Topic 6
Topic 6
MACROECONOMICS
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Motivating questions
• What is money?
• Where is money from?
• The government prints more paper money?
• From which mechanism?
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Study Plan
• What is money?
• Banks and the Creation of Money
• Central Banks
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What is Money?
The definition of money
• Money is any items or veritable records in an economy that people
regularly use to buy goods and services from other people.
• Money has (at least) three functions:
• Medium of exchange.
• Unit of account.
• Store of value.
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The functions of money (1)
Medium of exchange: a medium of exchange is anything that is
readily acceptable as payment that can return you a good or
service.
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Ancient-time medium of exchanges
• Market was not as predominant
as today.
• People was most self-subsistent
(produced and consumed by
themselves).
• Trading was a rare event before
the emergence of the modern
market economy.
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Medieval-time medium of exchange
• The emergence of the state: coins as the medium of exchange.
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Modern-time medium of exchange
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Medium of exchange
Criterion to use money as a medium of exchange:
• Acceptable by most traders.
• Standardized quality.
• Durable.
• Valuable relative to its weight.
• Divisible.
Medium of exchange in various cases
• Currencies in (physical or online) games.
• Bitcoin in certain online activities.
• Cigarettes and gasoline were used as a form
of commodity money in prisons of Europe
during World War 2.
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The functions of money (2)
Unit of account: a unit of account is the yardstick people use to post
prices and record debts. Examples:
• Local currency (VND): 1 kg of rice at 25,000 VND, 1 kg of minced pork at
120,000 VND.
• International currency (USD): nominal GDP per cap. Vietnam at ~$4,000, the
United States at ~$70,000 per year.
• Gold: houses in Hanoi ancient quarter. 10 taels (lượng) of gold per squared
meter.
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The functions of money (3)
• Store of value: a store of value
is an item that people can use
to transfer purchasing power
from the present to the future.
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Things can be considered as store of
value but not very liquid?
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(Hyper) Inflation and store of value
• Zimbabwe’s official inflation rate on July
2008 was 231,000,000%.
Source: https://www.reuters.com/article/idUSL3459092
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Other (less noticeable) function of
money
Means of final payment (as the legal tender)
• You can only pay taxes by the legal tender
• By laws, Viet Nam Dong (VND) is the only legal tender in
Vietnam
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Kinds of money
• Commodity money takes the form of a
commodity with intrinsic value.
• Examples: gold coins, silver taels, cigarettes…
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Kinds of money (2)
• Credit money: “I Owe You” (IOU)
• Imagine a friend owes you $1,000, while you owe $500 to your landlord
for rent.
• You cannot normally go to your landlord and tell them that while you
can’t give them cash, they can have your friend’s IOU, and collect the
money from your friend.
• But you can go to a bank to ask them to pay for you (from your
checking account).
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Credit money: “I Owe You” (IOU)
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Are checking accounts/demand deposits
money?
• Does checking account/demand
deposits/current accounts satisfy ALL
of these functions:
• Medium of exchange
• Unit of account.
• Store of value.
Is gold money?
• Does gold satisfy ALL of these
functions:
• Medium of exchange
• Unit of account.
• Store of value.
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Are crypto currencies (Bitcoin) money?
• Does Bitcoin satisfy ALL of these functions:
• Medium of exchange
• Unit of account.
• Store of value.
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Are credit cards money?
• You can open an international credit card
(Visa or Master) at a bank.
• Credit limit it is the maximum amount
granted by the credit card-issuing bank that
you can borrow on your credit card at any
given time.
• Ex: VCB Platinum Credit Card has the credit
limit of 100 million VND.
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Liquidity
• In general, liquidity describes how easily an item can be traded
for another item.
• For money, liquidity refers to how easy the conversion process
into the common currency is.
• The conversion process always incurs transaction costs.
• Example: time and cost associated with withdrawing money from time
deposit accounts, or with selling foreign exchange for the local currency.
• Liquidity is the “moneyness” of an asset.
Liquidity rank
Most liquid
• Cash, Checks (cheques).
• Checking Deposits.
• Time Deposit, Deposit Certificates.
• Gold, Foreign Exchange (USD, Euro…).
• Bonds, Stocks and Other Financial Products.
• Real estates, Cars, Jewelry … Less liquid
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Money supply
• The money supply refers to the total amount of money held by
the public (firms, households, the government, foreign
entities…) at a particular point in time.
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Money supply of an economy
Narrow money (M1, M2):
• M1: currency, checks, demand
deposits.
• M2: M1 + time deposits + saving
deposits + money market mutual
fund
Broad money (M3, M4): M2 + less
liquid assets
• Large-time deposits.
• Repurchase agreements.
• Commercial papers.
• Treasury bills.
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Check
The money stock includes all of the following except:
A. metal coins.
B. paper currency.
C. lines of credit accessible with credit cards.
D. bank balances accessible with debit cards.
Banks and the Creation of
Money
Banks create money by lending.
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Banks and the money supply
• (Commercial) banks receive deposit and
make loans.
• Banks’ profit comes from the difference
between the interests paying to savers
(depositors) and the interests charging on
borrowers.
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Balance sheet of a bank
• Banks, as any economic unit, has a balance Assets Liabilities
sheet (the T-account).
Reserves/Cash Deposits
• An asset is anything you own that has a
Loans Bank Capital
market price, and that you expect to receive
income or other benefits from in the future. E.g. Other Assets Other Liabilities
(What borrowers owe to (What bank owes to
loans and reserves. bank + bank’s money) depositors + bank’s capital)
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Money creation with fractional-reserve banking (1)
10% .
Money creation with fractional-reserve banking (2)
• When the lending bank
(Vietcombank) lends money to Assets Liabilities Assets Liabilities
a customer, that money is
generally deposited into another
Reserves Deposits Reserves Deposits
bank (Techcombank in this $10 $100 $90 $90
case).
• This creates more deposits on Loans
$90
Techcombank as reserves (not
lending yet). Total assets Total liabilities Total assets Total liabilities
$100 $100 $90 $90
• The total value of reserves and
(What borrowers owe to (What bank owes to (What borrowers owe to (What bank owes to
loans of the whole economy bank + bank’s money) depositors) bank + bank’s money) depositors)
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Required reserves
• The government can set reserve requirements: regulations on
the minimum amount of reserves that banks must hold against
deposits, usually as a ratio of the total deposits.
• The minimum ratio is called the required reserve ratio (RRR).
• Banks may hold more than this minimum:
Reserves = Required Reserves + Excess Reserves
• Excess reserves is always available for lending.
How can money supply increase?
• Banks need to keep adequate reserves as buffers from risks (e.g.
unexpected withdraws from depositors…).
• Banks are willing to lend more money when:
• Banks have more available reserves over its required level.
• Loans are profitable for banks to keep less excess reserves.
Loans $170
Given a bank with the balance sheet as in the above table, if the bank faces a
reserve requirement of 6 percent, then the bank:
A. is in a position to make new loans equal to a maximum of $12.
B. is in a position to make new loans equal to a maximum of $18.
C. has excess reserves of $120.
D. has excess reserves of $30.
Central Banks and Monetary
Policy
Central banks (1)
• Central banks both conduct monetary policy and serve as the ultimate bank
of governments and commercial banks.
• Note: central banks only interact with commercial banks, not with firms and
households.
• Central banks have the duty to ensure stability of the banking system.
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Central banks (2)
• Central banks’ other responsibilities:
• Monopoly on increasing the monetary base (e.g. currency issue).
• Handle commercial banks’ payments.
• Lender of last resort for the banking system.
• Manage the exchange rate and the country’s foreign exchange reserves.
• Control credit growth.
World’s notable central banks:
• Federal Reserve (Fed).
• European Central Bank (ECB).
• Bank of England (BoE).
• Bank of Japan (BoJ).
• People's Bank of China (PBoC).
Central Banks’ Tools (1)
• Open Market Operation (OMO) are activities of selling and
buying securities of the central bank (the CB) in order to
change available reserves to banks for lending:
• The CB sell securities (as government bonds) to withdraw money
from banks, less reserves are available for lending. The money supply
can decrease accordingly.
• The CB buys securities to inject money to banks, more reserves are
available for lending. The money supply can increase accordingly.
OMO’s balance sheet
• Recently, Fed also uses interest rate on reserves and overnight reverse
repurchase agreement rate to influence banks’ lending rates.
Fed’s target and actual rates
Note:
• Market Yield 5-year: US government bond market “interest rate” at the 5-year term.
• Bank Prime Loan Rate: base rates used by banks for short-term business loans.
• Commercial Bank Interest Rate on Credit Card: interest rate for credit-card loans.
Video explaining Fed Fund Rate
https://www.youtube.com/watch?v=AkMsMDk_brU
Monetary policy’s transmission
mechanism
Central bank
Open market operations Market
& other tools interest rates
Firms’ and households’
Federal Funds Rate
borrowings
Loan availability
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SBV set credit growth limit
• Credit is the term that captures the total
value of all commercial banks’ domestic
loans.
• As an economy with a significant
economic growth, banks’ loan (credit) in
Vietnam constantly expands.
• Very high rates of credit growth can
“over-fuel” economic activities and
render the economy too “hot” –
equivalent to very fast increase of the
money supply.
• Results? Too much inflation?
Vietnam's M2 and Credit (unit: billion VND)
16,000,000
14,000,000
12,000,000
10,000,000
8,000,000
6,000,000
4,000,000
2,000,000
0
Credit M2
Note: Credit outstanding is the total value of all commercial banks’ domestic loan.
Source: IMF
SVB’s intervention into the FX market
“Vietnam's central bank said on Tuesday it was making
efforts to shore up foreign exchange reserves by buying
up more U.S. dollars, after it was forced to sell a large
amount of greenback earlier in the year to support its
dong currency.”
Source: www.wichart.vn 80
The lender of last resort
• A risk of bank run at Saigon Commercial
Bank (SCB) – connected to the troubled real
estate company Van Thinh Phat happened on
Oct 2022.
• SBV performed the role as the lender of last
resort to support the bank system.
Bank run occurs when many clients
• During the first ten days of October, SBV withdraw their money from a bank. It
causes the bank become unable to
“pumped” totally at 61,274 billion VND, via
pay back deposit money, run out of
the open market, into the economy. money and get bankrupt.
Sources: https://vneconomy.vn/ngan-hang-nha-nuoc-day-manh-bom-
tien-lai-suat-lien-ngan-hang-ha-nhiet-nhung-ty-gia-tang-nong.htm
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Summary (1)
• Three functions of money: medium of exchange, unit of account,
store of value.
• T-account balance sheet of banks.
• The money supply (M1, M2, M3, M4): notes, cheques, checking
account, time deposits, money market mutual fund…
• Money is created by banks’ lending: banks can make loans out of
excess reserves; the money multiplier theory.
Summary (2)
• Open market operation: the central bank buys and sells government
bonds from/to bank to withdraw and supply excess reserves.
• Other tools: discount windows, interest rate on reserves…
• Fed changes the federal funds rate – interest rate charging on short-
term loans between financial institutions - to achieve its
macroeconomic objective.
• An increase of the fed funds rate leads higher market interest rates and less
credit availability (less money supply); and vice versa.
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