IEB 133 Week 5 The role of money_Lecture 2024.pdf

The Role of Money  Learning outcomes This lecture outlines: What is money What are the functions of money Why do we need money Where does money come from Can the economy function without money?  DEFINITION OF MONEY What is money? Money is anything t...

The Role of Money  Learning outcomes This lecture outlines: What is money What are the functions of money Why do we need money Where does money come from Can the economy function without money?  DEFINITION 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. Money is a generally acceptable means of payment  DEFINITION OF MONEY Economists differentiate between different types of money: 1. Commodity money is a good whose value serves as the value of money. Gold coins are an example of commodity money 2. Fiat money is a good, the value of which is less than the value it represents as money. E.g. dollar bills because their value as slips of printed paper is less than their value as money 3. Bank money consists of the book credit that banks extend to their depositors. E.g. transactions made using cheques drawn on deposits held at banks  FUNCTIONS OF MONEY… Money acts as a means of payment It stores value but this value can be eroded as a result of inflation Acts as a unit of account – is a convenient way of expressing the prices & values of goods & services.  THE CREATION OF MONEY Money is created when people or companies or even governments ‘borrow’ money from the bank. It is not created by printing or minting of notes & coins Banks are the profit maximizing organizations: bank profits are the difference between the interest paid to depositors & the interest they received from the borrowers  THE CREATION OF MONEY To maximize profits the banks will lend out as much money as possible. To make good business sense, the banks normally keep 4% of total deposits as CASH RESERVE REQUIREMENT (CRR) to satisfy the needs of withdraw of depositors THE CREATION OF MONEY  MONEY CREATION: EXAMPLE 1. A tourist pays you R100 for a service you have performed 2. You deposit your hard-earned money into a cheque account 3. In this case the bank keeps 10% of the deposit as cash reserve requirement (R10) which means that the bank can lend out R 90 to make profits 4. Mr. Smith goes to a bank and asks for a loan worth R90 to buy a 21st birthday present for his son 5. The shop deposits the R90 it received into the banking system. The bank then needs to keep R9 as (CRR) & has R81 to lend out!  Money Creation Triggers 1. Inflow of foreign currencies which are exchanged into Rand (ZAR) & deposited in SA’s banking system 2. Government runs a budget deficit & borrows from SARB. That cash is then injected into the banking system 3. Banks sell government bonds to SARB & receive cash in return. Which they then lend to clients  MONETARY POLICY The South African Reserve Bank (SARB) Primary objective of the SARB is to protect the value of the rand in the interest of balanced and sustainable economic growth Concerned with: Money Credit Interest rates  Repo (repurchase) rate - Responsibility of South African Reserve Bank main instrument: tries to achieve inflation target - Is the interest rate that the SARB (Central Bank) is willing to extend credit to the banks - Repo rate directly affects the cost of credit to the banking sector, and therefore, to the public as well - repo rate is set by Monetary Policy Committee of SARB  Prime overdraft & other interest rates - Prime overdraft rate: (prime rate) - Lowest rate at which a clearing bank will lend money to its clients on overdraft 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 Tends to be adjusted whenever the repo rate is adjusted Rate at which ordinary clients are charged on overdraft balances vary; significantly higher than prime rate  MONETARY POLICY The SA Reserve Bank implements measures to achieve its economic objectives by regulating: 1. Price fluctuations (controlling inflation) 2. The Balance of Payments 3. The international value of the Rand 4. Employment  MONETARY POLICY Sometimes monetary policy is tightened (called restrictive monetary policy) to reduce inflation & improve the BOP Remember: a major cause of inflation is a too rapid growth rate of the money supply At other times, monetary policy is relaxed to encourage acceleration in economic activity & growth (expansionary policy  INFLUENCE OF MONETARY POLICY Smoothes fluctuations in prices, BOP and employment Aims to affect the money supply, credit extensions by financial institutions to borrowers and interest rates Creates the right environment for the economy to grow in the longer term, by stabilising the short-term performance of these variables