Chapter 1

Question 1

What is monetary economics?

Answer 1

Studies the characteristics and influences of money in the economy and how monetary relationships affect the conduct and decision-making of economic units.

Question 2

Why is monetary economics closely related to macro economics?

Answer 2

Because most market transactions involve money.

Question 3

What is monetary economics centered around?

Answer 3

real economic variables and nominal variables.

Question 4

What relationships does monetary economics study?

Answer 4

Monetary economics studies relationships between:
-Nominal interest rates
-Nominal exchange rates
-Supply of money

Question 5

Name the factors that are affected by inflation according to monetary economics.

Answer 5

-Aggregate real output
-Domestic real expenditure
-Employment
-Balance of payments

Question 6

How does monetary economics relate to micro economics?

Answer 6

Demand and supply of money, financial institutions( mainly central bank and banks) .
However, the main focus is on monetary and macro economics.

Question 7

Why is it important to study monetary economics?

Answer 7

-To improve the understanding of monetary policy, which is what the monetary authorities can do to improve economics performance through the use of monetary policy operational procedure or the instruments that the central employs to reach its objectives.
-Improves economic policy and welfare of countries and population.
-The relationship between money and other aggregates can also be justified since money is an asset with a special significance in economic activity.

Question 8

What does monetary economics study?

Answer 8

-Money
-Interest rates
-Inflation
-Exchange rates
-Production
-Income
-Expenditure
-Employment

Question 9

What are the three functions that define money?

Answer 9

-Medium of exchange
- Store of value
- Unit of account

Question 10

What are the three other definitions of money outside of the functions money serves?

Answer 10

• Empirical Division
• Divisa monetary aggregates
• Definitions in practice

Question 11

What does “money as a medium of exchange” mean?

Answer 11

-Money is anything that is generally accepted as payment for goods and services or that is accepted in settlement of debt
-The use of money simplifies economic transactions → without money all transactions must be carried out as an exchange of goods for goods, which is often inefficient.

Question 12

What does “money as a store of value” mean?

Answer 12

-Money is the most liquid form in which wealth can be kept (can be used immediately in exchange for various goods and services
-Financial assets and real assets can be used as stores of value.
-Examples include shares, bonds, real estate and jewelry

Question 13

What does “money as a unit of account
“ mean?

Answer 13

-Money is an agreed measure for stating the prices of goods and services
-Also allows producers and consumers to compare relative prices
-Examples are the Rand for SA, Euro for the EU and $ for the US,
-All prices of goods and services are expressed in monetary terms → which will help in our spending decisions

Question 14

How does the 1st approach of the empirical definition define money?

Answer 14

-The demand for money is concerned with the extent that assets are substitutes for demand deposits.
- Closeness of substitutions is determined on the basis of price elasticity in the money demand functions.
-Assets are then regarded as means of payment and near-money assets.
-However, no simple combination of assets produced the desired definition of money.

Question 15

How does the 2nd approach of the empirical definition define money?

Answer 15

-Money is defined as the collection of assets mostly correlated with certain macroeconomic variables such real income.
-E.g. if inflation is caused by increased money supply, money would be defined in such a way that the demand for money is consistently related to real income.
-This approach generally favoured a broader definition of money rather than the means of payment function.

Question 16

Define Divisa monetary aggregates.

Answer 16

The weighted sum of the aggregate value of all assets included in definition of money.

Question 17

What is the criticism of the of the conceptual and empirical definitions of money?

Answer 17

• They measure money as the aggregate value of particular classes of assets.
• This is based on the assumption that each type of asset fulfills the functions of means of payment and store of value in exactly the same manner.
• Many assets classified as money provide the services of both money and near-money assets.

Question 18

Why was the divisa monetary aggregate developed?

Answer 18

In order to allow for differences in the extent that assets perform the functions of money.

Question 19

How does divisa monetary aggregates define money.

Answer 19

-It weights the growth of components (assets) by their ease of use in transactions - money’s role as a medium of exchange.

Question 20

What is the major concern with divisia indices?

Answer 20

-Deciding what weights should be assigned to the various assets included as money.
-Sometimes, more than one assets can qualify as a benchmark asset, which makes it difficult to decide on the most appropriate asset.
-The changing nature of interest rates of the assets may also pose difficulties.
-Very difficult to understand and to communicate to the public, hence in practice they play a very limited role.

Question 21

List the definitions of money i n practice.

Answer 21

• M0/ M1A
  -M1
  -M2
  -M3

Question 22

What falls under M1A?

Answer 22

-Narrow definition
-Banknotes and coins, plus cheques and transmission accounts
-Medium of exchange function (Means of payment)
-Most liquid

Question 23

What falls under M1?

Answer 23

Also narrow definition
M1(A) plus other demand deposits such as current account

Question 24

What falls under M2?

Answer 24

-Broader monetary aggregates
-M1 plus short-term deposits and medium-term deposits
-These funds are not immediately available as a medium of exchange (but can be withdrawn earlier at a cost) e.g. 32 day interest account
Store of value function

Question 25

What falls under M3?

Answer 25

-Broader monetary aggregates -M2 plus long-term deposits -Most important money aggregate

Question 26

Define Monetary Policy.

Answer 26

Concerned with the management of a country's money supply, the availability of credit, interest rates and exchange rates in such a way that this is consistent with broad national economic objectives.

Question 27

What is the ultimate goal of economic policy in all economic systems?

Answer 27

The allocation of scarce means, among competing ends, for the achievement of maximum satisfaction.

Question 28

What are the intermediate macroeconomic goals of achieving the ultimate goal of economic policy?

Answer 28

-Potential economic growth -High level of employment -Balance of payments equilibrium -Relatively equal distribution of income -Low inflation (price stability) \!!!!

Question 29

What choice does the monetary authorities make?

Answer 29

-It has to decide between managing the supply of money or the price of money -These operational variables, at the disposal of the central bank are suitable for achieving price stability or low inflation.

Question 30

What is the contribution of monetary policy?

Answer 30

Price stability

Question 31

What is price stability?

Answer 31

Normally regarded as a situation where changes in the general price level do not materially affect the economic decision-making process.

Question 32

Why is price stability important?

Answer 32

-Attainment of the country’s economic growth rate and employment creation -Leads to greater external balance -More equitable income distribution since poor household are more affected by high inflation than rich households who are able to easily protect themselves against it

Question 33

Why is it important that monetary policy is closely coordinated with other economic price measures of the authorities?

Answer 33

-Because monetary policy affects output and employment in the short-term. -Price stability must be maintained at the least cost – find a balance between boosting economic activity and maintaining low inflation

Question 34

What is the cost of disinflation?

Answer 34

-The transitional output loss that should be expected. - However this should not be a problem when price stability has been achieved.

Question 35

What is the gain of disinflation.

Answer 35

The lower the inflation, the better the economic performance.

Question 36

What does the cost of lowering inflation(disinflation) depend on?

Answer 36

The severity of the measures applied and the time it may take to achieve price stability.

Question 37

What are the effects that anti-inflationary policies may have in the labour market?

Answer 37

-Hysteresis effects - In other words, a long period of unemployment leads to an increase in the equilibrium level of unemployment and thus results in serious long-run costs.