1303AFE Lecture Notes - Lecture 6: Nominal Interest Rate, Opportunity Cost, Financial Technology
30 May 2018
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Week 6 Economics for Decision Making Lecture Notes
Money, Interest Rates and Inflation
What is Money?
• Money is any commodity or token that is generally accepted as a means of payment
• A commodity or token
o Use of commodities, ex: Gold and silver
o Token money, i.e. Notes and coins
• Generally accepted
o Money can be used to buy anything and everything
• Means of payment
o A means of payment is a method of settling a debt
The function of money
• Money performs three vital functions:
o Medium of exchange- object that is generally accepted in return for goods
and services
o Unit of account- used to state price of goods and services, and compare the
value of goods and services
o Store of value- a commodity or token that can be held and exchanged later
for goods and services
• Money today
o Money in the world today is called fiat money
o Fiat money is objects that are money because the law decrees or orders them
to be money
o The objects that we use as money today are
▪ Currency (notes and coins)
▪ Deposits at banks and other financial institutions
Official measures of Money: M1 and M3
• M1 consists of currency held by individuals and businesses and current deposits
owned by individuals and businesses
• M3 consists of M1 plus
all other bank deposits
including term deposits,
which can only be
withdrawn after a fixed
amount of time, and
certificated of deposit,
which are similar to
savings accounts
find more resources at oneclass.com
find more resources at oneclass.com
The Banking system
• The banking system consists of:
o The deposit-taking institutions
▪ They are banks, building societies and credit unions
o The Reserve Bank of Australia (RBA)- central bank
▪ The RBA is a public authority that supervises other banks, financial
institutions and financial markets and conducts monetary policy
▪ The RBA’s ai task is to regulate the quantity of money and interest
rate to achieve low and predictable inflation and sustained economic
growth
• The reserves Bank is a special kind of bank in three ways. It is the:
o Banker to banks and government, i.e. individuals cannot have an account
with the RBA
o Issuer of banknotes
o Lender of last resort. The Reserve Bank stands ready to make loans to bank
when the banking system as a whole is short of reserves
o (This happened a lot with central banks during the 2008 global financial crisis
when the overnight loans market. Inter-bank loans market (where banks
borrow from each other) froze and the financial system almost collapsed)
Money Multiplier
• Banks create deposits when they make loans and the new deposits created are new
money
• This process will allow for money multiplier to occur
• Moe ultiplier is the ultiplied epasio of a coutr’s oe suppl that result
from banks being able to create new deposits as they lend deposits that they receive
• The size of the multiplier effect depends on reserves ratio ( R)- the percentage of
deposits that banks hold as reserves
• When banks receive deposits, they will hold certain percentage as reserves
• Banks can not lend out all of the deposits received as some customers would need to
withdraw their deposits
• Suppose all banks hold 10% reserve ratio ( R). That means they would have 90%
lending ratio
Simple Money Multiplier
• Simply money multiplier = 1/R
• If R=10%, then Money Multiplier= 1/ 0.1= 10
• That is to say- assuming all the banks have reserve ratio of 10%- when a bank initially
received $10 deposit, eventually the money supply in the banking system will
expand to $100 (10x $10)
• Money Multiplier effect- How???
o If, for example, the R= 10%, for every $10 a customer deposits into a bank, $1
must be kept in reserve. However, the remaining $9 can be loaned out to
other bank customers. This $9 is then deposited by these customers into
another bank, which in turn must also keep 10%, or $0.9 in reserve, but can
lend out the remaining $8.1
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Week 6 economics for decision making lecture notes. It is the: banker to banks and government, i. e. individuals cannot have an account with the rba. Issuer of banknotes: lender of last resort. The reserve bank stands ready to make loans to bank when the banking system as a whole is short of reserves (this happened a lot with central banks during the 2008 global financial crisis when the overnight loans market. Inter-bank loans market (where banks borrow from each other) froze and the financial system almost collapsed) That means they would have 90% lending ratio. Simple money multiplier: simply money multiplier = 1/r, that is to say- assuming all the banks have reserve ratio of 10%- when a bank initially. If, for example, the r= 10%, for every a customer deposits into a bank, must be kept in reserve. However, the remaining can be loaned out to other bank customers.
