1. 9. Monetary system G 9 / 1 GENERAL ECONOMICS 6
Copyright Mark Van Couwenberghe,

2. 9.0 OVERVIEW G 9 / 2 9.1 HISTORY OF MONEY page G 9 / 3
9.2 FUNCTIONS OF MONEY page G 9 / 6
9.3 TYPES OF MONEY page G 9 / 7
9.4 MONEY SUPPLY page G 9 / 8
9.5 MONEY CREATION page G 9 / 10
9.6 MONETARY INFLATION page G 9 / 13
CPI page G 9 / 15
OTHER CAUSES & TYPES OF INFLATION page G 9 / 17
CONSEQUENCES OF INFLATION page G 9 / 19
9.10 MEASURES TO FIGHT INFLATION/DEFLATION page G 9 / 21
9.11 EXERCISES page G 9 / 23
9.12 VOCABULARY page G 9 / 26
Copyright Mark Van Couwenberghe,

3. 9.1 HISTORY OF MONEY G 9 / 3 1) monetary system: when? advantages:
disadvantages:
2) monetary system:
Copyright Mark Van Couwenberghe,

4. G 9 / 4 3) monetary system: when? advantages: disadvantages:
Copyright Mark Van Couwenberghe,

5. G 9 / 5 6) monetary system: when? advantages: disadvantages:
Monetary systems evolved through time and “money” took different forms; whatever the nature of money, money should always have these 5 characteristics:
Sustainable:
Divisible:
Easy to transport:
Generally accepted:
Limited (in terms of availability):
Copyright Mark Van Couwenberghe,

6. 9.2 FUNCTIONS OF MONEY G 9 / 6 Function Explanation Examples 1
Exchange / payment function
Money is accepted as a way to pay for products and services 2
Value measure function
Money is used to indicate the value of products & services 3
Wealth accumulaton function
Money is used to accumulate wealth (“wealth creates wealth”)
Copyright Mark Van Couwenberghe,

7. 9.3 TYPES OF MONEY G 9 / 7 Type Explanation Examples 1 Cash money
Physical money
+/- 5% of total money supply 2
Scriptural money
Electronic money
+/- 95% of total money supply
Copyright Mark Van Couwenberghe,

8. G 9 / 8
9.4 MONEY SUPPLY
In order to define the quantity of money, certain international definitions apply:
M 1 (“Money 1”) = cash money and scriptural money (directly) available to the public
Most liquid money
“Social money”
“Narrow money”
M 2 = M 1 + ST financial deposits (less liquid money)
M 3 = M 2 + LT financial deposits (least liquid money)
Money definition used by European Central Bank (ECB)
“Broad money” M3 M2 M1
Copyright Mark Van Couwenberghe,

9. G 9 / 9 M 3 = +/- € Explain the evolution of M3:
Copyright Mark Van Couwenberghe,

10. 9.5 MONEY CREATION G 9 / 10 There are 2 types of money creation:
Cash money creation = ECB (and the national central banks) bring additional coins and bank notes into the money supply
Scriptural money creation: commercial banks inject additional scriptural money into the money supply by granting loans
MONEY = DEBT
but… banks are not allowed to create deposits in an unlimited way
reason: banks need to provide enough liquidity to pay out deposit holders
therefore: banks need to respect a certain “reserve ratio”
the maximum scriptural money a bank is allowed to create = 1
money multiplier = ____________________
reserve ratio
Copyright Mark Van Couwenberghe,

11. G 9 / 11 An example of scriptural money creation:
1) Imagine Tina depositing € on her bank acount
The bank keeps € in the safe and grants a loan of € to Carl
(the national central bank has set a reserve ratio of 20%)
Tina considers her € as money and Carl considers his loan of € also as money
Result: money supply = €
Cash money = €
Scriptural money = € 8.000
2) Imagine Carl spending all his money on a motorbike
The owner of the motorbike shop deposits the € on his bank account
The bank keeps € in the safe and grants a loan of € to Lizzy
Lizzy considers her € also as money
Result: money supply = €
Scriptural money = €
Imagine the scriptural money creation process continues…
Copyright Mark Van Couwenberghe,

12. G 9 / 12
The maximum money that can be created, can be calculated as follows: 1
1) money multiplier = ____________________
reserve ratio
5 = __________
0,2
2) a cash money amount of € may lead to a maximum money amount of €
Cash money = €
Scriptural money = €
Copyright Mark Van Couwenberghe,

13. G 9 / 13
9.6 MONETARY INFLATION
Economist Irving Fisher described the relation between real economy and financial economy
Real economy: every transaction in the economy takes place at a certain price
average price per transaction x number of transactions = flow of products and services
Financial economy: every transaction needs to be paid with money
money circulates in the economy (“velocity”)
money supply x velocity = flow of money
Flow of products and services should = flow of money
M x V = P x T
financial economy = real economy
this is the Fisher equation
Copyright Mark Van Couwenberghe,

14. G 9 / 14
The quantity theory of money explains the link between money supply and inflation (increase of general price level):
The assumption is: V and T are fixed parameters
Therefore: increase of M will lead to increase of P = inflation
but… recent economic theory shows that V and T are not fixed at all
CLASSICAL ECONOMISTS
V and T are fixed parameters (inflation is always related to money supply)
MONETARISTS
V and T are not fixed parameters
Velocity changes because paying habits change over time
T changes because the economy grows; as long as full production capacity has not been reached, T will grow (inflaton will only occur if T can not grow any longer)
Copyright Mark Van Couwenberghe,

15. G 9 / 15
9.7 CPI
Inflation is measured through the Consumer Price Index
Consumer price index (CPI) measures changes in the price level of a basket of consumer goods and services purchased by households
The index is usually computed monthly, or quarterly in some countries
Every product/service has a certain weight (according to its importance in the average household budget)
Prices are compared with a reference year (index = 100)
CPI without volitale elements such as food and energy = core inflation
Explain the importance of core inflation:
Copyright Mark Van Couwenberghe,

16. G 9 / 16
Inflation rate: +/-
Explain the evolution of the inflation rate:
Copyright Mark Van Couwenberghe,

17. 9.8 OTHER CAUSES AND TYPES OF INFLATION
G 9 / 17
9.8 OTHER CAUSES AND TYPES OF INFLATION
Cause
Type
Examples 1
Demand in economy exceeds production capacity (demand surplus)
Demand inflation 2
Price of production factors increases
Cost inflation 3
Prices of import products increases
Import inflation
Copyright Mark Van Couwenberghe,

18. G 9 / 18 Special types of inflation: Cause Type Examples 1
Excessive increase in money supply (without any noticeable growth in real economy)
Hyperinflation 2
General price level decreases (economy “cools down”)
Deflation
Copyright Mark Van Couwenberghe,

19. 9.9 CONSEQUENCES OF INFLATION
G 9 / 19
9.9 CONSEQUENCES OF INFLATION
Positive consequences
Negative consequences
Copyright Mark Van Couwenberghe,

20. G 9 / 20 Discuss: what would you prefer as a Minister of Economics?
Inflation or deflation?
Your answer(s):
Your explanation:
Copyright Mark Van Couwenberghe,

21. 9.10 MEASURES TO FIGHT INFLATION / DEFLATION
Measures to fight deflation
Copyright Mark Van Couwenberghe,

22. G 9 / 22
Fill-in the following table on the monetary policy of the ECB:
ECB main target
“Transition mechanism”
Monetary instrument 1: interest rates
Monetary instrument 2: money supply
Positive and negative feedback on “quantitive easing (QE)” policy
Copyright Mark Van Couwenberghe,

23. G 9 / 23
9.11 EXERCISES
1) We learnt that there are 2 types of money creation What would “money destruction” mean?
Cash money destruction:
Scriptural money destruction:
Copyright Mark Van
Couwenberghe,

24. G 9 / 24 2) Imagine an economy with the following parameters:
M = € 200 billion
V = 10
T = € 250 billion
Apply the Fisher equation to calculate inflation
Imagine M increasing to € 230 billion and V decreasing to 9; calculate the impact on T and inflaton
Copyright Mark Van
Couwenberghe,

25. G 9 / 25
3) Describe the Belgian system of wage indexation + discuss advantages and disadvantages:
System:
Advantages:
Disadvantages:
Copyright Mark Van
Couwenberghe,

26. G 9 / 26
9.12 VOCABULARY EN NL
Copyright Mark Van Couwenberghe,

27. G 9 / 27 EN NL
Copyright Mark Van Couwenberghe,

28. G 9 / 28 EN NL
Copyright Mark Van Couwenberghe,