money & financial institutions

Money & Financial Institutions

Circular Flow of Income

What is Money?• a store of value,• A unit of account• A medium of exchange”

• Without money you would have…………….

• Barter

• Problems with barter?

• Double coincidence of wants

Properties Of Money

• Liquidity • Scarcity • Portability • Uniformity• Durability

Kinds Of Money• Convertible paper money The

paper money that can be converted into gold and silver. Examples are Gold and Silver certificates…

• ‘I promise to pay the bearer the sum of one pound on demand’

Commodity MoneyO Has value and

can be used for other purposes.

Inconvertible money – legal tender - Notes and Coins issued by government.

Bank deposits• – Bank deposits Savings.

• Either cash or deposit accounts.

Electronic moneyO - Examples are

Credit Card, Debit card, Charge card

Interest Rates and Money

O People hold more when interest rate is low and hold less when interest rate is high.

Why is this the case?

Money Supply DefinitionsO M1 cash and notes and cash

accounts in banks.

O M2 includes M1 + deposit accounts in banks

O M3 (M1 +M2) cash at non-bank institutions, e.g. Insurance companies and in Pension Funds.

Money Supply – Quantity Theory of Money

MV=PT OM = MoneyOV =Velocity of CirculationOP = PricesOT = number of transactions

Why have money?O Transactions Demand purchases

O Precautionary Demand For uncertain expenses

O Speculative DemandDemand affected by changes in interest

rates (what will happen to the demand for money if interest rates increase?)

Determination of Interest Rate

O Supply and demand for money (if floating)

O In most economies it is set by the central Bank.

BankingO Retail Banking day to day banks

O Wholesale Banking – commercial and investment banks

MAIN FUNCTIONS OF THE BANK OF ENGLAND• Banker to the Government• Manages the issue of Government Debt• Banker to the Commercial Banks• Holds gold and foreign-exchange

reserves• Manages the issue of notes and coins• Implements domestic monetary policy• It sets interest rates.

Tools for Changing the Money Supply

O Changing the discount rate.

O i.e. the rate the Central Bank charges when they make loans to large organizations.

O Buying or selling bonds.

O Buying bonds……… increases cash deposits within banks increases the nation’s M1 or M2 and therefore increases the money available to lend.

O Selling bonds………. Reduces cash deposits within banks.