Chapter 6:
Money and
monetary policy
Money
• What is money?
• Barter economy
– double coincidence of wants
• Functions of money
– medium of exchange (means of payment)
– unit of account
– store of value
Coincidence of needs
• A lot of search and
negotiation
– Takes too much time Maize
Tailor
• Result Shirts
(wants maize)
– Complicated
– Slow economic
activity Shirts
Maize farmer Carpenter
(wants shoes) (wants shirts)
Chairs
Chairs
Shoemaker
(wants chairs)
Shoes
3
Solution to lack of coincidence
• Be self-sufficient Th
• Keep all possible products is n e eco
to ow e nom
d
• Find a medium of exchange mu eve nab y
ch lop led
fas
– Accepted by all for any product ter
– First role for money (acts as go-between)
– Makes transactions quicker and easier
MONEY Shoemaker (wants
Maize farmer chairs but will take
(wants shoes) money too)
SHOES
4
• What is money then?
• What money is not
– income
– wealth
– factor of production
• DIFFERENT KINDS OF MONEY
– Commodities
– Coins
– Paper money (fully backed by gold)
– Credit money (partially backed by gold)
– Confidence
– The role of the SARB
• What does money consist of?
- notes and coins
- deposits
• How is the total amount (stock) of money measured?
– M1 (notes and coins and demand deposits)
– M2 (broader, short-term deposits)
– M3(broadest measure, includes long-term deposits)
• Financial Intermediaries
- act as an intermediary between
surplus units and the deficit units
- Accept deposits and grant credit
Financial intermediaries
Financial
Surplus investment
units (make more
money)
Sa
Real
vin
investment
gs
(make more
Financial real)
market
Loa
ns
Deficit Factories,
units vehicles,
equipment etc
7
South African Reserve Bank
• South Africa’s central bank and main monetary authority
• Most vital financial institution
• Endorsed by the constitution of the Republic
• Functions
– formulation and implementation of monetary policy
– service to government
– provision of economic and statistical services
– maintenance of financial stability
• Service to government
– acts as banker and advisor
– custodian of gold and foreign exchange reserves
– exchange control
• Economic and statistical services
• Maintenance of financial stability
– supervises banks
– National Payment System
– acts as banker to other banks (lender of last resort)
– banknotes and coins (sole issuer)
Demand for money
• Why do households, firms and government hold money?
• Cost of holding money
– opportunity cost
– interest forgone
– impact of inflation
• Why do people hold part of their income or wealth in the
form of money, which earns little or no interest and loses
some of its value during inflation?
• Motives for holding money
– transactions & precautionary motive (money as means
of payment/medium of exchange)
– speculative motive (money as an asset; store of value)
• Demand for money as a medium of exchange (L1)
= transactions demand (demand for active balances)
(positively related to income Y)
• Demand for money as an asset (L2)
= speculative demand (demand for passive balances)
(inversely related to interest rate i)
• Graphical presentation:
Figure 6-1 The demand for money
(Textbook page 141)
• Thus: total demand for
money (or liquidity
preference) determined
by income Y and interest
rate i
• L = L1(Y) + L2(i)
• Summarised in table below
Table 6-1 The demand for money (or liquidity preference): a summary
(Textbook page 140)
Money creation
• 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
• Stock of money determined by interaction between demand
for money and the interest rate
Figure 6-2 The money market
(Textbook page 147)
• Stock (quantity) of money thus essentially dependent on the
demand for money
Monetary policy
• Definition (interest rates, quantity of money)
• Responsibility of SARB
• Monetary Policy Committee (MPC)
• Monetary policy framework:
– ultimate objective (protect the value of the currency in
the interesst of balanced and sustained economic
growth)
– intermediate objective (pre-announced inflation
target)
– operational variable (repo rate)
– monetary control system (classical reserve system)
• Instruments
– accommodation policy/repo system/repo rate
– open market policy
– other instruments
