3.1 - Money and banking Flashcards
What is money?
An item which is generally acceptable as a means of payment
What are the 4 functions of money?
Medium of exchange - Allows goods and services to be exchanged with out a double coincidence of wants
Function of money - Allows people to store money without the money detreating it in value with it being effected by inflation
Unit of account - Comparison of goods and services comparing the differences in the goods and services
Standard of deferred payment - Allows people to pay for goods and services in the future the amount due will be the exactly amount due for the services allows it to be paid in the future received now and payed later
How does inflation affect the functions of money?
Medium of exchange- used for buying and selling goods - Inflation reduces the effectiveness of money as a medium of exchange it means it will become more difficult to place value on goods and services because of the reason that money value is always falling.
Store value - Valuing goods through money makes them easier to compare - As inflation increases, the vitality of the inflation rate tends to increase which means its harder to place value on money, making it more difficult to use it s a store of the value savers because of inflation
Standard of deferred payment - Money allows people to borrow and lend - With high rate of inflation the real value of debt erodes which means it is effectively easier to pay back the debt. Banks will be less likely to lend money because they will lose out if people pay back the debt in the future when the money is worth less
Unit of account - Prices are expressed in monetary terms - With high inflation, there will be greater menu cost, which is the cost of the changing price list to reflect the changing value of money
What are the characteristics of money?
Divisibility: to be a valued medium of exchange, currency must be divisible. €50 notes can be exchanged for €10 euro notes or €1 coins
Acceptability: the currency must be valued & widely accepted by society as a valid way to pay for goods/services
Durability: the currency must be robust, not easily defaced/destroyed & last for a long period of time
Scarcity: the supply of the currency should be such that is remains desirable & retains its value in the market. Oversupply would decrease its worth
Uniformity: in order to be a valid measure of value each denomination must be exactly the same e.g. every $50 note must be exactly the same
Portability: good currency is easy to carry/conceal
What is the central bank?
A government owned bank which provides banking services to the government and commercial banks
How do banks make profit?
Interest rate: the reward for saving and the cost of borrowing
Commercial banks make most of their profit by charging a higher interest rate to the borrowers than they pay to people who save their money with them
Banks are delivering profits to their share holders
What is the relationship between savers, banks and borrowers?
Banks act as intermediates between savers and borrower. Money that is deposited by savers is then lent out to borrowers.
What are the functions of commercial banks?
Commercial Banks play a central role in financial markets
They facilitate saving: storing money for future use is essential for households & firms. It also provides a pool of money that financial institutions can lend
They lend to businesses & individuals: access to credit is a key requirement for economic growth & development. Being able to borrow money speeds up consumption by households & investment by firms. It also allows households or firms to purchase assets & pay them off over an extended period of time e.g. mortgages on home purchases
They facilitate the exchange of goods & services: each purchase of goods/services requires the movement of money between at least two parties
They provide forward markets in currencies & commodities: forward markets are also called futures markets. They provide some price stability in commodity markets & enable investors to make a profit by speculating on future prices
What is bank run?
Bank run: When a large number of customers of a bank withdraw their deposits simultaneously over concerns of a banks solvency
What does profitability conflict with?
Banks have to ensure that they meet their customers request to withdraw money from their account to do this they have to keep a certain amount of what are called liquid assets
Liquid assets are items which can be turned into cash quickly without incurring loss
Banks earn most of the interest by giving long-term loans but they tie up all their money in such loans, not be able to pay out cash to their customers without requesting it
What are the functions of the central bank?
Act as a banker the the government - Tax revenue is paid to the governments account at the central bank and payments by the government for goods and services are made out of this account
Operates as a banker to commercial banks - Holding accounts at the central banks enables commercial banks to settle debts between each, and to draw out cash if they customers are taking more cash from their branches than usual.
Acts as a lender of last resorts - Lends to banks which are temporarily short of cash
Manages the national debt - Carries out borrowing on behalf of the government by issuing government securities, paying intrest on them and repaying them when they fall due
Holds the country’s reserves of foreign currency - The central bank keeps a stock of its own and foreign currency to influence the exchange rate
Issues bank notes - Responsible for printing notes and destroying notes that are no longer suitable for circulation.
Implements monetary policy - Controls the money supply and influences the interest rates through the economy.
