1. ECF 320 – MONEY, BANKING AND FINANCIAL MARKETS

2. OUTLINE Objectives Learning outcomes Introduction
Money and its characteristics and functions
Measures of money
Evolution of the payment system

3. Objectives This topic aims at:
Introducing students to money, banking and financial markets as a separate discipline of economics
Defining money and discussing its various characteristics and functions
Explaining how money is measured
Discussing the evolution of the payment system

4. Learning outcomes At the end of this topic, you should be able to:
Explain the importance of money, banks and other financial institutions in an economy
Outline the characteristics and functions of money
Distinguish the various measures of money
Explain the evolution of the payments system

5. Introduction
As the name of the course suggests, there are three important components that need to be understood :
Money and Monetary Policy
Banking
Financial Institutions
By looking at the three components, we try to understand the role of money, monetary policy, banks and financial institutions in an economy

6. In addition, we look at how these three factors affect other macroeconomic variables such as interest rates, economic growth, inflation, employment, exchange rates, etc
Therefore, this course is an exciting field of economics that directly affects your life.

7. For instance, interest rates influence earnings on savings and the payments on loans on a car or a house, and monetary policy may affect job prospects and the prices of goods in the future.
Financial markets and institutions not only affect your everyday life but also involve huge flows of funds throughout the economy, which in turn affects business profits, the production of goods and services, and even the economic well being of countries

8. Your study of this course will introduce you to many of the controversies about the conduct of economic policy and will help you gain a clearer understanding of economic phenomena you frequently hear about in the news media.
The knowledge you gain will stay with you and benefit you long after the course is done.

9. Money and its Functions
Money, also referred to as money supply is defined as anything that is generally accepted in payment for goods and services or in the repayment of debts.
Money is linked to changes in economic variables that affect all of us and are important to the health of the economy
However, for anything to qualify as money it should the following characteristics:

10. Acceptability
Portability
Homogeneity/standard/identical
Scarcity
Divisibility
Durability

11. Functions of Money
Money performs the following functions in an economy:
Medium of exchange: Money is used to purchase goods and services e.g. producers sell their produce to wholesalers in exchange for money and wholesalers sale to consumers in exchange for money.
This function distinguishes it from other assets such as bonds, stocks and houses
Use of money as a medium of exchange promotes efficiency by minimizing the time spent in exchanging goods and services. E.g. consider a barter system

12. II. Store of Value: Money allows people to store surplus purchasing power and use it whenever they want.
In this way, money is used as a liquid asset.
Liquidity refers to the ease of converting a store of value into a medium of exchange.

13. III. Unit of account (measure of value): money is used to express values of various products and services produced in an economy
If for example the economy has only three goods, then we need only three prices to tell us how to exchange one for another
As such money reduces transaction costs by reducing the number of prices that need to be considered

14. The benefit of this function of money grows as the economy becomes more complex
IV. Standard of deferred payments: Money is used to settle future payments.
For instance, modern economies are based on credit e.g. people get loans such as financing loans, mortgages and settlement of these is done using money.

15. Evolution of the Payment System
Coin Money: With time, the gold bars used as commodity were transformed into coins.
People started using gold coins and silver coins as money.
Bank Notes: paper money started in form of representative money.

16. Those with gold would deposit their gold with the bank and the bank would issue a receipt and/or note to the depositor that was redeemable for whatever gold or silver they had stored.
Since having a receipt or note was as good as having gold, these notes/receipts started being traded and with time these notes/receipts were legalized as money.

17. Bank Credit: as banks and paper money increased, banks realized that they could make money by loaning out money trusting that not everyone would want their money back at the same time.
The idea of fractional reserves was introduced and banks started extending credit to those who wanted to borrow.

18. Checks: Given some challenge posed by coins and paper money that it becomes bulky if the payment is too big, checks were introduced.
A check is an instruction from you to your bank to transfer money from your account to someone else’s account when she deposits the check

19. However, because checks could bounce and also took time to clear before one can access the money, other methods of payment have continued to emerge including credit cards, interest payment, mobile banking, electronic payments
Measuring Money
Three measures have been identified:
1. M1: this is a very narrow definition of money. It constitutes money (notes + coins) in circulation, which is money outside the central bank plus commercial bank deposits with the central bank.

20. This emphasizes the medium of exchange function.
It also includes demand deposits and traveller’s checks
2. M2: M1 + Savings Deposits +Time deposits + Money market mutual funds
3. M3: M2 + other non-personal fixed term deposits + foreign currency deposits by residents of the country

21. ACTIVITY Explain the following components of money: Demand deposits
Traveller’s checks
Time deposits
Money market mutual funds
Non-personal fixed term deposits

22. ~THE END~