2. The Evolution and Transformation of Money

3. Basic Kinds of Economic Interaction Gifts -- Transfer of value without any particular expectation of anything in return. Involuntary Transfers – e.g., theft, robbery, extortion, taxes. Reciprocal Exchange – equal exchange of value between two parties by voluntary agreement.

4. The Ladder of Economic Civilization Stages in the development of the process of reciprocal exchange:  Barter trade  Commodity money  Symbolic money  Credit money

5. Barter Trade Barter is the most primitive form of reciprocal exchange. Barter involves only two people; each has something the other wants. The Barter Limitation If Ali Ariz wants something from Sheikh Uzair Bin Arif, but has nothing that Sheikh wants, there can be no barter trade.

6. The First Evolutionary Step From barter trade to commodity money Transcending the Barter Limitation  Barter depends upon the coincidence of wants and needs.  Money bridges the gap in both space and time by widening the exchange circle.  Money acts as a “place holder” enabling needs to be met wherever and whenever the needed good or service may be found.

7. Commodity Money The most primitive type of money is commodity money. Some useful commodity that is in general demand is used as an exchange medium and may serve both as a means of payment and a measure of value.

8. 7 Examples of Commodity Money Various commodities have historically served as money –  Cattle, tobacco, sugar, grains, nails, shells, hides, metals, etc. But the transaction is still essentially a barter trade of one good or service for another good.

9. 8 Metallic Money Metals became the commodities of choice because they are durable, fungible (divisible), and easily portable. “In all countries, however, men seem at last to have been determined by irresistible reasons to give the preference, for this employment, to metals above every other commodity.” – Adam Smith, Wealth of Nations, p. 30

10. 9 Symbolic Money The simplest form of symbolic money is the warehouse receipt, or “claim check” for goods on deposit somewhere. Examples:  Grain bank receipts.  Vouchers for redemption of various goods that have been deposited.  Currencies redeemable for gold or silver.

11. 10 Bank Gold The first bank notes were symbolic money. They were warehouse receipts for gold or silver placed on deposit. The First Kind of Paper Money Symbolic Money

12. 11 The Second Evolutionary Step From commodity money to credit money “Some ingenious goldsmith conceived the epoch-making notion of giving notes not only to those who had deposited metal, but to those who came to borrow it, and so founded modern banking.”  Hartley Withers, The Meaning of Money, p. 18

13. 12 The Embodiment of Credit in Bank Notes At first, bank notes were redeemable on demand for commodity money (gold or silver), so they were symbolic money; later bank notes were credit money. The paper money so largely in use in all civilized countries as a common medium of exchange is in reality a coinage of credit or trust. – Henry George, 1894

14. 13 Bank Gold Banks issued two different kinds of money but they did not distinguish between them, and few people realized it. The same identical bank notes were issued to represent both symbolic money and credit money. Two Distinct Kinds of Paper Money Symbolic Money Mortgage Note Mortgage note Credit Money

15. 14 Problems With Early Credit Money Bank notes were often problematic because now there were two different kinds of paper money being issued into circulation, the one a “claim check” for gold on deposit, and the other a credit instrument issued on the basis of a promise to pay and backed by some collateral assets, yet both were redeemable for gold. This became known as “fractional reserve” banking because there was never enough gold to redeem all the notes.

16. 15 Redeemability Abandoned Eventually, the redeemability feature was abandoned and symbolic money disappeared. Now, virtually all of the money in circulation is credit money. Most of the money in circulation exists as deposits in bank accounts. Very little money exists as paper notes or coins.

17. MONEY SUPPLY Currency Token Money Little Intrinsic Value Checkable Deposits Commercial Banks Thrift Institutions Definition…

18. MONEY SUPPLY = Plus... Near-monies Savings Deposits Money Market Deposit Accounts (MMDAs) Smaller Time Deposits Money Market Mutual Funds (MMMFs)

19. MONEY SUPPLY = Plus... Large Time Deposits Illustrated…

20. Inflation & Price of Money D = 1/Price Level

21. WHAT BACKS THE MONEY SUPPLY? So, What Backs the Money Supply? Stable Value! through... Appropriate Fiscal Policy Intelligent Management of the Money Supply – Monetary Policy

22. THE DEMAND FOR MONEY Transactions Demand, D t varies directly with nominal GDP Asset Demand, D a varies inversely with the interest rate Liquidity Preference illustrated...

23. + Transactions Demand, D t Rate of interest, i (percent) Amount of money demanded (billions of dollars) DtDt 10 7.5 5 2.5 0 0 50 100 150 200 250 300 THE DEMAND FOR MONEY

24. += Transactions Demand, D t Asset Demand, D a Rate of interest, i (percent) Amount of money demanded (billions of dollars) DtDt 10 7.5 5 2.5 0 0 50 100 150 200 250 300 THE DEMAND FOR MONEY Rate of interest, i (percent) Amount of money demanded (billions of dollars) 10 7.5 5 2.5 0 DaDa 0 50 100 150 200 250 300

25. += Transactions Demand, D t Asset Demand, D a Total demand for money, D m 0 50 100 150 200 250 300 Rate of interest, i (percent) Amount of money demanded (billions of dollars) DtDt 10 7.5 5 2.5 0 0 50 100 150 200 250 300 THE DEMAND FOR MONEY Rate of interest, i (percent) Amount of money demanded (billions of dollars) 10 7.5 5 2.5 0 DaDa Rate of interest, i (percent) Amount of money demanded (billions of dollars) 0 50 100 150 200 250 300 10 7.5 5 2.5 0 DmDm

26. += Transactions Demand, D t Asset Demand, D a Total demand for money, D m 0 50 100 150 200 250 300 Rate of interest, i (percent) Amount of money demanded (billions of dollars) DtDt 10 7.5 5 2.5 0 0 50 100 150 200 250 300 THE DEMAND FOR MONEY Rate of interest, i (percent) Amount of money demanded (billions of dollars) 10 7.5 5 2.5 0 DaDa Rate of interest, i (percent) Amount of money demanded (billions of dollars) 0 50 100 150 200 250 300 10 7.5 5 2.5 0 SmSm Equilibrium Interest Rate ieie Rate of interest, i (percent) Amount of money demanded (billions of dollars) 0 50 100 150 200 250 300 10 7.5 5 2.5 0 DmDm ADD THE MONEY SUPPLY TO FIND THE EQUILIBRIUM RATE OF INTEREST

27. Rate of interest, i (percent) Amount of money demanded (billions of dollars) 0 50 100 150 200 250 300 10 7.5 5 2.5 0 DmDm ieie SmSm THE MONEY MARKET Suppose the money supply is decreased from $200 billion, S m, to $150 billion S m1.

28. Rate of interest, i (percent) Amount of money demanded (billions of dollars) 0 50 100 150 200 250 300 10 7.5 5 2.5 0 DmDm ieie SmSm S m1 THE MONEY MARKET

29. Rate of interest, i (percent) Amount of money demanded (billions of dollars) 0 50 100 150 200 250 300 10 7.5 5 2.5 0 DmDm ieie SmSm THE MONEY MARKET Suppose the money supply is increased from $200 billion, S m, to $250 billion S m2.

30. Rate of interest, i (percent) Amount of money demanded (billions of dollars) 0 50 100 150 200 250 300 10 7.5 5 2.5 0 DmDm ieie SmSm S m2 THE MONEY MARKET A temporary surplus of money will require the purchase of some assets to meet the de- sired level of liquidity.

31. Rate of interest, i (percent) Amount of money demanded (billions of dollars) 0 50 100 150 200 250 300 10 7.5 5 2.5 0 DmDm ieie SmSm S m2 THE MONEY MARKET A temporary surplus of money will require the purchase of some assets to meet the de- sired level of liquidity.

32. State Bank of Pakistan Functions Issuing Currency Setting Reserve Requirements & Holding Reserves the Cash Reserve Requirement (CRR), and Statutory Liquidity Requirement (SLR) of the banks Lending Money to Banks & Govt. Management of Foreign Exchange Supervising Banks Controlling the Money Supply Discount Rate