1. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-1 Chapter 9 Money, banking and the financial system

2. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-2 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 Determine what ‘backs’ the supply of money in Australia — what gives it its value and ability to be used almost universally

3. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-3 Learning objectives (cont.) 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  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-4 The functions of money What is money? Anything that performs the function of money is money Money is what money does

5. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-5 The functions of money (cont.) Medium of exchange –Useable for 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  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-6 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  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-7 Currency The coin and note components of the money supply In Australia, these are token money –Money for which the intrinsic value of the commodity used to hold the monetary unit is less than the recorded value of the money

8. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-8 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  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-9 Non-current deposits Highly liquid financial assets Can be readily converted into currency or current deposits New technologies (such as EFTPOS) have increased the importance of these as a source of payment

10. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-10 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 M 3 or broad money? –M 3 is the preferred measure as it is directly and immediately usable as a medium of exchange

11. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-11 Money in Australia: M 3 and broad money Figure 9.1

12. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-12 Money in Australia: M 3 and broad money (cont.) Figure 9.1 (cont.)

13. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-13 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

14. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-14 Monetary base Composed of: Currency held by the public Currency held by the banks Banks’ demand deposits with the RBA

15. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-15 Backing the money supply Money as debt –Notes and deposits are simply debts of the RBA and the banks Acceptability of money Legal tender –By law an acceptable form of payment for debt owed –Fiat money Relative scarcity –Money derives its value from its scarcity relative to its usefulness

16. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-16 Money and prices Government’s responsibility in stabilising The value of money involves: Application of appropriate fiscal policies Effective monetary management

17. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-17 Demand for money The demand for money is the demand for real money balance Two reasons why people demand money: Transactions demand (D t ) Asset demand (D a )

18. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-18 Transactions demand The demand for money as a medium of exchange Level depends on money GDP (not interest rates!) Money demand curve is vertical

19. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-19 Assets demand The demand for money as financial assets and store of wealth Level depends on interest rates Down-sloping money demand curve

20. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-20 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

21. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-21 Demand for money += Rate of interest, (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

22. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-22 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

23. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-23 Equilibrium interest rate Rate of interest, i (per cent) Amount of money demanded (billions of dollars) 10 7.5 2.5 0 DmDm ieie 0 50 100 150 200 250 300 SmSm Equilibrium interest rate

24. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-24 The Australian financial system Comprised of: The Reserve Bank of Australia (RBA) The banks Financial intermediaries

25. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-25 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

26. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-26 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

27. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 9-27 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