Economics: The Role of Money

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.

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.