MONEY AND THE FINANCIALSYSTEM Definition of money; The central bank and its functions; Commercial banks and their functions;

Definition of money Money is a difficult concept to define partly because it fulfills not only one function but many. The definition of money is based on so many theories and functions. Hence, there are so many definitions of money. But this class will just look at the FUNCTIONAL DEFINITION of money

FUNCTIONAL DEFINITION Basically, money is anything that is generally accepted in payment for goods and services or in the repayment of debts. Prof. Coulborn defines money as a means of valuation and of payment in terms of the unit of account and exchange. Sir John Hides (1967) says that money is defined by it functions. Anything is money which is used as money. So in simple terms, Money is what money does.

Some even defined money based on the legal terms Some even defined money based on the legal terms. That is, anything backed by law to be accepted by everyone for payment is called money. So the functional definition of money is very wide. It includes cheques, gold, coin, savings deposits etc., so long as it can perform the functions of money.

FUNCTIONS OF MONEY 1. MEDIUM OF EXCHANGE By serving as a medium of exchange, money revokes the need for double coincidence of wants and the inconveniences and difficulties associated with barter. This function of money also separates the transactions in time and place because the sellers and buyers of a commodity are not required to perform the transactions at the same time and be at the same place.

2. UNIT OF ACCOUNT Money is the standard for measuring value just as the yard or meter is the standard for measuring length. The monetary unit measures and expresses the values of all goods and services. In fact, the monetary unit expresses the value of each good or service in terms of price. The use of money as a standard of account eliminates the necessity of quoting the price of apples in terms of oranges, the price of oranges in terms of nuts, and so on.

Money as a unit of account also facilitates accounting (easy addition and subtraction). Further, money as a unit of account helps in calculations of economic importance such as the estimation of the costs, and revenues of business firms, etc.

3. STANDARD OF DEFERRED PAYMENTS Money has simplified both the taking and repayment of loans because the unit of account is durable. E.g., Money facilitates borrowing by firms and businessmen from banks and other non-bank financial institutions. Also the buying and selling of shares, debentures and securities is make possible by money. This function of money develops financial and capital markets and helps in the growth of the economy.

4. STORE OF VALUE The commodity chosen as money is always something which can be kept for long periods without deterioration or wastage. It is a form in which wealth can be kept intact from one year to the next. So money is more of a bridge from the present to the future. NOTE: money is not the only store of value. This function can also be served by any valuable asset (though it might be less liquid).

So money is the most liquid store of value. However, money’s usefulness as a store of value can be eroded by inflation(a general rise in the prices of all goods). If, through inflation, all prices double, then the value of money has been cut in half.

The Central Bank The central bank is the apex bank in a country. Samuelson widely define it as “a bank of bankers”. It posses powers of supervision and control over the commercial banks. The central bank is called by different names in different countries. It is the Bank of Ghana in Ghana, the Federal Reserve System in America, the Riks bank in Sweden, etc. The central bank has narrowly been defined by many economists in terms of its functions, example, Hawtrey defines it as a lender of last resort, etc.

Functions of the Central Bank 1. Regulator of currency The central bank is the bank of issue. It has monopoly of note issue. These notes circulate as legal tender money. 2. Banker to the government Custodian of government money and wealth. Keeps deposits of governments, makes payments on behalf of governments, buys and sells foreign currencies on behalf of the government.

3. Adviser to the government Advises the government on economic and money matters as controlling inflation or deflation, devaluation and revaluation of currency, balance of payments, etc. 4. Custodian of cash reserves of commercial Banks Commercial banks are required by law to keep reserves equal to a certain percentage of deposits with the central bank. This facilitates the clearing of cheques.

5. Lender of last resort The central bank lends to financial institutions in times of stress so as to save the financial structure of the country from collapse. 6. Clearing house for transfer and settlement It acts as a clearing house for transfer and settlement of mutual claims of commercial banks. Thus, it transfers funds from one bank to another bank.

7. Custodian and management of foreign exchange reserves. It is an official reservoir of gold and foreign currencies. The central bank buys and sell gold and foreign currencies. It buys and sells foreign currency to manage the exchange rate. It can also fix the exchange rate (in a fixed exchange rate regime)

Commercial banks It is an institution which accepts deposits from the public and in turn advances loans by creating credit. It is different from financial institutions in that they cannot create credit though they may accept deposits. FUNCTIONS OF COMMERCIAL BANKS 1. Accepting deposits These includes savings deposits or savings accounts, current accounts, fixed or time deposits.

2. Advancing loans Commercial banks advances loans to its customers. A bank lends a certain percentage of the cash lying in deposits and charges a higher interest rate than it pays on such deposits. This is how banks earns profits. By advancing loans, they create credit. 3. Financing foreign trade Commercial banks finances foreign trade of its customers by accepting foreign bills of exchange and collecting them from foreign banks. It also buys and sells foreign currency.

4. Agency services Collecting and paying cheques as an agent of its customers. Buys and sells shares, securities, etc. for its customers Pays subscriptions, electricity and water bills on behalf of its clients. NOTE: This is not the finite list of the functions commercial banks. Aside these basic functions, there are many miscellaneous services performed by the commercial banks.