ECS 1601

Study Unit 2
The Monetary Sector

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Content
In this study unit you will learn more about:

The functions of money

Different kinds of money
Money in South Africa
Financial intermediaries
The South African Reserve Bank (SARB)
The supply of money
The demand for money
The equilibrium in the money market
Instruments of monetary policy

Read section
15.1 in
textbook pg.
314-315

2.1 Functions of money

Alternative to an economy with money is a

barter system: people would exchange goods
for other goods. For example, you can
exchange apples for milk.
For example if David has a lot of apples from
the tree in his garden. But he needs milk.
Then he can trade his apples for milk.
Problem is, he needs to finds someone that
has a lot of milk and NEEDS/ WANTS apples.
That is called double coincidence of wants

2.1 Continued
Due to the inefficiency and high transaction costs of a
barter system, people started to use different forms of
money.
Money is anything that is generally accepted as
payment for goods and services or that is accepted in
settlement of debt.
Watch 1601 DVD, for
Money is:
more on money as unit
of account and store of
a unit of account
value. And discuss with
a store of value
your e-tutor
not income or wealth

Read section
15.2 in
textbook pg.
315-316.

2.2. Different kinds of

money

Various things have been used as money in

the past: cattle, seashells and even cigarettes.
Not all forms of money were practical, it was
difficult to carry cattle around and it could not
be split into a thousand pieces (money should
be divisible). Seashells differ from one
another (money should be uniform).
Cigarettes could break or even be smoked
(money should be durable).
Eventually people started using metals such
as copper, iron, silver and gold coins.
Coins are heavy and due to large transaction,
paper money were introduced.

Study box
15-1 on
pg. 317

Box 15-1:

A cheque is not money, a cheque simply

transfers a demand deposit from one person
to another.
Debit cards also simply transfers a demand
deposit from one person to another.
Credit cards is a fast way to acquire a small
loan from the bank, in order to make a
purchase. But you have to pay the bank back
later.
With a credit card you do not pay immediately, the
bank does, but you will have to repay the bank,
eventually. You are postponing the payment.

Read section
15.3 in
textbook pg.
316-318

Watch 1601
DVD, for
more on M1,
M2 and M3.

2.3. Money in South Africa

To measure money, three groups are used:

M1 The conventional measure
Coins and notes that is used by the public PLUS
demand deposits (cheque and transmission
deposits). M= C+ D

M2 A broader definition of money

M1 PLUS short and medium term deposits

M3 The most comprehensive measure of

money
M2 PLUS all long term deposits
Puts emphasis on store of value function of money

Read section
15.4 in
textbook pg.
318

2.4. Financial intermediaries

An economy has a real and financial

sector with real and financial transactions
Financial transactions is when no goods or
services are exchanged
Financial intermediaries act as middle
man between surplus units (people that
save) and deficit unit (people that borrow)
If you lend money to a institution/person
you get paid for the money (interest
rate)

Read section
15.5 in
textbook pg.
318 - 321

2.5. SARB

What is the primary objective of the

SARB?
See top of page 320 in the text book

What is the four major areas of

responsibility of the SARB?
1)Formulation and implementation of monetary
policy
2)Service to the government
3)Provision of economic and
statistical services
4)Maintaining financial stability

(1) SARB: formulation and

implementation of monetary
policy

Main instrument of implementing monetary

policy is the repo rate (accommodation policy/
refinancing system).
Financial intermediaries lend money to the
public at interest rates.
But the financial intermediaries sometimes
need to borrow money from someone
Financial intermediaries borrow from the
SARB at repo rates
Thus the repo rate influences the interest rate
SARB can also set cash reserve requirements
or use open market transactions.
Repo Rate

Interest
Rate

(2) SARB: service to the

government
The SARB helps the government in 3
ways:
Banker and advisor: the government
mainly banks with the SARB. The SARB can
also give the government financial advice
Custodian of gold and foreign exchange
reserves: the SARB stores all the countrys
gold and foreign exchange reserves. They
also formulate exchange rate policies.
Administration of exchange
control: the SARB keeps an
eye on the amount of
foreign exchange that
leaves the country

(3) SARB: provision of

economic and statistical
services

The SARB collects,

processes, interprets
and publishes economic
statistics and other
information. The data
these publications
contain are major source
of information for
policymakers, analysts
and researchers.
Go check it out on the
SARB website, you will
see a lot of this:

(4) SARB: maintaining financial

stability
SARB are dedicated to financial and price stability.
They do this by
supervising banks in order to ensure a healthy
banking system,
overseeing the National Payment System (NPS)
in order to manage risks in the banking system,
being the only institution that can make or
destroy currency.
serving as a bank for other banks:
They also set the cash reserve requirements (the is
the legal amount of money a bank are not aloud to
lend out).
They settle obligations that one bank has towards
another, thus, they act as a clearing bank.
The SARB is a lender -of-last-resort. If a bank is
in trouble they can borrow from the SARB.

Read section
15.6 in
textbook pg.
321-325

2.6.

Supply of money

In order to examine quantity of money supplied:

We only work with M1
We assume that only banks can hold deposits
We assume there is central bank that controls the
activities of banks.
Now, we are going to look at three things
regarding the supply of money:
1)The role of banks in the money creations process
2)The reserve asset position and the credit
multiplier
3)Other factors that influence the money supply

(1) The role of banks in the

money creating process

Watch 1601
DVD, for more
on banks that
creates
money.

Banks create money. But how? Also see box 154 in the textbook on page 324
Banks allow the public to create demand
deposits by means of cheque accounts;
meaning people are now able to transfer money
to someone by writing a check (a promise that
the bank will pay them)
Demand deposits can be created by giving the
bank a certain amount of money and then you
get a cheque book for the same amount
Or a bank will lend you same amount of the
money someone else saved, if they are sure you
will be able to pay it back.

(2) The reserve asset position

and the credit multiplier

Watch 1601
DVD, for more
on reserve
asset
requirements

David saved R1 000 at East Bank, then Susan came to

East
Bank to borrow R1 000. East Bank, said to Susan: We
will lend you Davids money, but not all of it, he might
want some of it back. We will lend you R 700. The SARB
will not allow us to lend you more than that.
This is an example of the reserve asset requirement.
The R300 East Bank holds back is the cash reserve the
SARB set.
David has to trust East Bank, otherwise, David and all
the other East Bankers will withdraw all their money
immediately (called a run on the bank), and East Bank
will collapse.

(2) Do the following.

Watch 1601
DVD, for more
on reserve
asset
requirements

(3) Other factors that influence

the money supply
The money supply can also be
influenced due to transactions with
other countries. For example if South
Africans exchange Rands for Euros
for a trip to France. Or if Americans
exchange Dollars for Rands in order
to buy South African goods.
Foreign transactions are
influenced via the gold and
foreign exchange reserves.

Read section
15.7 in
textbook pg.
325-328

2.7.

Watch 1601
DVD, for more
on the
demand for
money

Demand for money

What can make a person wealthy?

Real assets such as property
Valuable assets such as paintings
and jewelry
Financial assets; money and bonds
However:
The demand for money is the amount
that people want in the form of money

Why do we have a demand for cash? If we

invested all our money, we can earn
maximum interest. Cash earns NO
INTEREST.
For example:
David has R1 000 in his wallet. If David
invested the R1 000 (at an interest rate of
10%) he would have had R1 100. But he
did not invest it, he kept it in his wallet.
Thus, David foregone the R100 interest
and that is why we say, the opportunity
costs of holding money in your wallet is
the interest rate.

If David could have earned an extra R100. Why did he choose to

hold the R1 000 in cash and not to invest it? John Maynard Keynes
has three reasons:
1.He has a transaction demand for money: meaning, he wants
to buy goods and services. David can only buy goods and services
with money and not with a bond or an investment.
2.David is unsure of the future, he therefore has a precautionary
demand for money. If his car breaks down or he cellphone is
stolen he has to have money for unforeseen transactions.
3.The speculative motive to hold money has to do with the
opportunity cost of holding money. Lets say David would like to
invest some money every month. The first month, there is interest
rate of 1%. David realises that if he invests with such a weak
interest rate, he will have almost no return (it is a weak
investment) and the opportunity cost of having cash is very low!
Next year, however, the interest rate is 20% and David rushes to
invest all the money he can because this is a great investment. He
does not want to have money in his wallet with such high
opportunity costs

Study table 152 in the

textbook on
page 327

Meaning, if
your income
is Y1 , your
demand for
money will be
L1
cash you

Remember:
this is only
your ACTIVE
demand for
money, not
L1(Y1) the passive
demand!

Active balances
Interest Rate (i)

The amount of
would like to hold (L) is The active
determined by your
quantity of
income, NOT the interestmoney
Interest rate
rate!
demanded is a
is on the ystraight line
The interest
rate has no
axis! ALWAYS
because it is not
influence on
you active
remember to
demand to hold
cash. influenced by Quantity of
name you
the interest rate
The graph shows
money is on
axis! your
active demand to hold
the x-axis!
cash. As it is not
ALWAYS
remember to
influenced by the interest
name you
rate, it will be the same
axis!
quantity of money
demanded at ANY
0
interest rate
Quantity of money (L

Remember:
Passive balances (speculative
this is only
your PASSIVE
motive)
demand for

Interest Rate (i)

Remember the
passive
opportunity cost of The
holding
quantity of
money? That influences
money
the speculative motive
to
demanded is a
hold money.
negative sloping
Unlike the active demand
line because it
for money, the passive
influence by
demand for moneyis(or
theisinterest rate
speculative motive)
inversely
determined by the interest
rate!
A high interest rate causes
a low demand for money
A low interest rate causes
a high demand for money
0

money, not
the active
demand!

L2

Quantity of money (L

Interest Rate (i)

Interest Rate (i)

Active
+
Passive
=
Total
L (Y )
demand for money

Interest Rate (i)

L2
0

Quantity of money (L,M)

0
Quantity of money (L,M)

2.8. Equilibrium in
the money market

Usually equilibrium is found

where demand and supply
intersects.
In the money market, the supply
curve is extremely complex, one
might even say it does not exist.
Therefore, the equilibrium in the
money market is not determined
by the intersection of the
demand and supply of money but
by the demand for money and
the interest rate as indirectly
determined by the SARB.

S
Interest Rate (i)

Read section
15.8 in
textbook pg.
329

Equilibrium

Equilibrium

D
0

Quantity of money (L

Read section
15.10 in
textbook pg.
332-335

2.9.
Instruments
of monetary policy

Watch 1601
DVD, for more
on the
demand for
money

Key market-orientated policy instruments are:

Accommodation policy
The SARB sets a cash reserve requirement (a minimum
percentage of funds that a bank may not lend out to
someone else). If more money is drawn from the bank, than
they have available, the bank can lend from the SARB. The
SARB can also influence the interest rate by changing the
repo rate.

Open-market policy
If the SARB would like to decrease the amount of money in
the economy, they can write out Treasury Bills. This is a type
of interest yielding investment. The SARB sell the bond to
the public and so they withdraw money from the public.

Public debt management

Intervention of foreign exchange markets

Do you

understand a barter system?

know what money is and is not?
know different types of money?
know a short history of money?
know the difference between M1, M2 and M3?
understand the role of financial intermediaries?
understand the primary objection of the SARB?
know the major functions of the SARB?
understand supply of money?
understand demand for money?
understand equilibrium in the money market?
know the instruments of monetary policy?

Done and
dusted.
Great
work!

That is the end of study

unit 2.
A quiz on this work will
be available soon, make
sure you do it and
discuss it
with your e-tutor!