money and banking ppt.ppt

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Money and Banking

Chapter 5

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Money and Banking

If money were to grow on trees,

everybody would be dealing in bananas.

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Definition and functions

money

Money is something which is generallyaccepted as a medium of exchange.

Before money came into existence, exchange

took place through barter system. Barteroccurs when people directly exchange theirgoods for someone elses goods.!he bartersystem has certain ad"antages#

1. $imple and reduces the complexity of themodern monetary system

2. !here is no %uestion of o"er&under production

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'. !he problem of international trade such asforeign exchange crisis, ad"erse Bo( do notoccur in barter system

). !here is no problem of concentration ofeconomic power in the hands of few sincethings can not be stored for long.

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Difficulties of barter system:

1. Lack of double coincidence of wants

2. Absence of common measure of value3. Lack of divisibility

. !"e #roblem of storing wealt"

$. Difficulty of deferred #ayments

%. &roblem of trans#ortation

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money

'volution and develo#ment of money Animal money: *n ancient *ndia, according to +eda,

o -han cow wealth/ was accepted as a form ofmoney.*n 0oman state up to )thcentury BC, cow and

sheep were officially recognied as money used forcollecting taxes and fines. (ommodity money:*n many countries, a number of

commodities like bows, arrows, animal skins, shells,precious stones, rice, tea were used as money. !he

selection of commodity was dependent on factors likethe location of the community, climate of the region,cultural economic de"elopment of the society. orexample, community li"ing close to sea shore choseshells, fish hooks as money.

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'volution and develo#ment of money

3. Metallic money uncoined metals and coins/# 4long withthe growth of society from pastoral to commercialstage, the composition of money also changed fromanimal and commodity money to metallic money. oldand sil"er were mainly used a money.

). &a#er money:*nitially paper receipts against metallicmoney carried by merchants for safety. ater, scarcity

of metals led to the introduction of con"ertible papercurrency i.e. paper money con"ertible into metals. Butin the later stage, paper money de"eloped into fiatmoney i.e. paper money not con"ertible into metals.

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'volution and develo#ment of money

$. (redit money: Mainly che%ues issued againstthe demand deposits.

%. )ear Money: *n recent days near money arealso accepted as money since they pro"idealmost all the ma7or functions of money.

$uch money are bills of exchange, treasurybills, bonds, debentures, sa"ings certificatesetc.

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Classification of money#

1. Metallic:

Standard Money-9nder this, face "alue ofmoney is e%ual to intrinsic "alue. $uch money arealso called as full bodied coins.

Token Coins -9nder this, face "alue is alwaysgreater than intrinsic "alue. $uch money are alsocalled as representati"e coins.

Subsidiary Money -Coins minted to assist fortransaction are token coins e.g. coins of less thanone rupee.

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2. (aper Money# *e#resentative &a#er Money; (aper money

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3. Credit Money C!e"ue or draft #ome under t!is#ategory. Su#! money are not legal tender but!ig!ly used in $resent day e#onomi#transa#tions.

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money

Definition:

In sim$le term, anyt!ing t!at is generallya##e$table as a means of e%#!ange and att!e same time a#ts as a measure and store ofvalue is #alled money.

&$$roa#!es to t!e definition

'. Traditional a$$roa#! Money is regarded onlyas a medium of exchange. 4ccording to this

approach, money includes currency C/ anddemand deposits -/. !his approach isanalytically superior because it pro"ides themost li%uid and exact measure of money.

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Definition:

2. Monetarist a##roac": !he Chicago school led by Miltonriedman defined money anything that ser"es the function asa temporary abode of purchasing power. 4ccording to thisapproach, money > currency?demand deposits? timedeposits.

!his approach emphasies on the store of "alue function ofmoney and pro"ides a broader measure of money.

'. -urley and "aw a##roac":@ohn urley and Adward $hawfurther widened the approach of money . 4ccording to this

approach, money includes currency ?demand deposits ?timedeposits? the liabilities of non;banking intermediaries.!he liabilities of non;banking intermediaries co"er sa"ing bank

deposits, shares, bonds etc and are close substitutes ofmoney.

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Definition:

. !"e *adcliffe A##roac": !his is also known as li%uidityapproach based on the recommendations made by thecommittee of 0adcliffe in 1:5: in the 9. 4ccording to

this approach, money co"ers the whole li%uidityposition that is rele"ant to spending decisions. !hespending is not limited to the amount of money inexistence. *t is related to the amount of money thatpeople think they can get hold of whether by receipts of

income, by disposal of assets or by borrowing. !husmoney supply includes# cash ? all kinds of bankdeposits ? deposits with other institutions ?near moneyassets ? borrowing facilities a"ailable to the people.

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hat is the best definitionD !here is no clear answer on this. !here are many official

definitions such as M1, M2, M' etc. !he definition of money depends on the purpose. or

example, if one asks which definition of money supply isthe most controllable by monetary authority, the answeris the narrow medium of exchange. But if one wants toknow which correlates best with the economic acti"ity,the broader li%uidity definition.

!here are strong arguments against the "iew of urley,$haw and 0adcliffe committee. Critics say that liabilitiesof nonbank institutions do not work as the medium ofexchange and are not under the control of monetaryauthority.

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unctions of Money

!he definition of moneyis anything that

ser"es as a medium of exchange, unit ofaccount, and a store of "alue. !hat is whythroughout history, money has taken the formof precious metals, furs, and e"en cigarettes.

unctions of money also relate to thedefinition of money.

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unctions of Money1. Money as a Medium of '/c"ange. *f one of

societys goals is to expand the number oftransactions, then the function of medium ofexchange is "itally important. Medium of exchangemeans that money is widely accepted in exchangefor goods and ser"ices. *t stimulates and increasestrade by pro"iding an easy method of exchange.$ince coins and currency are small and portable,money is an effecti"e medium of exchange. !hisuseful feature makes bartering unnecessary.

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unctions of Money

2. Money as a 0nit of Account. !his functionof money pro"ides a common measurementof the relati"e "alue of goods and ser"ices.ithout money, there is no commondenominator. Eow would a farmer know howmany bushels of corn it would take to buytools from a hardware storeD Eow wouldgo"ernments collect taxesD Fr for thatmatter, spend money on programsD

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unctions of Money

3. Money as a tore of alue. 4 third function ofmoney is its use as a store of "alue. !his means

money has the ability to hold "alue o"er time. !hismakes money a useful mechanism for transformingincome in the present into future purchases. !hisfunction is "aluable if we look at the barter system.*magine you are a farmer. Gou ha"e a crop to sell,

lets say apples. Eow would you make futurepurchasesD Gour apples might spoil and lose their"alue. Hot so with money.

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unctions of Money. Money a#ts as a standard of deferred $ayments

-uring the barter system there was a problem offuture payments. Money has helped for the futurepayments of present borrowings.

(. Money as a transfer of value !here was alsodifficulty to transfer the "alue from one place toanother during the barter system since the "alue or

the property were in terms of kind and was difficultto transfer from one place to another. How moneyhas helped to transfer the "alue easily from oneplace to another.

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Limitations of credit creation

1. 4mount of cash# Eigher the amount ofcash, higher is the credit creation. !hus,the power to create credit is limited bythe bankIs cash.

2. C00# the sie of the C00 determinescredit creation. Eigher C00 leads tolower credit creation and "ice "ersa.

'. eakages# !he actual credit creation bythe banking system may be less than thepotential because of certain leakages#excess reser"es and cash drains.

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'. eakages# *f banks instead of granting loansmaintain excess reser"es because of the fearof recession or expectation of interest ratehike, credit creation may be constrained.

$imilarly, if people instead of depositing moneywith bank hold currency with themsel"es, thepower of the bank to create credit is reduced.

). 4"ailability of borrowers and securities&collateral

5. Banking habit

3. Business condition

6. Monetary policy3

money and banking ppt.ppt

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