Money Functions and Aspects
Question 1: What are the functions of Money? To what extent will it be possible to design a society in which there was no money? In the early human civilizations, there was no money, as we know it now. ... Money is something that is generally accepted as a means of payment in the settlement of all transactions, including debts incurred. ... This makes money and money alone has the power to buy things directly in the market. Functions of Money: Keynes in his theory of demand for money has described various functions of money. ... A medium of exchange for buying goods and services: this means that individuals demand money for transactional purposes. Without money, exchange will involve direct barter of goods and services. ... Money avoids much of waste by economizing on the use of scarce real resources in carrying out exchanges. ... A store of value when saving and a standard for deferred payment when calculating loans: individuals hold their wealth in the form of money. Money is indeed an asset, and is therefore one way of holding wealth. ... The value of money may change over time, but that is true of any other store of value Society with No Money In this electronic age, the technical problems of establishing a ‘money-less society’ have been largely solved. ... If the system was perfect and all transactions could be recorded at point of sale, probably we would never require money. ... Thus, it may not be possible to have a society without money as that would be possible only in an utopian world where there was no black money or black market, no precautionary or speculative demand for money. This is a far and distant dream from the reality we face now, even though we have greatly reduced the amount of money we demand for the number of transactions we undertake. Question 2: Evaluate the effect of introduction and increased popularity of credit cards on the demand for money. Credit cards have been gaining popularity around the globe as a surrogate for money. Technically speaking, credit cards are not actually a form of money but just a way of deferring payments of money for transactions. Money is demanded primarily for this motive and credit cards offer an easy alternative for the usage of cash for transactions. The credit limits on these cards are determined by the amount of money the user actually has in his bank account and thus can be seen as another form of deferring payments such as cheques or drafts do. IMPACT OF CREDIT CARDS- An Intuitive explanation Logically speaking, credit cards have reduced the need for carrying hard cash and thus the effects can be that individuals do not withdraw much currency from the bank money- credit multiplier scheme. Thus, with the same amount of M0, the amount of M3 can increase much more, thus reducing the demand for money with respect to the supply. With lesser money demanded by the individuals in the form of cash, the banks can safely keep lesser reserves with them and create higher disbursements with the same base of H, i. ... , high-powered money. This increases the supply of money by a large extent and puts a pressure on the interest rates to reduce. ... Studies in this direction show a more in-depth explanation and are discussed briefly as under: · Effects of Credit Cards on the Money Supply: Research Paper by Teresa Schoellner, University of Ohio, USA · Price Flexibility Model: Patinkin, 1965 As a recently expanded alternative technology for conducting transactions, credit cards have the potential to alter consumers’ demand for money. A look at how credit cards have changed money balances spotlights the traditional monetary theme that transactions costs influence a consumer’s level of liquid assets. ... Credit cards may change the timing of flows through these accounts, for example by replacing a continual outflow of money with discreet monthly card payments, in a way that offsets any reduction in the precautionary demand for money. An inventory management model of money holdings is analyzed for cases where the ability to aggregate transactions would have this positive impact on money holdings. ... Revolving consumer credit outstanding was incorporated into a model of money holdings following a monetary policy shock. The price of consumer credit is relatively non-responsive to the change in the cost of funds following a monetary policy shock; revolving consumer credit provides an independently priced substitute for money balances. ... , credit) and money markets are highlighted. Use of credit cards is captured by a shift parameter, a, such that increases in it increase the supply of bonds and reduce the demand for money, thereby generating excess supply in each market. ... An increase in the use of credit cards reduces the demand for money, thereby shifting LL down to LL1. ... These shifts are the manifestation of interpreting interest rate movements in the partial equilibrium terms, respectively, of money and credit markets. ... If the commodity market (CC curve) had been formally considered, the respective excess supplies in the bond and money markets would imply an excess demand for commodities. The CC relation in Figure 1 accordingly shifts to the right, as a result of which it intersects the bond and money equilibrium schedules at b. ... Economists on the other hand are predisposed to interpreting credit cards as simply a way of reducing money demand, with no effect on aggregate demand, perhaps because of the Keynesian-oriented money-bonds as substitutes framework. Yet, falling money demand is only one element in the credit card story; increases in the supply of bonds is another; together with the consequent excess supplies in the money and bond markets, there must be an excess demand for goods and services. ... The reduction in money demand because of greater usage of credit cards shifts the LL curve down along the BB0 curve. And the excess supply of money shifts the CC curve to the right so that it intersects the other curves at a higher interest rate and price level. ... Question 3: Describe how banks create money. ... Credit is created when one party (a party, a firm or an institution) lends money to another party, the borrower. ... Banks are financial intermediaries that receive money from people in the form of checkable deposits, and they use these funds to buy bonds, stocks, and to make loans. ... HOW DO BANKS CREATE MONEY? Banks create money by 1. ... Limitations on the Credit creating power of banks 1) Banks may hold Extra Reserves 2) People may hold money 3) The required reserve ratio Question 4: Would the probability of a bank run, other things constant, be higher or lower with a higher cash reserve ratio? ... •Self-fulfilling expectations: If people believe that a bank will fail, they will run on the bank to withdraw their money. •If everyone withdraws their money at once, bank cannot cover the withdrawals given reserves on hand. ... These aspects of the banking business make banks particularly vulnerable to volatility in relative prices and to losses of confidence. ... INCREASES IN BANK DEPOSITS AND MATURITY/CURRENCY MISMATCHES Growing economies also experience an increase in the ratio of broad money supply to GDP. In other words, there is more money in the economy during periods of economic growth. ... Depositors will choose to keep their money in the domestic banking system only if they are confident that the system has sufficient access to international reserves to cover liquidation into dollars. ... Also, banks in developing economies face higher risks from maturity mismatches between their deposits and their loans because they have less access to longer-term sources of funding (depositors are less willing to put their money in long-term savings accounts) and cannot increase their liquidity (have money available) through the securities markets (for example, issue corporate bonds).