1 Money and Banking Professor Chris Adam Australian Graduate School of Management University of Sydney and University of New South Wales

2 INTRODUCTION What is money? What are the forms of money? How does banking work? How does the government influence money?

3 MEANING OF MONEY Money is set of assets used in economy to buy goods and services from people Three functions of money: 1. Medium of exchange Universally accepted for exchange Can be used to pay taxes

4 MEANING OF MONEY Three functions of money: 2. Unit of account Yardstick of measuring value 3. Store of value Transfer purchasing power from present to future Concept of liquidity: ease of converting asset into medium of exchange

5 KINDS OF MONEY Commodity money has intrinsic value –Gold standard –Cigarettes Fiat money has value established by decree Economic conditions can induce people to substitute first for second

6 MONEY IN ECONOMY Money supply as circulating volume of purchasing power Basic type as currency: notes and coins in hands of public –Includes EFTPOS (debit cards) –Also called money base or high powered money

7 MONEY IN ECONOMY Broader definitions (M1, M2, etc.,) include –cheque accounts –savings accounts –time deposits (Certificates of Deposit) –deposits in non-bank financial intermediaries Credit cards are means of deferring payment: not part of current money supply

8 AUSTRALIAN MONETARY AGGREGATES CHANGES

9 AUSTRALIAN MONEY AND CREDIT CHANGES

10 RESERVE BANK OF AUSTRALIA RBA is Australian central bank –Created in 1959 from Commonwealth Bank –Established to manage financial system stability for good of economy –Policy maker for banking system and money supply functions –RBA Board as guide to RBA Governor

11 RESERVE BANK OF AUSTRALIA RBA functions: 1. Originally to monitor bank financial conditions and recommend actions to keep solvent – prudential supervision Now with APRA 2. Guarantor of banking system stability but not lender of last resort Operates cheque clearance process

12 RESERVE BANK OF AUSTRALIA RBA functions: 3. Monetary policy design and implementation, to influence growth rate of economy and inflation Through open-market operations

13 BANKS AND MONEY SUPPLY Bank balance sheet model to demonstrate credit creation with 100% reserves –no credit creation! Bank balance sheet model to demonstrate credit creation with frational reserves –Allows creation of credit –Money multiplier

14 AUSTRALIAN BANK INTEREST SPREADS

15 AUSTRALIAN BANK FEE INCOME

16 AUSTRALIAN BANK EQUITY RETURNS

17 AUSTRALIAN MONETARY POLICY RBA uses changes to cash rate to adjust level of interest rates in economy –overnight loans among intermediaries –shifts base of yield curve Open-market operations to adjust to excess supply or demand of overnight funds –buying and selling government securities from own portfolio

18 AUSTRALIAN CASH RATE

19 AUSTRALIAN INTEREST RATES

20 AUSTRALIAN MONETARY POLICY RBA also oversees reserve requirements for banks –Basel Agreement: Tier 1 and Tier 2 reserves held against assets with appropriate risk classes Problems for RBA in monetary policy: –Household deposits at banks are discretionary –Bank lending as decisions of banks –Confidence in banks: role of bank runs

21 AUSTRALIAN CREDIT AND GDP CHANGES