in South Africa

See Box 14-7 Inflation targeting as a framework for monetary policy

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