ROLE OF MONEY

University of Guyana
Faculty of Social Sciences
Department f Economic
Lecturer: Mr. Coli Luckie ( B.Sc. Economics; Dip. Trade Policy; AdvDip. Trade Policy
Week 11
 DEFINITION OF MONEY
• Money is any good that is widely used and accepted in transactions involving the transfer of
goods and services from one person to another. Economists differentiate among three different
types of money: commodity money and fiat money. 

• Commodity money is a good whose value serves as the value of money. Gold coins are an
example of commodity money. In most countries, commodity money has been replaced with
fiat money.
• Fiat money is a good, the value of which is less than the value it represents as money. Dollar
bills are an example of fiat money because their value as slips of printed paper is less than their
value as money.
Week 11
 CHARACTERISTICS OF MONEY
• Durability
• Portability
• Divisibility
• Uniformity

Week 11
 FUNCTIONS OF MONEY
• Medium of Exchange
• Store of Value
• Unit of Account
• Standard of Deferred Payments

Week 11
 MEDIUM OF EXCHANGE
• Medium of Exchange
 Money's most important function is as a medium of exchange to facilitate
transactions. Without money, all transactions would have to be conducted
by barter, which involves direct exchange of one good or service for
another. The difficulty with a barter system is that in order to obtain a
particular good or service from a supplier, one has to possess a good or
service of equal value, which the supplier also desires. 

Week 11
 MEDIUM OF EXCHANGE
• In other words, in a barter system, exchange can take place only if there is
a double coincidence of wants between two transacting parties. The
likelihood of a double coincidence of wants, however, is small and makes
the exchange of goods and services rather difficult. Money effectively
eliminates the double coincidence of wants problem by serving as a
medium of exchange that is accepted in all transactions, by all parties,
regardless of whether they desire each others' goods and services.

Week 11
 STORE OF VALUE
• In order to be a medium of exchange, money must hold its value over time; that is, it
must be a store of value. If money could not be stored for some period of time and
still remain valuable in exchange, it would not solve the double coincidence of wants
problem and therefore would not be adopted as a medium of exchange. As a store of
value, money is not unique; many other stores of value exist, such as land, works of
art, and even baseball cards and stamps. Money may not even be the best store of
value because it depreciates with inflation. However, money is more liquid than most
other stores of value because as a medium of exchange, it is readily accepted
everywhere. Furthermore, money is an easily transported store of value that is
available in a number of convenient denominations.
Week 11
 UNIT OF ACCOUNT
• Money also functions as a unit of account, providing a common measure
of the value of goods and services being exchanged. Knowing the value or
price of a good, in terms of money, enables both the supplier and the
purchaser of the good to make decisions about how much of the good to
supply and how much of the good to purchase.

Week 11
 MONEY IN AN ECONOMY
• The different ways of measuring the money stock in an economy are:
• M1: Currency (coins and paper money) in the hands of the public + all
demand deposits in deposit taking financial institutions + travellers checks
+ other checkable deposits
• M2: M1 + Savings deposits + small time deposits (less than $100,000) +
Money market deposit accounts + other short term investments
• M3: M2 + large time deposits (more than $100,000.)
Week 11
 ROLE OF THE FINANCIAL SECTOR
• A financial market is any exchange that facilitates trading of instruments, such
as stocks, bonds, foreign exchange, or primary commodities such as oil and gas
• To facilitate saving by businesses and households
To lend to businesses and individuals
To allocate funds to productive uses
To facilitate the final exchange of goods and services
To provide forward markets in currencies and commodities
To provide a market for equities and bonds

Week 11
THE ROLE OF THE CENTRAL BANK
A country’s central bank is often seen as the bankers’ bank and is supposed to be
independent of the government.
1) Issuing Currency
2) Setting reserve requirements
3) Lending money to banks
4) Provides for Check collection or clearing between banks
5) Fiscal Agent to the government
6) Supervision of Financial Institutions
7) Controlling the money supply
Week 11
 THE CREDIT CREATION PROCESS
Important Terms
• Required Reserves: That part or percentage of total deposits which banks
by law must not make available for loans.
• Required Reserve Ratio (RRR): The ratio of required reserves to total
deposits.
• Excess Reserves: That part of total deposits which banks can make
available for loans.

Week 11
 THE CREDIT CREATION PROCESS
The money multiplier tells us the maximum amount of new demand-deposit money that can be created by a
single initial dollar of excess reserves. This multiplier, m, is the inverse of the reserve requirement.
• m = 1/R Where m = money multiplier and R = reserve requirement ratio
• Maximum Checkable-Deposit Creation = Excess Reserves * Money Multiplier
• Example Assuming that Jane Doe deposits $ 40.00 into her bank account what is the maximum possible
money that can be created from that initial deposit.
The RRR is equal to .2 or 20%.
• Maximum money created = $32 * 1/.2 = $160

Please note that the entire initial deposit was not used to find the maximum money created.
Week 11
 THE DEMAND FOR MONEY
• Keynesians believe that there are three motives for demanding (holding)
money:
• the transactions motive, the precautionary motive, and the speculative
motive.

Week 11
SPECULATIVE DEMAND FOR MONEY
• At high rates of interest, individuals expect interest rates to fall and bond prices to rise. To benefit
from the rise in bond prices individuals use their speculative balances to buy bonds. Thus when
interest rates are high speculative money balances are low. At low rates of interest, individuals
expect interest rates to rise and bond prices to fall. To avoid the capital loses associated with a fall in
the price of bonds individuals will sell their bonds and add to their speculative cash balances.
• The speculative motive for demand for money arises when investing the money in some asset or bond
is considered riskier than simply holding the money. The speculative motive for demand for money is
also affected by the expected rise or fall of the future interest rates and inflation of the economy.
The speculative demand for money is inversely related to the interest rate. A fall in the interest rate
increases the quantity demanded of money

Week 11
 TOTAL DEMAND FOR MONEY
• The total demand for money is obtained by summating the transactions,
precautionary and speculative demands.
• Represented graphically, it is sometimes called the liquidity preference
curve and is inversely related to the rate of interest.
• Activity 1: Provide a well labelled diagram of the liquidity preference
curve.
• Activity 2: Briefly discuss the Liquidity Preference Theory.
Week 11
 LIQUIDITY TRAP
When monetary policy becomes ineffective because, despite zero/very low-
interest rates, people want to hold cash rather than spend or buy illiquid assets.
• Very low-interest rates
• Low inflation
• Slow/negative economic growth
• Preference for saving rather than spending and investment
• Monetary policy becomes ineffective in boosting demand
Week 11
 QUESTION
• Assume that John deposits $100 into his GBTI bank account, and
assuming that the bank does not lend any part of his deposit, would John’s
action lead to an increase in the money supply?
• Ishkebar is an alien country that has seen little financial innovation. Its
central bank requires commercial banks to keep 100% of their deposits as
reserves. Calculate money multiplier for the economy. Does mean that
money creation is possible? Why?

Week 11