12 Money, Banking Interest rates and Monetary Policy

Chapter Objectives The Properties and Functions of Money Demand for Money Equilibrium interest rate SA Reserve Bank Tools of Monetary Policy Monetary policy evaluation

Money The Properties of Money General acceptable Durability Portability Homogeneity Recognisable Stable value Relative scarce

Money The Functions of Money Medium of Exchange Unit of Account Store of Value

Forms of Money M3 M1A Coins and Banknotes Cheque and Transmission deposits M1 All other demand deposits M2 All short and medium term deposits M3 Plus long term deposits

Demand for Money …Graphically Transactions Demand, D1 Asset Demand, D2 Total Money Demand, Dm …Graphically 12.1 12.1

Money Supply Are Credit Cards Money? What “Backs” the Money Supply? Stable Value of Money Money as Debt Acceptability Legal Tender Relative Scarcity

Interest Rates Defined as the Price Paid for the Use of Money

Interest Rates Demand for Money and the Money Market + = (a) Transactions Demand for Money, Dt (b) Asset Demand for Money, Da (c) Total Demand for Money, Dm And Supply 10 7.5 5 2.5 Sm + = Rate of Interest, I percent 5 Dt Da Dm 50 100 150 200 50 100 150 200 50 100 150 200 250 300 Amount of Money Demanded (Billions of rand) Amount of Money Demanded (Billions of rand) Amount of Money Demanded and Supplied (Billions of rand)

Interest Rates Equilibrium Interest Rate Interest Rates and Bond Prices Bond Prices Fall When Interest Rates Rise Bond Prices Rise When Interest Rates Fall Inverse Relationship Between Interest Rates and Bond Prices 12.1 12.2

Reserve Bank The Reserve Bank Historical Background Monetary Policy Committee

Reserve Bank Functions Issue banknotes and coins Banker to the government Custodian of other banks reserves Clearance of interbank claims Custodian of foreign reserves Bank of discount and lender of last resort Collection and analysis of statistics

Tools of Monetary Policy Open Market Operations Buying Securities From Commercial Banks From the Public Selling Securities To Commercial Banks To the Public When the Reserve bank Sells Securities, Commercial Bank Reserves are Reduced 12.2 12.3

Tools of Monetary Policy Reserve bank Buys R1,000 Bond from a Commercial Bank New Reserves R1000 R1000 Excess Reserves R5000 Bank System Lending Total Increase in the Money Supply, (R5,000)

Tools of Monetary Policy Reserve bank Buys R1,000 Bond from the Public Check is Deposited New Reserves R1000 R800 Excess Reserves R200 Required Reserves R1000 Initial Checkable Deposit R4000 Bank System Lending Total Increase in the Money Supply, (R5000)

Tools of Monetary Policy The Reserve Ratio Raising / Lowering the Reserve Ratio The Repo Rate History Borrowing from the Reserve bank by Banks Increases Reserves and Enhances Lending Ability Relative Importance of Each

Monetary Policy Expansionary Monetary Policy (Easy Money) Prime Interest Rate Restrictive Monetary Policy (Tight Money)

Real Domestic Product, GDP Monetary Policy Monetary Policy and Equilibrium GDP (a) The Market For Money (b) Investment Demand (c) Equilibrium Real GDP and the Price Level Rate of Interest, i (Percent) Amount of Money Demanded and Supplied (Billions of rand) Sm1 Sm2 Sm3 Amount of Investment, I (Billions of rand) Price Level Real Domestic Product, GDP (Billions of rand) AS 10 8 6 P3 AD3 I=R25 P2 AD2 I=R20 Dm ID AD1 I=R15 R125 R150 R175 R15 R20 R25 Q1 Qf Q3

Monetary Policy Effects of an Expansionary Monetary Policy Effects of a Restrictive Monetary Policy

Monetary Policy Expansionary Monetary Policy Problem: Unemployment and Recession CAUSE-EFFECT CHAIN Reserve bank Buys Bonds, Lowers Reserve Ratio, or Lowers the Discount Rate Excess Reserves Increase Reserve bankeral Funds Rate Falls Money Supply Rises Interest Rate Falls Investment Spending Increases Aggregate Demand Increases Real GDP Rises

Monetary Policy Restrictive Monetary Policy Problem: Inflation CAUSE-EFFECT CHAIN Reserve bank Sells Bonds, Increases Reserve Ratio, or Increases the Discount Rate Excess Reserves Decrease Reserve bankeral Funds Rate Rises Money Supply Falls Interest Rate Rises Investment Spending Decreases Aggregate Demand Decreases Inflation Declines

Monetary Policy Evaluation and Issues Problems and Complications Speed and Flexibility Isolation From Political Pressure Problems and Complications Recognition Lag Administrative Lag Operational Lag Cyclical Asymmetry

The world was hit by a storm Last Word Global financial crises Causes Effects globally Effects on SA Global reaction

Key Terms medium of exchange unit of account store of value M1A M1 M2 transaction demand asset demand total demand for money balance sheets Reserve Bank functions of the Reserve Bank monetary policy open market operations reserve ratio repo rate expansionary monetary policy restrictive policy evaluation of monetary policy

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