Economics: The Role of Money

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Questions and Answers

What percentage of total deposits do banks normally keep as a CASH RESERVE REQUIREMENT (CRR)?

What happens to the R10 that is kept as cash reserve requirement when you deposit R100 into a cheque account?

It is kept by the bank and is not lent out.

When Mr. Smith receives a loan of R90 from the bank, what happens to the R90 when he spends it at a shop?

The shop deposits the R90 into the banking system, and the bank then needs to keep R9 as CRR and has R81 to lend out.

What is one way that a government can trigger money creation in the banking system?

Running a budget deficit and borrowing from the central bank. Signup and view all the answers

What happens when banks sell government bonds to the central bank?

They receive cash in return, which is then injected into the banking system. Signup and view all the answers

What is the term for the process by which banks create new money by lending out a portion of their deposits?

Money creation Signup and view all the answers

What is the primary objective of the South African Reserve Bank (SARB)?

To protect the value of the rand in the interest of balanced and sustainable economic growth Signup and view all the answers

What is the repo rate, and what is its impact on the banking sector and the public?

The repo rate is the interest rate at which the SARB lends to banks, and it directly affects the cost of credit to the banking sector and the public. Signup and view all the answers

What is the prime overdraft rate, and how is it related to the repo rate?

The prime overdraft rate is the lowest rate at which a clearing bank will lend to its clients on overdraft, and it tends to be adjusted whenever the repo rate is adjusted. Signup and view all the answers

What are the key areas that the SA Reserve Bank focuses on to achieve its economic objectives?

Price fluctuations (controlling inflation), the Balance of Payments, and the international value of the Rand. Signup and view all the answers

Which committee is responsible for setting the repo rate?

The Monetary Policy Committee of the SARB. Signup and view all the answers

How do banks determine the prime overdraft rate?

Banks are free to set the prime rate at their own discretion, but competition (or collusion?) forces the banks to set the same prime rate. Signup and view all the answers

What is the definition of money?

Anything that is generally accepted as payment for goods and services or that is accepted in settlement of debt. Signup and view all the answers

What are the three types of money differentiated by economists?

Commodity money, Fiat money, and Bank money. Signup and view all the answers

What is the primary function of money?

To act as a means of payment. Signup and view all the answers

What is the role of banks in the creation of money?

Banks create money when they lend it to people, companies, or governments. Signup and view all the answers

What is the motivation behind banks lending out as much money as possible?

To maximize profits. Signup and view all the answers

What is the relationship between inflation and the value of money?

Inflation can erode the value of money. Signup and view all the answers

What is an example of commodity money?

Gold coins. Signup and view all the answers

What is the alternative to money in facilitating transactions?

Bartering or other forms of exchange. Signup and view all the answers

Study Notes

Definition of Money

Money is anything that is generally accepted as payment for goods and services or settlement of debt.
Economists differentiate between three types of money:
- Commodity money: a good whose value serves as the value of money (e.g. gold coins).
- Fiat money: a good whose value is less than the value it represents as money (e.g. dollar bills).
- Bank money: book credit that banks extend to their depositors (e.g. transactions made using cheques drawn on deposits held at banks).

Functions of Money

Acts as a means of payment.
Stores value, but this value can be eroded as a result of inflation.
Acts as a unit of account, a convenient way of expressing the prices and values of goods and services.

The Creation of Money

Money is created when people or companies borrow money from banks.
Banks create money by lending out as much as possible to maximize profits.
Banks normally keep 4% of total deposits as Cash Reserve Requirement (CRR) to satisfy the needs of depositors.

Money Creation: Example

A deposit of R100 triggers a money creation process:
- Bank keeps 10% (R10) as CRR and lends out R90.
- The lent out R90 is deposited into the banking system, triggering another round of money creation.

Money Creation Triggers

Inflow of foreign currencies exchanged into Rand (ZAR) and deposited in SA's banking system.
Government runs a budget deficit and borrows from the South African Reserve Bank (SARB).
Banks sell government bonds to SARB and receive cash in return.

Monetary Policy

The South African Reserve Bank (SARB) has the primary objective of protecting the value of the Rand in the interest of balanced and sustainable economic growth.
Concerned with: money, credit, and interest rates.

Repo (Repurchase) Rate

The interest rate at which the SARB is willing to extend credit to banks.
Affects the cost of credit to the banking sector and the public.
Set by the Monetary Policy Committee of SARB.

Prime Overdraft and Other Interest Rates

Prime overdraft rate: the lowest rate at which a clearing bank will lend money to its clients on overdraft.
Banks are free to set the prime rate, but competition forces them to set the same rate.
Tends to be adjusted whenever the repo rate is adjusted.
Rate at which ordinary clients are charged on overdraft balances varies and is significantly higher than the prime rate.

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Description

This quiz covers the basics of money, its functions, and its importance in the economy. Learn about the definition of money, its role in transactions, and whether an economy can function without it.