UGANDA MARTYRS UNIVERSITY NKOZ

EDUCATION IN GEOGRAPHY AND MINOR ECONOMICS

GROUP SIX MANAGERIAL ECONOMICS II

NAME REG. NUMBER

OLENY DANIEL MARVIN 2023-B201-12687

TASKS

 Money and banking

 The theory of money demand

 The central bank and its functions

 Money supply

 Commercial banking

 Equilibrium supply and demand for money,

 the importance of bonds, especially the price of bonds in relation to interest rates.

 Monetary policy tools

 Monetary policy management in Uganda.

 IS-Lm theories/cause

MONEY AND ITS EVOLUTION.

Money is defined as an asset used as a mean of payment in the exchange of goods and services or
repayment of debts. It’s a fascinating journey that reflects the progression of human civilization and the
development of economic system.

Before money, there was barter trade or exchange—the exchange of goods and services for goods and
services.

Barter transactions can be possible only when two persons desiring exchange of commodities
should have such commodities which are mutually needed by each other. For example, if Ram wants
cloth, which Shyma has, then Ram should have such commodity which Shyam wants. In the
absence of such coincidence of wants, there will be no exchange. However, it is very difficult to find
such persons where there is coincidence of wants. One had to face such difficulties in barter
economy because of which this system had to be abandoned.

Money has evolved over time initially from commodity.

 Commodity money: this is a means of payment in terms of an actual good. In the early days,
commodity included silk, ivory, fur, beads, butter, pieces of silver and gold etc according to different
places and time. Commodity money is unique because it has an intrinsic value. However, all the
above had uses other than money and thus people could consume them. To prevent this, government
made fiat money.
Fiat money (currency): fiat money is money in form of coins or paper and it has little or no
intrinsic value but its purchasing power depends of the backing by government hence legal tender.
Bank deposits: In the developed countries the main type of money is not paper notes issued by the
central bank but the bank deposits which people hold with the commercial banks and against which
cheques can be drawn or credit and debit cards used. They serve as money because through drawing
cheques on them, they can be used to make payments for good and services
Electronic money: this is another form of payment that is growing very fast. The commonest
instruments used here are the credit cards or debit cards and other forms of electronic funds
transfers.
Barter system. In ancient times, people exchanged goods and services directly through barter.
Forexample a farmer might exchange grain for tools with a black smith however this system had
limitations due to the double coincidence of wants where both parties had to desire what the other
offered

Demand for money

This is the amount of money individuals chose to hold in cash other than other forms.

Characteristics of good money

 Acceptability; money must be generally accepted i.e. People should have confidence in it.
 Durability; money must be long lasting. This implies therefore that perishable items are
vulnerable to deterioration in physical quality and value and they cannot as such serve as money.
 Divisibility; money should be divisible into smaller denominations or units in order to enable the
payment of smaller debts or financial obligations.
 Portability; money should be easily carried (portable) or transferable from one place to another.
 Homogeneity; money should be similar in looking and nature in order to enable it to be easily
recognized. Change of materials out of which money is made can encourage forgery for money.
 Scarcity; items used, as money must be generally scarce and difficult to obtain. This will make
money retain its value and services as a store of wealth.
 Legal tender: If anything is to be called money, it should be issued by the central bank in order to
remain legal tender. It is money because gov’t says so.

LIMITATIONS OF GOOD MONEY

Lack of double coincidence of wants

Barter transactions can be possible only when two persons desiring exchange of commodities should
have such commodities which are mutually needed by each other. For example, if Ram wants cloth,
which Shyma has, then Ram should have such commodity which Shyam wants. In the absence of such
coincidence of wants, there will be no exchange. However, it is very difficult to find such persons where
there is coincidence of wants. One had to face such difficulties in barter economy because of which this
system had to be abandoned.

Lack of Division:

The second difficulty of barter exchange relates to the exchange of such commodities which cannot be
divided. For example, a person has a cow and he wants cloth, food grains and other items of
consumption. Under such a condition, exchange can be possible only when he discovers a person, who is
in need of a cow and has all such commodities, but it is very difficult to get such a person. Then how to
affect the exchange

Similarly, the second problem relates to the exchange of such commodities which cannot be divided
into pieces, because in this kind of situation, a big commodity like cow cannot be divided into small
pieces for making payment of the goods of smaller value.

Lack of a Common Measure of Value:

The biggest problem in the barter exchange was the lack of common measure of value i.e., there was no
such commodity in lieu of which all commodities could be bought and sold. In such a situation, while
facilitating the exchange of a commodity its value was to be expressed in all commodities, such as one-
yard cloth is equal to ½ kilogram of potato etc. It was a very difficult proposition and made exchange
virtually impossible. Now, with the discovery of money, this difficulty has been totally eliminated.

Lack of Store of Value:

In a barter economy, the store of value could be done only in the form of commodities. However, we all
know that commodities are perishable and they cannot be kept for a long time in the store. Because of
this difficulty, the accumulation of capital or store of value was very difficult and without the
accumulation of capital, economic progress could not be made. It is because of this reason that as long
as barter system continued, significant progress was not made in the world anywhere.

There was difficulty in transport. Some commodities were difficult to carry around. These goods were
heavy and bulky to carry.

Goods produced may have been of poor quality. Due to various problems encountered in barter trade,
traders attempted to produce all their required commodities. This discouraged specialization. As a
result, inferior goods were produced because of lack of competition.

Functions of money:
 Money acts as a medium of exchange or means of payment. Without money transactions would
rely on barter trade.
 It serves as a unit of account: a unit of account is how we measure price (value) of goods. This
allows for a quick comparison of prices across goods.
 It is a standard of deferred payment i.e. it facilitates payment of debts and transactions at a future
date.
 It is a store of value. If money is to be valuable for transactions, it must retain value over time.
THE CENTRAL BANK
This refers to a government established agency responsible for controlling the nation’s money
supply and credit conditions and for supervising the financial system especially commercial
banks.

o Functions of Central Banks

• Issuing currency
• Stabilizes the economy
• Acts as a banker to the country
• It acts as a banker to other banks
• It is a lender of last resort i.e. to commercial banks and government.
• It regulates the interest rate
• It controls credit
• Acts as adviser to government on the monetary policy
• Regulates the financial system and enforces regulation on financial institutions.
• Promotes development of the financial sector e.g. establishes stock markets and financial
institutions.
• Acts as market for the second-hand mortgages.

THE MONEY SUPPLY

The money supply refers to the total amount of money available in an economy at a specific point
in time. It includes both physical currency (like coins and banknotes) and various types of
deposits held by the public and businesses in financial institutions.
Factors that influence money supply
Central Bank Policy: Expansionary Policy: When the central bank adopts expansionary policies
like lowering interest rates or buying government securities, it increases the money supply. This
stimulates borrowing and spending, fostering economic growth.
Contractionary Policy: Conversely, contractionary policies such as raising interest rates or
selling government securities reduce the money supply. This aims to control inflation by slowing
down spending and investment.
Reserve Requirements: Increasing Reserve Requirements: Raising reserve requirements for
commercial banks reduces the amount of money they can lend out, limiting the money supply.
This can help prevent excessive lending and control inflation. Decreasing Reserve Requirements:
Lowering reserve requirements gives banks more freedom to lend, increasing the money supply.
This can stimulate economic activity by encouraging borrowing and spending.

Open Market Operations: Buying Securities: When the central bank buys government securities,
it injects money into the economy, increasing the money supply. This provides liquidity to financial
markets and encourages lending. Selling Securities: Conversely, when the central bank sells
securities, it absorbs money from the economy, reducing the money supply. This can help control
inflation by reducing excess liquidity.

Interest Rates: Lowering Interest Rates: Lower interest rates make borrowing cheaper,
encouraging individuals and businesses to take out loans. This increases the money supply by
stimulating investment and spending. Raising Interest Rates: Higher interest rates discourage
borrowing and encourage saving, reducing the money supply. This can help curb inflation by
slowing down spending and investment.
 Government Spending and Taxation: Increasing Government Spending: Government spending
injects money into the economy, increasing the money supply. This can stimulate economic
growth by boosting demand for goods and services. Raising Taxes: Higher taxes reduce disposable
income, limiting spending and decreasing the money supply. This can help prevent overheating
of the economy and control inflation.

Demand for money

This is the amount of money individuals chose to hold in cash other than other forms.

The theory of money demand

This theory is sometimes referred to as the liquidity preference theory. It was advanced by John
Keynes who identified three motives of keeping money in liquid or cash form and these involved;

The transaction motive. Money under this motive is demanded for day transactions. For example,
transport costs, this aims to control inflation by slowing down spending and investment.

Precautionary motive. Money is held as a precautionary measure to meet unforeseen expenses or

emergencies. This motive arises from the desire to maintain a buffer of liquid assets to cover un
expected needs. The demand for money for precautionary purposes increases with uncertainty about
future income, expenditures, and economic conditions.

Speculative motive. Money is held for speculative purposes such as investment opportunities or to take
advantage of expected changes in asset prices. This motive arises from the desire to hold cash
temporarily while awaiting favorable investment opportunities or asset price movements. Factors
influence speculative demand include interest rates, expected returns on alternative investments, and
expectations about future asset prices.

Note; The following are some of factors that influence money demand. Interest rate, income levels,
price levels, transaction costs, economic uncertainty, financial innovation and others

Commercial banking

In a fully developed financial system all economic agents have bank accounts, and all transactions in the
economy are made against money. This means that the economy is fully monetized. Banks are at the
heart of a fully monetized economy and they bring together savers and borrowers. Other financial
intermediaries include; investment brokers (who buy and sell bonds and securities), insurance
companies, national security funds, postal banking systems, microfinance institutions, finance
companies etc.

Commercial banks are profit-making organizations seeking to maximize profit by essentially dealing in
lending funds. They accept deposits from the public and make profits through lending to the deficit
spending unit. Commercial banks can be privately owned or owned by government.
 Functions of Commercial Banks

• They accept and provide custody of deposits from customers

• Advance loans and overdrafts to customers. These loans can be short term, medium term or long
term. It is out of these loans that commercial banks create credit.

• Facilitates easy and quick means of settling obligations by use of cheese, standing orders, bank drafts
etc.

• All commercial banks perform the important functions of creating credit.

• Provide custody for customer’s valuable possessions e.g. land titles and important other documents

• They provide employment opportunities.

• They transfer money on behalf of customers.

• They provide saving facilities for their customers.

• They look after the property of deceased customers.

Equilibrium supply and demand for money; the importance of bonds, especially the price of bonds in
relation to interest rate.

Equilibrium Supply and Demand for Money:

The equilibrium supply and demand for money refer to the point where the quantity of money
demanded by individuals and businesses equals the quantity of money supplied by the central bank.

The demand for money is influenced by factors such as the level of economic activity, interest rates, and
expectations about future economic conditions. As economic activity increases, the demand for money
typically rises.

The supply of money is controlled by the central bank through monetary policy tools such as open
market operations, reserve requirements, and interest rate adjustments.

When the supply of money matches the demand for money, the economy is said to be in equilibrium.
Changes in either supply or demand can disrupt this equilibrium and affect interest rates and economic
activity.

Importance of Bonds, Especially the Price of Bonds in Relation to Interest Rate:

Bonds are debt securities issued by governments, municipalities, or corporations to raise capital. They
typically have a fixed interest rate and maturity date.
The price of a bond and its interest rate (also known as yield) have an inverse relationship. When
interest rates rise, the price of existing bonds falls, and vice versa. This is because investors demand
higher yields to compensate for the opportunity cost of investing in lower-yielding bonds.

The relationship between bond prices and interest rates is crucial for understanding bond market
dynamics and investment decisions. For example, if an investor expects interest rates to fall, they may
buy bonds at current prices to lock in higher yields. Conversely, if interest rates are expected to rise,
investors may sell bonds to avoid potential losses in value.

Bond prices and interest rates also influence borrowing costs and investment decisions in the broader
economy. For instance, changes in bond yields affect mortgage rates, corporate borrowing costs, and
the cost of government debt financing.

Central banks closely monitor bond markets and interest rates as part of their monetary policy
decisions. They may adjust interest rates or conduct open market operations to influence bond prices
and borrowing costs, thereby affecting economic activity and inflation.

Monetary Policy Tools

This is where central bank manipulates demand for money, supply of money and interest rate of money
to achieve macroeconomic stability.

Types of Monetary Policy Stance

There two types of monetary policy stance:

• Expansionary monetary policy: This involves increase of the volume of money in circulation.

• Contractionary/restrictive monetary policy (sometimes known as monetary squeeze): This involves

decrease of the volume of money in circulation.

Money is necessary in an economy and it can be termed as grease that lubricates its wheels. Too little
of it leaves some parts creaking; too much of it gums up the works! So it is the work of government,
through the central bank, to ensure that an appropriate mass of money circulates in the economy.

Tools of the Monetary Policy

The Bank Rate

Bank rate is the rate at which the Central bank lends money to commercial banks for their liquidity
requirements. The borrowing is collateralized by government securities, i.e. the treasury bills and bonds.
The bank rate affects other market rates and as of October 2015, it stood at 22 percent.

The extent to which this policy is effective largely depends on;

• The degree of dependency of commercial banks on borrowed funds (excess reserves).

 • How much commercial banks can borrow from other sources.

The profitability in the market

Monetary policy management in Uganda

Monetary policy management in Uganda is primarily the responsibility of the Bank of Uganda, which is
the country's central bank. The Bank of Uganda employs various tools and strategies to achieve its
monetary policy objectives, which include maintaining price stability, promoting sustainable economic
growth, and ensuring financial stability. Here's an overview of how monetary policy is managed in
Uganda:

Interest Rate Targeting; The Bank of Uganda sets a policy rate known as the Central Bank Rate (CBR),
which serves as the benchmark for short-term interest rates in the economy. Changes in the CBR
influence lending and deposit rates offered by commercial banks, thereby affecting borrowing and
spending decisions by businesses and households.

Open Market Operations (OMOs): The Bank of Uganda conducts open market operations by buying and
selling government securities in the secondary market. Through these operations, the central bank aims
to manage liquidity in the banking system and influence short-term interest rates.

Reserve Requirements: The Bank of Uganda sets reserve requirements that commercial banks must
hold in the form of cash or deposits with the central bank. Adjustments to reserve requirements affect
the amount of funds available for lending by commercial banks and, consequently, the overall money
supply in the economy.

Foreign Exchange Operations: Given Uganda's reliance on imports and the importance of exchange rate
stability, the Bank of Uganda may intervene in the foreign exchange market to influence the value of the
Ugandan shilling (UGX) against foreign currencies. By buying or selling foreign exchange reserves, the
central bank can mitigate excessive exchange rate volatility and maintain external stability.

Communication and Transparency: The Bank of Uganda communicates its monetary policy decisions,
objectives, and economic assessments through regular publications, such as monetary policy statements
and reports. Enhancing transparency and providing clear guidance on the central bank's policy stance
help anchor inflation expectations and shape market perceptions.

Overall, the Bank of Uganda's monetary policy framework is aimed at achieving macroeconomic stability
and supporting sustainable economic development in Uganda. The effectiveness of monetary policy
management depends on various factors, including the prevailing economic conditions, external shocks,
and coordination with fiscal policy measures.

IS-LM theories/ curve

The IS-LM model is a macroeconomic framework used to analyze the relationship between real output
(income) and interest rates in an economy. It consists of two main curves: the IS curve and the LM curve.
IS Curve: The IS curve represents equilibrium in the goods market and shows combinations of interest
rates and levels of output where total spending (investment, consumption, and government
expenditure) equals total output (production).

The IS curve, IS-LM theories/ curve slopes downward, indicating an inverse relationship between the
interest rate and output. When interest rates are low, investment and consumption increase, leading to
higher output.

Factors that shift the IS curve include changes in autonomous spending (such as changes in government
spending or investment), fiscal policy (taxes and government spending), and expectations about future
economic conditions.

LM Curve: The LM curve represents equilibrium in the money market and shows combinations of
interest rates and levels of output where money demand equals money supply. The LM curve slopes
upward, indicating a positive relationship between the interest rate and output. When output increases,
the demand for money rises (due to higher transaction demand), leading to higher interest rates.

Factors that shift the LM curve include changes in the money supply (controlled by the central bank
through monetary policy), changes in the demand for money (affected by income, prices, and interest
rates), and changes in expectations about future inflation.

Causation in the IS-LM Model:

The IS-LM model illustrates how changes in fiscal and monetary policy affect equilibrium output and
interest rates in an economy.

Expansionary fiscal policy, such as increased government spending or tax cuts, shifts the IS curve to the
right, leading to higher output and potentially higher interest rates.

Expansionary monetary policy, such as lowering interest rates or increasing the money supply, shifts
the LM curve to the right, leading to lower interest rates and potentially higher output.

Conversely, contractionary fiscal or monetary policy shifts the IS or LM curve to the left, respectively,
leading to lower output and potentially lower interest rates.

The combined effects of fiscal and monetary policy depend on the relative magnitude and timing of
policy changes, as well as other factors influencing the economy, such as external shocks and
expectations.

The IS-LM model provides a simplified framework for understanding the transmission mechanisms of
fiscal and monetary policy and their impact on aggregate demand, output, and interest rates in the short
run.