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Milton Mudombo R226739R

What is money?
It is any general accepted legal tender. Anything accepted as a medium for exchange for
goods and services is money.

Origins of Money

According to Uzonwanne (2018), evolution of money is not clear; even the hunting societies
used animal skins as money, agricultural society used grain as money and Greeks used coins,
just to name a few societies.

Stages in the evolution of money

Stage 1

Commodity Money: initial the societies used commodities as money. The used the
commodities to exchange for goods. The commodities which were used were skins, spears,
stones, cattle, grain and salts. However these lacked standardization, difficulties in value
preservation and store and divisibility. Therefore they paved way for metallic money

Stage 2

Metallic Money: As a results in improvement in trade relation among nations and

civilization, metals were used as money. These metals consisted of gold , silver , tin , iron ,
copper etc .The metals was made into coins of predetermined weight and value .However
people were reluctant to accept metal as money due to issues to do with weight , divide and
quality assessment .for example India used gold coins . However metal money suffered the
problems which consisted of difficulties in weighting money, lack of security attached with
carrying precious metals such as gold and that metallic money was heavy to carry .These
difficulties paved way for paper money

Stage 3

Paper Money: Paper money started with gold smith. People had trust on the gold smith.
Gold smith kept the gold for people. They gave people receipt in exchange for the deposit of
gold. Thus receipts acted as money and they were backed by gold. These receipts were
convertible into gold on demand. Thus these receipts led to the development of bank notes.

Stage 4
Credit Money: Cheque s were used to transfer money from one person to another
Stage 5

Near Money: The securities which were easily converted to money were used. These are
securities with high liquidity namely treasury bills and bills of exchange

Forms of Money
 M1: this is the currency in circulation. The components of M1 are bank notes and
coins, demand deposits, checking deposits and interest earning deposits and traveler’s
checks.
 M2 : it involve s M1 aggregates plus deposits with a maturity period of up to 2 years
and a period of notice of 3 months to redeem them . These include savings deposits
and time deposits. Money market mutual funds are also types M2.
 M3: M2 plus repurchase agreements, money market fund shares, and units as well as
debt securities with a maturity of up to and including two years Source:
http://www.ecb.int/pub/.

Properties of Money
 Acceptable: The public should accept it as a means of payment.
 Uniformity : money of similar denomination should look the same
 Divisible : money should be divisible into small denominations .for example $1 can be
divided into 20c , 50c , 10c and 5c coins
 Durability: money should stay for a loan period of time without being torn or losing
shape and texture.
 Scarcity: There should be limited supply of money. Increase in the supply of money
increases inflation.
 Recognizable; One should be able to recognize or notice money of different
denominations. A person should be able to separate true money from fake money.
 

 Homogeneity: similar material should be used to make money. Therefore money of

similar denomination should look similar .This is done to reduce confusion and forgery
of money.
 Portability: money should be easy to carry, it should not be heavy.
 Stability in value: the value of money should not fluctuate. The value of money should
be stable and predictable.
 Liquidity : It should be easy to convert money into other forms of wealth

Functions of money
 Medium of exchange: Any person should accept money in exchange of goods and
services eg shop keepers should accept money for exchange of goods in the shop.
 Store of value: Money should preserve value .People should be able to keep money for
future transactions without losing its value.
 Measure of value: the value of goods and services are expressed in monetary
terms .For example the price of bread in a shop should be expressed in monetary terms
(eg usd$1 for a loaf of br ead).
 Unit of account: It is a unit by which the value of goods and services are calculated
and records kept.
 Transfer of immoveable assets; money should be used when immoveable assets are
transferred from one person to another.
 Standard of deferred payment: it is used to settle credit transactions.


MONEY SUPPLY
Definition

The money supply is the total amount of assets in circulation, which are acceptable in

Exchange for goods. In modern economies people accept either notes and coins or an

Increase in their current account as payment. Hence the money supply is made up of
Cash and bank deposits. M1=M = Ms=Money supply

Factors that can influence money supply

(i) Market participants

(a) Central bank

Which determines the conditions and level of the cash

Reserves to be held by the commercial banks against their demand

Deposits.

(b) Commercial Banks

They decide on the basis of business

Considerations, on the quantity of excess reserves to be held. If they

Hold high excess reserves, an increase in legal reserve requirement in

Order to bring about a change in the money supply may be a total

Failure.

(c) Public

The greater the need for cash, the smaller the commercial

Banks’ credit creation capacity becomes.

(ii) Foreign transactions

If a local exporter earns foreign currency (in payment for exports) and exchanges

It at his bank for a demand deposit, the money supply will be directly increased.

The commercial bank which deposits the foreign currency with Reserve Bank at

The same time increases its own reserves which can be used to create further

Demand deposits. Local importers have a negative effect on the quantity of money.

That is a country’s money supply generally increases when it’s gold and foreign
Currency reserves increase and falls when the gold and foreign currency reserves

Decrease.

(iii) Government transactions

Financing of government expenditures from sources other than taxes exerts a

Particularly strong influence on the money supply. See Appendix 4A to this chapter

For a detailed derivation of the supply of money.

Credit Creation

The most important services rendered by commercial banks are (1) acceptance of

Deposits (demand as well as time deposits) and (2) the transfer of payments, usually

By means of cheque facilities and (3) the granting of credit, inter alia in the form of

Overdraft facilities. The most important characteristic of demand deposits is the fact

That the bank is obliged to pay out the deposit in cash (bank notes) or to transfer it to

Another bank or account holder in full or partially, immediately or on demand.

Some customers leave money in the bank earning interest. A bank can use these idle

Deposits to make loans to people who then buy goods. Shopkeepers receive extra

Money, which they redeposit with the bank. Some of this re-deposited money is left to

Earn interest and can be re-lent. The bank has therefore created money. If all

Customers were to try to cash their deposits at once, there would not be sufficient

Cash. The amount of money the bank can create therefore depends on the ratio of cash

To liabilities that they hold. The higher this cash ratio the less money the bank can relend

Or create.

How banks create money

 Assume a single bank, Barclays bank

 Mr. Moyo deposits $20000 cash in the bank.

 by depositing $20000 in the bank, money changes its form from cash to

Deposit.The change in M is expressed as follows:

M C  D 0  $20000 $20000 (see M=C+D in 2 above)

 Mrs. Maphosa wants to borrow money for her small business.

 Banks know that the demand deposits held by them are not all withdrawn

Immediately or simultaneously, hence they get into the habit of lending some

Of these funds to deficit units in the form of overdraft facilities.Barclays Bank

Can lend money to borrowers because it knows depositors will not withdraw

All at once. Provided that the bank can be convinced of Mrs. Maphosa’s credit

Worthiness, a demand deposit can therefore be created in her favour without

Any cash deposit. But it knows it must keep some cash as a reserve say 10%

Therefore Barclays lends $18000 to Mrs. Maphosa. (NB.Deposits that banks

Have received but have not loaned out are called reserves). Barclays Bank in

This case has created credit and also money supply in the country has been

Increased. Mrs Maphosa can make out a cheque for $18000 to Mrs. Ndlovu

Who in turn deposits the cheque in a Standard Bank account? This becomes a

Deposit in the bank. M C  D 0  $18000 $18000. By lending

Money to Mrs. Maphosa, the bank(s) increased money supply to $38000 ($20

000+$18 000) from just $20000. The banks are able to create money because

People have confidence that the cheques signed by the banks are honoured. In

The next stage of money creation, of the $18000 deposited by Mrs Maphosa,

Only $16200 can be lent out by the Standard Bank B with the 10% ($1800)
Being retained as reserves. The process goes on until it works itself out. The

Total increase in demand deposits or change in demand depositsD is given

By

1 ( ) 1 $20000

Change in cash reserves or deposits R

Reserve ratio

Where r is the cash reserve ratio.

$20000 $200000

0.1

. Therefore

Total increase in demand deposits (D) is equal to $200000. From this

Calculation changes in deposits can be as high as $200000 from an initial

Deposit of $20000. If the reserve ratio increases, it limits the change in

Deposits because most of the deposits are kept as reserves and not lent.

Therefore D

Where R = increase in cash reserves or deposit and r

= cash reserve ratio. R

Is called the credit money multiplier (m). It is clear that

The individual banks credit creation possibilities are restricted to only a part of

The deposits (or cash reserves) received. What in fact happens is that the

System as a whole, via the credit multiplier, can convert the amount received

In the form of a deposit (R) by a multiple thereof into demand deposits.

Just as a change in the credit multiplier can lead to a change in the level of demand

Deposits, a change in the reserves (R) available to commercial banks can also lead to

Changes in the Demand deposits. In other words the reserves form the basis on which

Credit creation is possible. Any change in this monetary base can therefore give rise to

A much greater change in demand deposits. It must be noted that if banks hold all

Deposits in reserve, banks do not influence the supply of money.

Limits to banks to create money will depend on:

 Amount of reserves (liquid) assets

 Reserve asset ratio
 Willingness of people to borrow
 Desire of people to hold cash.
 What is regarded as reserve asset must be defined by law. The following assets
CAN however be regarded as reserve assets
i. Cash balance with central bank
ii. Foreign exchange
iii. Treasury bills
iv. Gold etc.

Demand for money

Keynesian Theory

It was formulated in 1936 by Keynes. According to Keynes there are three motives or
components for the demand for money namely transaction demand, precautionary demand
and speculative demand for money. Money demand is determined by money income (Y) and
rate of interest (r)

Md = f (Y, r) …. This indicates that money demand is a function of income (Y) and interest
rates (r).

Transaction motive or demand: Money is used to meet regular commitments or to meet daily
transactions. This means that transactions are a function of the income one have. This means
that those with high level of income can transact more than those with low levels of income.
Thus there is a positive relationship between the level of income and transaction demand for
money.

Md = k Y, where Md is transaction demand for money, K a coefficient for Income and Y is

income level. Where (0< K < 1). Assuming that the level of income for a maid in Zimbabwe
is RTGS $1000 and K is 0.1. The Maid “s transactional demand for money calculated as
follows:

Md = 0.1 ($1000) = $100. Therefore the house maid requires RTGS $100 to meet
transactional demand.

Precautionary Motive or precautionary demand for money: Individual hold money to meet
unforeseen future events or contingencies. Thus money is held as buffer to meet uncertain
events such as accidents, death in the family or technological change which can require firms
to buy new machinery. This is buffer to meet natural disasters such as this COVID 19
pandemic which has affected individuals, firms and governments. Precautionary demand for
money is a function of income.

Speculative Demand or Speculative motive: Individuals and business hold money to take
advantage of changes in the market events .Under this speculative demand for money,
demand for money is a function of both income and interest rates .Speculative demand for
money is sensitive to changes in interest rates. Demand for money is positively related to
money and inversely related to interest rates.
Monetary Policy

It is a macroeconomic policy .It is formulated by the Central Bank (Reserve Bank of

Zimbabwe, in case of Zimbabwe). It deals with the monetary issues such as management of
interest rates and money supply. It helps the government to attain its macroeconomic
objectives such as liquidity, economic growth and inflation control.

Objectives of the Monetary Policy

 Stabilize price of commodities. The monetary policy helps to set acceptable level of
inflation (inflation targets). This helps in stabilizing prices.
 Employment .The monetary policy has an influence on the level of unemployment. A
contractionary monetary policy leads to unemployment whilst an expansionary
monetary policy leads to reduction in unemployment
 Exchange rate stability: The monetary policy has an influence in the exchange rate
market. This is done through the control of money supply. If money supply is high,
the demand for the local currency falls. The value of the local currency also falls.
 To achieve a healthy Balance of Payment ( BOP ) position
 To foster economic growth and thereby improving the standard of living of citizens.
Instruments of the Monetary Policy

The tools of monetary policy consist of bank rate , open market operations (OMO ) , cash or
liquidity requirements , selective credits control , directives and request ( moral suasion ) .

Bank rate
The Central bank can increase or decrease the interest rates at which it lends to the
commercial banks .When the Central bank increases the interest rates at which it lends to
commercial banks, the commercial banks also increase interest rates at which it lends to
customers. This results in commercial bank loans becoming expensive. Some customers are
discouraged from borrowing mind the money supply decreases. When central banks increase
the interest at which it lends to commercial banks, the commercial banks also reduce lending
rates to its customers. Customers are encouraged to borrow as the cost of borrowing will be
low. This results in increase in money supply.

Open Market Operation (OMO)

This involves the Central Bank buying or selling securities in order to control money supply
in the economy. When the Central bank want to increase the money supply in the economy it
will buy securities. When the Central Bank want to decrease money supply in the economy it
sells securities and they by mopping up money from the economy.

Cash or liquidity ratio requirements

The Central Bank can request the commercial banks to hold certain percentage of deposits as
cash and then the rest as liquid assets .If the Central bank ask banks to reduce liquidity ratio,
it discourages banks from using cash and hence this results in reduction in money supply.

Credit Controls
The Central banks can instruct commercial banks to lend more to a certain sector of the
economy.

Directives
The Central Bank can issue directive on the interest rates that a commercial banks can charge.

Request or Moral Suasions

This is where by the Central Bank ask the banks to act or not act in a certain way .The central
bank may ask a bank to adopt a certain lending policy.

Compulsory deposit requirements

This is where by the Central Bank request commercial bank to deposit certain amount of
money in the Central Bank in a special account. This has an impact on the money supply.
When the compulsory deposit requirement increases, the money supply decrease because the
banks deposit more money in Central banks and little money is available for lending.