23115 Lecture Notes - Lecture 9: Reserve Bank Of Australia, Openmarket

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17 May 2018

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23115–EconomicsforBusiness



THEMEANINGOFMONEY

 Moneyisthesetofassetsinaneconomythatpeopleregularlyusetobuygoodsand

servicesfromotherpeople.

 Thethreefunctionsofmoneyare:

1. Mediumofexchangeisanitemthatbuyersgivetosellerswhentheywanttopurchase

goodsandservices.

2. Unitofaccountistheyardstickpeopleusetopostpricesandrecorddebts.

‐ E.g.Apairofshoescosts$20.

3. Storeofvalueisanitemthatpeoplecanusetotransferpurchasingpowerfromthepresent

tothefuture.

‐ Otherassetscanalsobestoresofvalue,suchasshares,bondsandrealestate.

‐ Wealthreferstothetotalofallstoresofvalue.

‐ Liquidityistheeasewithwhichanassetcanbeconvertedintotheeconomy’smediumof

exchange.

‐ Assetsvarywidelyintheirliquidity.Whendecidinginwhatformtoholdtheirwealth,people

balancetheliquidityofeachassetagainsttheasset’susefulnessasastoreofvalue.

‐ Becausemoneyistheeconomy’smediumofexchange,itisthemostliquidassetavailable

butitisfarfromperfectasastoreofvalue.

‐ Thisisbecausewhenpricesrise,thevalueofmoneyfalls.Inotherwords,whengoodsand

servicesbecomemoreexpensive,eachdollarinyourwalletcanbuyless.

THEKINDSOFMONEY

 Commoditymoneyisthemoneythattakestheformofacommoditywithintrinsicvalue.

‘Intrinsicvalue’meansthattheitemwouldhavevalueevenifitwerenotusedasmoney.

Examplesofcommoditymoneyaregold(operatingagoldstandard–whenaneconomy

usesgoldasmoney)andcigarettes(inprisoner‐of‐warcampsduringtheWWIIandthe

SovietUnioninthelate1980s).

 Fiatmoneyisthemoneywithoutintrinsicvaluethatisusedasmoneybecauseof

governmentdecree.

‐ Fiat–governmentdecree.EachAustraliannote(dollar)reads‘ThisAustraliannoteislegal

tenderthroughoutAustraliaanditsterritories’.

‐ Asuccessfulsystemoffiatmoneyalsodependsonexpectationsandsocialconvention.

 MoneyintheAustralianeconomy–thequantityofmoneyavailableintheeconomyiscalled

themoneysupply.Howisthequantityofmoneymeasured?

Currency(Cp)isthepaperbillsandcoinsinthehandsofthepublic.

‐ Currency–theplasticnotesandmetalcoinsinthehandsofthenon‐bankpublic.

Demanddeposits(D)arethebalancesinbankaccountsthatdepositorscanaccesson

demandbywritingacheck.

 MoneysupplyMs=Cp+D.

‐ Variousmeasuresofthemoneysupply:M0,M1,M2,M3andbroadmoney–alluseCpand

D,buteachusesdifferentcriteriaformeasuringD.

 ThreemeasuresofthemoneysupplyfortheAustralianeconomy.

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23115–EconomicsforBusiness

 Creditcards=methodofdeferringpayment(excludedfrommeasuresofmoneyquantity).

THERESERVEBANKOFAUSTRALIA[RBA]

 Wheneveraneconomyreliesonasystemoffiatmoney,someagencymustberesponsible

forregulatingthesystem.ThisisthecentralbankinAustraliawhichiscalledtheRBA.

 Centralbankisaninstitutiondesignedtooverseethebankingsystemandregulatethe

quantityofmoneyintheeconomy.

 OrganisationoftheRBA.

‐ TheoriginsareintheCommonwealthBankofAustraliaestablishedin1911;thepowersof

thecentralbanksareformalisedintheCommonwealthBankActandtheBankingActin

1945;theRBAwascreatedinitscurrentformbytheReserveBankActof1959.

‐ TheReserveBankBoardisresponsiblefordeterminingthebank’smonetarypolicyand

bankingpolicy.Theboardconsistsofninemembers.

‐ TheRBAnowoperatesindependentlyofthegovernmentoftheday.

o TherehavebeenchangesintheRBA’sroleandthecurrentfunctionsoftheRBAare:

 Moneysupplyisthequantityofmoneyavailableintheeconomy.

 Monetarypolicythesettingofthemoneysupplybypolicymakersinthecentralbank.

1. Determinemonetarypolicy.Monetarypolicyisthemanagementbythecentralbankof

liquidityconditionsintheeconomy.Liquidityconditionisthepriceandavailabilityof

fundingfortheeconomy’sexpenditure.Thelong‐runobjectiveofmonetarypolicyisto

influencetherateofgrowthintheeconomyandthelevelofprices.

 Currently,targetinflationaround2%to3%overtime.

2. Actasaguarantorofstabilityinthebankingsystem–facilitatingtheoperationofthe

paymentsystemorthesettlementofchequesbetweenbanks.

 Before1998,theRBAalsomonitorsindividualbankstoensuretheirstability–prudential

supervision.

BANKSANDTHEMONEYSUPPLY

 Asimplecaseof100percentreservebanking–consideraneconomywith$100heldbythe

non‐bankpublic(Cp).Supposethereisonebank–FirstStateBank.Thebankaccepts

deposits,butdoesnotmakeloans.Ifpublicdeposits$60withthebankalldepositsare

heldasreserves100%reservebanking

 Asalways,Ms=Cp+D=40+60inthiscase.Moneysupplyisalways100.

Reservesaredepositsthatbankshavereceivedbuthavenotloanedout.

‐ Thepurposeofthebankistogivedepositorsasafeplacetokeeptheirmoney.Whenevera

persondepositssomemoney,thebankkeepsthemoneyinitsvaultuntilthedepositor

comestowithdrawitorwritesacheckagainsthisorherbalance.

‐ Depositsthatbankshavereceivedbuthavenotloanedoutarecalledreserves.

‐ Inthisimaginaryeconomy,alldepositsareheldasreserves,sothissystemiscalled100‐

percent‐reservebanking.

‐ Eachdepositinthebankreducescurrencyandraisesdemanddepositsbyexactlythesame

amount,leavingthemoneysupplyunchanged.

‐ Thus,ifbanksholdalldepositsinreserve,banksdonotinfluencethesupplyofmoney.

 Moneycreationwithfractional‐reservebanking–whatifFirstStateBankmakessomeloans

andkeepsonlyafractionofitsdepositsinreserve?Fractional‐reservebanking.

Fractional‐reservebankingisabankingsysteminwhichbanksholdonlyafractionof

depositsasreserves.

Reserveratioisthefractionofdepositsthatbanksholdasreserves.

‐ Onceagainconsiderthesupplyofmoneyintheeconomy.BeforeFirstStateBankmakesany

loans,themoneysupplyisthe$100ofdepositsinthebank.

‐ YetwhenFirstStateBankmakestheseloans,themoneysupplyincreases.Thedepositors

stillhavedemanddepositstotalling$100,butnowtheborrowershold$90incurrency.The

moneysupply(whichequalscurrencyplusdemanddeposits)equals$190.

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23115–EconomicsforBusiness

‐ Thus,whenbanksholdonlyafractionofdepositsinreserve,bankscreatemoney.

THEMONEYMULTIPLIER

 Moneymultiplieristheamountofmoneythebankingsystemgenerateswitheachdollarof

reserves.

‐ Whatdeterminesthesizeofthemoneymultiplier?Itturnsoutthattheanswerissimple–

themoneymultiplieristhereciprocalofthereserveratio.

‐ IfRisthereserveratioforallbanksintheeconomy,theneachdollarofreservesgenerates

1/Rdollarsofmoney.Forexample,ifR=1/10,themoneymultiplieris10.

‐ Thehigherthereserveratio,thelessofeachdepositbanksloanout,andthesmallerthe

moneymultiplier.

MONEYCREATION

 Modernfractional‐reservebankingsystemscancreateanddestroymoney.

‐ MS=CP+D

‐ MoneycreationmeansD andhenceMS.

‐ MoneydestructionmeansD andhenceMS.

 Wenowexamineasimplemodelofmoneycreation.





NON-BANK

PUBLIC





BANKING

SYSTEM

CENTRAL BANK

CONCEPTUALEXPLANATION–USEFLOWDIAGRAM

 Assumenon‐bankpublicreceivessumofcash,CP



 ThisisdividedbetweenCpandD

 BanksnowreceivenewdepositsD

 BankskeepEasideasexcessreserves(tomeetcashwithdrawalsbynon‐bankpublic),and

sendRCBtocentralbank(iflegallyrequired).

 Amountavailableforlendingis:D–E–RCB

 Thisamountislentoutto(borrowedby)publictopurchaseitems(Loans,L).

 Sellersofitemsreceivethemoneyandwereturnto

 .NewdivisionbetweenCPandD.

 Cyclerepeatsitselfuntilexhausted.

 Variableskeepgrowinguntiltheyreachamaximumlevel.

 Maximaarefinitebecauseofthreeleakagesfromcircuit(CP,E,RCB).

NUMERICALILLUSTRATIONEXERCISE

 c=0.2(Non‐bankpublicdesirestoholdcashequalto20%ofdeposits).Cp=cD.

 e=0.05(Banksdesiretoholdcashequalto5%ofdeposits).E=eD.

 r=0.05(Centralbankreceivescashequalto5%ofdepositsfrombanks)RCB=rD

 Assumesystemstartswith$1200cashissuedbythecentralbankbutheldbythenon‐bank

public.

 StartatCP

 anddocalculationsfor3or4circuits.

 NB:UsecorrectformulatogetDandhenceCP:CP

 =(1+c)D.

 Togetfinalchangesinallvariables,addupthechangesineachcircuit.E.g.CP

 Canderiveformulaeforallthefinalchanges.

,D,MS

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23115 Lecture Notes - Lecture 9: Reserve Bank Of Australia, Openmarket

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