Chap 10

Chapter 10
Money, Banking and

the Financial System
Copyright  2000 McGraw-Hill Australia Pty Ltd PPT t/a MacroEconomics 6E by Jackson and McIver (slide: 1)
By: Muni Perumal, UC
Learning Objectives
• Review the functions of money -
particularly money as a medium of
exchange, unit of account and store
of value
• Define what acts as money in our
economy - M3 and broad money
definition
Learning Objectives
• Determine what ‘backs’ the supply of
money in Australia - what gives it its
value and ability to be used almost
universally
• Explain the demand for money
• Examine the institutional structure of the
Australian Financial system
• Discuss the role of the RBA
Functions of Money
• Medium of exchange
– Buying and selling goods and services
• Unit of account
– Assist the measurement of the relative worth
of various goods, services and resources
• Store of value
– A form in which to store wealth due to its
liquidity and convenience
What is Money?
• Anything that is widely acceptable as
a medium of exchange
• Historically, whales’ teeth, shells, salt,
cattle, rum, etc. were used as money
• Currently, the debts of government
and financial institutions are
employed as money
Money Defined: M3
Three components:
• Currency (coins and notes)
• Current deposits in banks upon which
cheques can be drawn
• Non-current accounts such as
savings
Currency
• In Australia, token money
– intrinsic value is less than face value of
the money
• the coin and note component of the
money supply
Current Deposits
• Cheques enable the ownership of
current deposits to be transferred
• Generally acceptable as a medium of
exchange
• Can be readily converted into
currency
Non-Current Deposits
• Highly liquid financial assets
• Can be readily converted into
currency or current deposits
• New technologies (such as EFTPOS)
important
Broad Money
• M3 plus borrowings from the private
sector of non-bank financial
intermediaries (NBFIs) less holdings
of currency and bank deposits by
NBFIs.
Credit Cards
• Not money
• Simply a convenient method of
obtaining a short-term loan from the
card-issuer
Monetary base
Composed of the following
• Currency held by the public
• Currency held by the banks
• Banks’ demand deposits with the
RBA
Backing the Money Supply
• Money as debt
• Acceptability of money
• Legal tender
– Fiat money
• Relative scarcity
Money and Prices
Government’s responsibility in
stabilising the value of money
involves:
• Application of appropriate fiscal
policies
• Effective monetary management
Demand for Money
• The demand for money is the
demand for real money balance
Two reasons why people demand
money
• Transactions demand
• Asset demand
Transactions Demand
• The demand for money as a medium
of exchange
• Level depends on money GDP (not
interest rates!)
• Money demand curve is vertical
Assets Demand
• The demand for money as financial
assets and store of wealth
• Level depends on interest rates
• Downsloping money demand curve
Total Demand for Money
(Dm)
• Transactions demand and assets
demand are added horizontally
• Changes in interest rates leads to
movement along the curve
• Anything that changes money GDP
lead to a shift in the money demand
curve
Demand for Money
Transactions
Demand, Dt +
Rate of interest, i (percent)
10
7.5
2.5
Dt
0
0 50 100 150 200 250 300
Amount of money
demanded (billions
of dollars)
Copyright  2000 McGraw-Hill Australia Pty Ltd PPT t/a MacroEconomics 6E by Jackson and McIver (slide no. 19
)
Demand for Money
Transactions
Demand, Dt + Asset
Demand, Da =

10 10
7.5 7.5
5 5
2.5 2.5
Dt Da
0 0
0 50 100 150 200 250 300 0 50 100 150 200 250 300
Amount of money Amount of money
demanded (billions demanded (billions
of dollars) of dollars)
)
Demand for Money
Transactions
Demand, Dt + Asset
Demand, Da = Total demand
for money, Dm

10 10 10
7.5 7.5 7.5
5 5 5
2.5 2.5 2.5

Dm
Dt Da
0 0 0
0 50 100 150 200 250 300 0 50 100 150 200 250 300 0 50 100 150 200 250 300
Amount of money Amount of money Amount of money
demanded (billions demanded (billions demanded (billions
of dollars) of dollars) of dollars)
)
The Money Market
• The combination of the money
demand and money supply
determines the equilibrium interest
rate
Equilibrium Interest Rate
Rate of interest, i (percent) 10
7.5
2.5 Dm
0
0 50 100 150 200 250 300
Amount of money demanded

(billions of dollars)
Equilibrium Interest Rate
Sm
Rate of interest, i (percent) 10
7.5
Equilibrium
5 Interest Rate
2.5
ie Dm
0
0 50 100 150 200 250 300
Amount of money demanded

(billions of dollars)
The Australian Financial
System
Comprises of:
• The Reserve Bank of Australia (RBA)
• The banks
• Financial intermediaries
The Reserve Bank of
Australia (RBA)
• Responsibilities set out in the
Reserve Bank Act 1959
Major functions:
• Control of note issue
• Banker to the Banks
– Exchange Settlement Accounts
– Non-callable deposits
The Reserve Bank of
Australia (RBA) (cont.)
• Prudential supervision of the banking
system
– prime assets ratio
– capital adequacy
Other functions:
• Banker to the Government
The Reserve Bank of
Australia (RBA) (cont.)
• Management of the international
means of payment
• Implementation of monetary policy
Next Chapter
How Banks
Create Money

Chap 10

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Chapter 10

Money, Banking and

Rate of interest, i (percent)

Rate of interest, i (percent)

Rate of interest, i (percent)

2.5 2.5 2.5

Amount of money demanded

Amount of money demanded

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