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

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.

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.

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

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

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

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

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

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

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 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

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 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

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 Monetary base Composed of: Currency held by the public Currency held by the banks Banks’ demand deposits with the RBA

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 Backing the Money Supply Money as debt Acceptability of money Legal tender – Fiat money Relative scarcity

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 Money and Prices Government’s responsibility in stabilising the value of money involves: Application of appropriate fiscal policies Effective monetary management

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 Demand for Money The demand for money is the demand for real money balance 2 reasons why people demand money: Transactions demand Asset demand

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 Transactions Demand The demand for money as a medium of exchange Level depends on money GDP (not interest rates!) Money demand curve is vertical

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 Assets Demand The demand for money as financial assets and store of wealth Level depends on interest rates Down-sloping money demand curve

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 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

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 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) Transactions Demand, D t DtDt Asset Demand, D a DaDa Total Demand for Money, D m DmDm

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 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

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 Equilibrium Interest Rate Rate of interest, i (per cent) Amount of money demanded (billions of dollars) DmDm ieie SmSm Equilibrium Interest Rate

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 The Australian Financial System Comprised of: The Reserve Bank of Australia (RBA) The banks Financial intermediaries

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 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

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 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

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 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

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 Next Chapter: How Banks Create Money