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CONTENTS

Meaning & Types of Money

OVERVIEW OF
Functions of Money
MONEY AND BANKING
Financial System
Prepared by: Nguyen Thi Xuan Lan, PhD.
Fiscal Policy and Monetary Policy

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Meaning of Money Meaning of Money (cont’d)

• What is it?
Money (a stock concept) is different from:
 Money (or the “money supply”): anything that is
• Wealth: the total collection of pieces of property
generally accepted in payment for goods or services
that serve to store value
or in the repayment of debts.
• Income: flow of earnings per unit of time
(a flow concept)
=> A rather broad definition

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Types of Money 1) Commodity Money

• earliest form of money
• Definition: commodity with intrinsic value or non-
monetary value close to value in exchange
Electronic (monetary) value
money • Required properties of commodity money:
Fiat money
 scarcity and stability of supply
/ Credit
Commodity  durability
money
money  divisibility
• Metallic money fulfilled these requirements: iron and
copper; silver; gold.

1) Commodity Money
• Special case of commodity money: The Gold
Standard- full bodied money
• monetary value = non-monetary value
100%-reserve
• to maintain the system the government must: free banking with fractional reserve
 fix the value of gold in terms of the monetary unit ($). gold standard system with gold
 be willing to buy all gold at that price. standard
 legalize melting down of gold coins.

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• Characteristics of the gold standard:
– government has no control over the money supply
– production of money is expensive
• Representative Full Bodied Money
– With economic development coins were
supplemented with fully backed paper money. The
system functioned exactly as a pure commodity
money system.
– In the US 1900-1933, later partial backing only, gold
standard abolished in 1968.
3) Electronic Money (Paperless)
• Paper money (checks) shuffling is costly and takes time to
clear.
• Development of computer and information technology
enabled new stage in money:
• e- money- money stored electronically,
Several forms:
– debit cards- electronic transfer of funds from bank account
to merchant’s account
– Stored-value cards- (electronic wallet), contain fixed
amount of funds, the smart card can be reloaded. Mondex
smartcard transfer of funds with wireless device also
between individuals.
– Electronic cash- funds used on the Internet to purchase
goods and services.
– Electronic Checks used to pay bills on the internet,
equivalent of check is sent .
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2)Credit, Fiat Money
• Not convertible into comparable value as commodity
• Value based on faith in government : value in terms of
purchasing power stability.
• Definition: money that has a value in exchange greater
than its value as a commodity.
• Two types:
paper currency and coins issued by the
government and decreed as legal tender
banking money, IOU payable on demand in the
form of checks. (See later: deposit/ money
creation)
 Reduces cost of transactions (transportation)
• Advantages of e-money: cost saving, more efficient
• Disadvantages:
– Large initial investment in system
– paper checks provide receipts
– paper checks give the benefit of the “float”
– security and privacy concerns of e-money
– Slow rate of adoption
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Functions of Money Functions of Money (cont’d)

• Medium of Exchange:
• Unit of Account:
– Eliminates the trouble of finding a double coincidence of
needs (reduces transaction costs) – used to measure value in the economy
– Promotes specialization – reduces transaction costs
A medium of exchange must: • Store of Value:
be easily standardized – used to save purchasing power over time.
be widely accepted – other assets also serve this function
be divisible – Money is the most liquid of all assets but loses value
be easy to carry during inflation
not deteriorate (không bị hư hại) quickly

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Summary: Evolution of the Payments System

Commodity Money: valuable, easily standardized and

divisible commodities (e.g. precious metals, cigarettes).
Fiat Money: paper money decreed by governments as
legal tender.
Checks: an instruction to your bank to transfer money
from your account
Financial System
Electronic Payment (e.g. online bill pay).
E-Money (electronic money):
o Debit card
o Stored-value card (smart card)
o E-cash

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Six Parts of the Financial System

1. Money Six Parts of the Financial System
To pay for purchases and store wealth.
2. Financial Instruments 1. Money
To transfer resources from savers to investors and to transfer
risk to those best equipped to bear it. Money has changed from gold/silver coins
3. Financial Markets to paper currency to electronic funds.
To buy and sell financial instruments.
4. Financial Institutions Cash can be obtained from an ATM any
To provide access to financial markets, collect information & where in the world.
provide services.
5. Regulatory Agencies Bills are paid and transactions are checked
To provide oversight for financial system. online.
6. Central Banks
To monitor financial Institutions and stabilize the economy.

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Six Parts of the Financial System

Six Parts of the Financial System 3. Financial Markets
Once financial markets were located in
2. Financial instruments coffeehouses and taverns.
Buying and selling individual stocks used Then organized markets were created, like
to be only for the wealthy. the New York Stock Exchange.
Today we have mutual funds and other Now transactions are mostly handled by
stocks available through banks or online. electronic markets.
Putting together a portfolio is open to • This has reduced the cost of processing financial
everyone. transactions.
There is a much broader array of financial
instruments available.
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Six Parts of the Financial System

Six Parts of the Financial System
5. Government regulatory agencies
4. Financial Institutions
Banks began as vaults, developed into
institutions, to today’s financial
supermarket.
Offer a huge assortment of financial
products and services.
Government regulatory agencies were introduced by
federal government after the Great Depression.
Government regulatory agencies provide wide-ranging
financial regulation - rules and supervision.
Government regulatory agencies examine the
systems a bank uses to manage its risk.
The 2007-2009 financial crises has led governments
to consider greater regulation.

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Flows of Funds Through the Financial System

Six Parts of the Financial System

6. Central banks
Central banks began as large private banks
to finance wars.
Central banks control the availability of
money and credit to ensure low inflation,
high growth and stability of financial system.
Today’s policymakers strive for transparency
in their operations.

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The Role of the Financial System in Economic
Development
Six major functions of the financial system
Providing payment services
Matching savers and investors
Generating/distributing information
Allocating credit efficiently
Pricing, pooling, and trading risks
Increasing asset liquidity
Differences between developed and developing-
country financial systems
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Structure of Financial Markets
Debt and Equity Markets
Debt instruments (maturity)
Equities (dividends)
Primary and Secondary Markets
Investment Banks underwrite securities in
primary markets
Brokers and dealers work in secondary
markets
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Function of Financial Markets
Perform the essential function of channeling funds from
economic players that have saved surplus funds to those
that have a shortage of funds
Direct finance: borrowers borrow funds directly from
lenders in financial markets by selling them securities
Promotes economic efficiency by producing an efficient
allocation of capital, which increases production
Directly improve the well-being of consumers by allowing
them to time purchases better
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Structure of Financial Markets (cont’d)
Exchanges and Over-the-Counter (OTC)
Markets
Exchanges: NYSE, Chicago Board of Trade
OTC Markets: Foreign exchange, Federal funds
Money and Capital Markets
Money markets deal in short-term debt instruments
Capital markets deal in longer-term debt and
equity instruments
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The Role of Central Banks
Functions of a full-fledged central bank
Issuer of currency and manager of foreign
reserves
Banker to the government
Banker to domestic commercial banks
Regulator of domestic financial institutions
Operator of monetary and credit policy
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Why Study Money and Monetary Policy?
Evidence suggests that money plays an important
role in generating business cycles
Recessions (unemployment) and expansions
affect all of us
Monetary Theory ties changes in the money
supply to changes in aggregate economic activity
and the price level
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The Role of Central Banks and
Alternative Arrangements (cont’d)
Currency boards
Form of central bank that issues domestic
currency for foreign-exchange at a fixed exchange
rate
Alternatives to central banks
Transitional central banking institution
Supranational central bank
Currency enclave
Open-economy central banking institution
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Money, Business Cycles and Inflation
The aggregate price level is the average price of
goods and services in an economy
A continual rise in the price level (inflation) affects
all economic players
Data shows a connection between the money
supply and the price level
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Money and Interest Rates Fiscal Policy and Monetary Policy

Interest rates are the price of money
Prior to 1980, the rate of money growth and the
interest rate on long-term Treasury bonds were
closely tied
Since then, the relationship is less clear but the
rate of money growth is still an important
determinant of interest rates
Fiscal policy deals with government spending
and taxation.
Budget deficit is the excess of expenditures over
revenues for a particular year
Budget surplus is the excess of revenues over
expenditures for a particular year
Any deficit must be financed by borrowing

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Fiscal Policy and Monetary Policy

Monetary policy is the management of the

money supply and interest rates
Conducted by the central banks (by the Federal
Reserve System (Fed) in the U.S. )
2 types of monetary policy :
expansionary monetary policy
contractionary monetary policy

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