Chapter 30

The Monetary System

Key Termsmoneymedium of exchangeunit of accountstore of valueliquiditycommodity moneyfiat moneycurrencydemand depositscentral bankmoney supplymonetary policy

reservesfractional-reserve bankingreserve ratiomoney multiplierbank capitalleverageleverage ratiocapital requirementopen-market operationsdiscount ratereserve requirements

Two Choices

Make

or

Trade

Barter

Direct trade - stuff for stuff

No money

Double coincidence of wants

Both sides have to want what the other side has

Double coincidence of wants

Both must want what the other has at the

same time

Double coincidence of wants

Money makes trade easier

What is money?

Money

Something people use to trade with

Why would you accept a cigarette if you didn’t smoke?

Functions of Money

Medium of exchange

Unit of account

Store of value

Medium of Exchange

Buyers give to sellers

Sellers accept from buyers

Unit of Account

Measurement

Prices

Debts

Store of ValueTrading time for time

Today for tomorrow

Tomorrow for today

Earn - Save - Spend

LiquidityHow easy is it to convert

something to money

Kinds of MoneyCommodity

Fiat

Commodity MoneyIntrinsic value

Easy to carry

Easy to measure

Easy to verify

Hard to copy

=

Gold Standard

Central Bank will convert paper money to gold at a fixed rate

Fiat Money

No intrinsic value

Declared money by government decree

Fiat Money

Why do people accept fiat money?

Trust that someone else will also accept it

Money

Trust inscribed

If people lose trust, money loses it value

Coins

Currency

Checks

Card Type Payment

Credit Defer

Debit Instant

Why credit and debit cards are not money

Not a method of payment, but a method of

making payment

Debit card is like a check

Takes money out of your bank account

Credit Card

Defer the payment

Demand Deposits

Bank account that you can access by writing a check or using a debit

card

Saudi Arabia Monetary Agency

The Central Bank of Saudi Arabia

SAMAsama.gov.sa

Central Bank

The bank that oversees the banking system and

regulates the money supply in a country

Dr. Fahad Al Mubarak

Chairman of the BoardGovernor

Saudi Arabia Monetary AgencySAMA

Six Functions• Issues national currency, the Saudi Riyal.

• Acts as a banker to the government. 

• Supervises commercial banks.

• Manages Kingdom’s foreign exchange reserves.

• Conducts monetary policy for promoting price and exchange rate stability.

• Promotes the growth and ensures the soundness of the financial system.

Source: sama.gov.sa

Money Supply

The quantity of money available in a country.

Monetary Policy

Setting the money supply by the central bank policymakers

Two Types of Banks

100 Percent Reserve

Fractional Reserve

100-Percent Reserve Bank

All the deposits are kept in a safe vault.

No loans

Fractional-Reserve Bank

Bank only holds a fraction of the deposits

as reserves

Loans out the remainder

Reserve Ratio

The fraction of deposits that banks hold as

reserves

Fractional-Reserve Banking

Creates money

Bank DepositReserve

10%Loan

Remainder

1000 100 900

900 90 810

810 81 729

• • • •

• • • •

• • • •

Total 10,000

How does 1000 become 10,000?

Reserve Ratio

Fraction Reciprocal MoneyMultiplier

100% 1 1÷1 1

50% 0.5 1 ÷ 0.50 2

25% 0.25 1 ÷ 0.25 4

10% 0.1 1 ÷ 0.10 10

5% 0.05 1 ÷ 0.05 20

1% 0.01 1 ÷ 0.01 100

Money multiplier is the reciprocal of the reserve ratio

Reserve RatioNot changed very often

What is the current reserve ratio in Saudi Arabia? 7%

What is the Money Multiplier?

1÷7% = 14.28

Bank Deposit Insurance

Protects against bank runs

Moral Hazard to take more risk because government

will pick up losses

Bank RunCustomers all want their money at the same time

Many banks runs at once

Bank Panic

Zimbabwe, Nov. 2008 Highest monthly inflation: 79,600,000,000%Prices doubled every: 24.7 hours