1. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-1 Chapter 10 Money, Banking and the Financial System

2. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-2 Learning Objectives Review the functions of money— particularly money as a medium of exchange, unit of account and store of value. Define what acts as money in our economy—the M 3 and broad money definitions.

3. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-3 Learning Objectives (cont.) Determine what ‘backs’ the supply of money in Australia—what gives it its value and ability to be used almost universally. Explain the transactions demand and asset demand for money. Examine the institutional structure of the Australian financial system. Discuss the current role of the Reserve Bank of Australia.

4. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-4 The Functions of Money What is money? Anything that performs the function of money is money Money is what money does

5. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-5 The Functions of Money (cont.) Medium of exchange – Buying and selling goods and services Unit of account – Assisting measurement of relative worth of various goods, services and resources Store of value – A form in which to store wealth, due to its liquidity and convenience

6. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-6 Money Defined: M 3 Three components: Currency (coins and notes) Current deposits in banks upon which cheques can be drawn Non-current accounts such as savings

7. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-7 Currency In Australia, token money – intrinsic value is less than face value of the money Coin and note component of the money supply

8. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-8 Current Deposits Cheques enable the ownership of current deposits to be transferred Generally acceptable as a medium of exchange Can be readily converted into currency

9. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-9 Non-Current Deposits Highly liquid financial assets Can be readily converted into currency or current deposits New technologies (such as EFTPOS) important

10. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-10 Broad Money M 3 plus borrowings from the private sector of non-bank financial intermediaries (NBFIs) less holdings of currency and bank deposits by the NBFIs

11. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-11 Credit Cards Not money Simply a convenient method of obtaining a short-term loan from the card-issuer Facilitate the synchronisation of receipts and expenditures, reducing the demand for cash

12. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-12 Monetary base Composed of: Currency held by the public Currency held by the banks Banks’ demand deposits with the RBA

13. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-13 Backing the Money Supply Money as debt Acceptability of money Legal tender – Fiat money Relative scarcity

14. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-14 Money and Prices Government’s responsibility in stabilising the value of money involves: Application of appropriate fiscal policies Effective monetary management

15. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-15 Demand for Money The demand for money is the demand for real money balance 2 reasons why people demand money: Transactions demand Asset demand

16. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-16 Transactions Demand The demand for money as a medium of exchange Level depends on money GDP (not interest rates!) Money demand curve is vertical

17. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-17 Assets Demand The demand for money as financial assets and store of wealth Level depends on interest rates Down-sloping money demand curve

18. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-18 Total Demand for Money (D m ) Transactions demand and assets demand are added horizontally Changes in interest rates lead to movement along the curve Anything that changes money GDP leads to a shift in the money demand curve

19. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-19 Demand for Money += Rate of interest, i (per cent) Amount of money demanded (billions of dollars) Amount of money demanded (billions of dollars) Amount of money demanded (billions of dollars) 0 50 100 150 200 250 300 Transactions Demand, D t DtDt 10 7.5 5 2.5 0 10 7.5 5 2.5 0 10 7.5 5 2.5 0 Asset Demand, D a DaDa 0 50 100 150 200 250 300 Total Demand for Money, D m DmDm

20. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-20 The Money Market The combination of the money demand and money supply determines the equilibrium interest rate The interest rate represents the opportunity cost of holding money balances

21. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-21 Equilibrium Interest Rate Rate of interest, i (per cent) Amount of money demanded (billions of dollars) 10 7.5 5 2.5 0 DmDm ieie 0 50 100 150 200 250 300 SmSm Equilibrium Interest Rate

22. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-22 The Australian Financial System Comprised of: The Reserve Bank of Australia (RBA) The banks Financial intermediaries

23. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-23 The Reserve Bank of Australia (RBA) Responsibilities set out in the Reserve Bank Act 1959 Main functions: – Control of note issue – Banker to the Banks  Exchange Settlement Accounts  non-callable deposits

24. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-24 The Reserve Bank of Australia (RBA) (cont.) Main functions (cont.): – Banker to the Government  vital role in financing government deficits – Management of the international means of payment – Implementation of monetary policy

25. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-25 The Reserve Bank of Australia (RBA) (cont.) Other functions: – Regulation of the payment system – Membership of the board of the Australian Prudential Regulation Authority (APRA) – Membership of the Council of Financial Regulators

26. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia 10-26 Next Chapter: How Banks Create Money