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Money and Banking

Professor Chris AdamAustralian Graduate School of ManagementUniversity of Sydney and University of New

South Wales

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INTRODUCTION

• What is money?

• What are the forms of money?

• How does banking work?

• How does the government influence

money?

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MEANING OF MONEY

• Money is set of assets used in economy to

buy goods and services from people

• Three functions of money:

1. Medium of exchange• Universally accepted for exchange

• Can be used to pay taxes

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MEANING OF MONEY

• Three functions of money:

2. Unit of account• Yardstick of measuring value

3. Store of value• Transfer purchasing power from present to

future

• Concept of liquidity: ease of converting

asset into medium of exchange

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KINDS OF MONEY

• Commodity money has intrinsic value– Gold standard

– Cigarettes

• Fiat money has value established by

decree

• Economic conditions can induce people to

substitute first for second

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MONEY IN ECONOMY

• Money supply as circulating volume of

purchasing power

• Basic type as currency: notes and coins in

hands of public– Includes EFTPOS (“debit” cards)

– Also called money base or high powered money

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MONEY IN ECONOMY

• Broader definitions (M1, M2, etc.,) include – cheque accounts

– savings accounts

– time deposits (Certificates of Deposit)

– deposits in non-bank financial intermediaries

• Credit cards are means of deferring

payment: not part of current money supply

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AUSTRALIAN MONETARY AGGREGATES CHANGES

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AUSTRALIAN MONEY AND CREDIT CHANGES

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RESERVE BANK OF AUSTRALIA

• RBA is Australian central bank– Created in 1959 from Commonwealth Bank

– Established to manage financial system stability

for good of economy

– Policy maker for banking system and money

supply functions

– RBA Board as guide to RBA Governor

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RESERVE BANK OF AUSTRALIA

• RBA functions:

1. Originally to monitor bank financial conditions

and recommend actions to keep solvent –

prudential supervision

• Now with APRA

2. Guarantor of banking system stability but not

lender of last resort

• Operates cheque clearance process

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RESERVE BANK OF AUSTRALIA

• RBA functions:

3. Monetary policy design and implementation, to

influence growth rate of economy and inflation

• Through open-market operations

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BANKS AND MONEY SUPPLY

• Bank balance sheet model to demonstrate

credit creation with 100% reserves– no credit creation!

• Bank balance sheet model to demonstrate

credit creation with frational reserves– Allows creation of credit

– Money multiplier

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AUSTRALIAN BANK INTEREST SPREADS

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AUSTRALIAN BANK FEE INCOME

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AUSTRALIAN BANK EQUITY RETURNS

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AUSTRALIAN MONETARY POLICY

• RBA uses changes to cash rate to adjust

level of interest rates in economy– overnight loans among intermediaries

– shifts base of yield curve

• Open-market operations to adjust to excess

supply or demand of overnight funds– buying and selling government securities from

own portfolio

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AUSTRALIAN CASH RATE

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AUSTRALIAN INTEREST RATES

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AUSTRALIAN MONETARY POLICY

• RBA also oversees reserve requirements

for banks– Basel Agreement: Tier 1 and Tier 2 reserves held

against assets with appropriate risk classes

• Problems for RBA in monetary policy:– Household deposits at banks are discretionary

– Bank lending as decisions of banks

– Confidence in banks: role of bank runs

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AUSTRALIAN CREDIT AND GDP CHANGES