LECTURE 5 Money and Banking. What is Money? Money is a good that is accepted as a medium of exchange in transactions. Other functions of money include:

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Presentation transcript:

LECTURE 5 Money and Banking

What is Money? Money is a good that is accepted as a medium of exchange in transactions. Other functions of money include: (a) Unit of account – for measuring the relative worth / value of a wide variety of goods and services. (b) Store of value – enables people to transfer purchasing power from the present to the future.

The Demand for Money Transactions demand The need for money as a medium of exchange, to pay mortgage, bills etc. Asset demand Storing financial assets in many forms such as corporate stocks, private or government bonds, or money.

Total Demand for Money Transactions demand + Asset demand

The Supply of Money Money supply is the total amount of money available in an economy at a particular point in time. Types of money: (a) M1 (b) M2 (c) M3

M1 Currency: Coins & Paper Money Checkable Deposits Institutions That Offer Checkable Deposits A Qualification M1 = currency + checkable deposits

M2 Savings deposits, including money market deposit accounts Small (less than RM100,000) time deposits Money market mutual funds M2 = M1 + savings deposits + small time deposits +MMMF

M3 Large time deposits (RM100,000) or more, usually owned by businesses as certificates of deposit. M3 = M2 + large time deposits

The International Monetary System Rules and procedures by which different national currencies are exchanged for each other in world trade.

What are Exchange Rates? The exchange rate states the price, in terms of one currency, at which another currency can be bought. There are 2 types of exchange rates: (a) Fixed exchange rate (b) Flexible exchange rate

Fixed Exchange Rate A fixed exchange rate system through which governments determine exchange rates and make necessary adjustments in their economies to maintain those rates.

Flexible Exchange Rate A flexible or floating exchange rate system through which demand and supply determine exchange rates in which no government intervention occurs.

Appreciation and Depreciation A nation’s currency is said to appreciate when exchange rates change so that a unit of its currency can buy more units of foreign currency. Example: When the dollar price of RM rises, from USD1 = RM4.00 to USD1 = RM3.50, this means that the RM has appreciated relative to the USD (and the USD has depreciated relative to the RM).

A nation’s currency is said to depreciate when exchange rates change so that a unit of its currency can buy fewer units of foreign currency. When the dollar price of Ringgit Malaysia rises, for example, from RM3.50 = USD1 to RM4.00 = USD1, the RM has depreciated relative to the USD (and the RM has appreciated relative to the USD).

What is a depreciation to one country must be an appreciation to the other.