Unit 3 Long-run economic performance: The financial side
1. Money is an asset that people are generally willing to accept in exchange for goods and services or payments of debts.
2. The characteristics of money are acceptability, portability, durability, divisibility, standardisable and ecognisability.
3. Money has four functions:
a. as a medium of exchange.
b. as a unit of account.
c. as a store of value.
d. as a standard for deferred payments.
4. There are two kinds of money " commodity money and fiat money.
5. In Malaysia, M1 = currency held by the non-bank public + demand deposits at commercial banks; M2 = M1 + savings and time deposits held by the non-bank public at commercial banks + NIDs and Repos issued by commercial banks and held by the non-bank public + foreign currency deposits at commercial banks and held by the non-bank public; M3 = M2 + savings and time deposits held by the non-bank public at finance companies, merchant banks, discount houses and Islamic banks + NIDs and Repos held by the non-bank public at these financial institutions.
6. For banks, the major items of assets are loans and reserves. The major liabilities are deposits.
7. With fractional reserve banking, banks inf luence the money supply through the money creation process.
8. Total reserves are the sum of the required reserves and the excess reserves.
9. The money multiplier is defined as the ratio of bank deposits to bank reserves. In general, if the reserve requirement ratio is rd, the money multiplier is equal to 1/rd.
10. When someone deposits money in the bank, the money supply is not affected, but when a bank makes a loan, the money supply increases.
11. There are several policy instruments available to the central bank to control the money supply:
a. open market operations.
b. statutory reserve requirements and liquidity ratios.
c. discount rates.
d. selective credit controls.
e. moral suasion.
12. Monetary neutrality asserts that a monetary change affects nominal variables and does not affect real variables.
13. The quantity equation of money is M × V = P × Y, where Y, M, P and V denote the real GDP, the money supply, the price level and the velocity, respectively. The quantity theory of money asserts that when the money supply M increases, (a) the velocity V is stable and remains unchanged; (b) the real output Y remains unchanged and is determined by the underlying supply and demand conditions. Thus according to the quantity theory of money, by the quantity equation M × V = P × Y, an x % increase in the money supply (M) leads to an x % increase in the price level (P), and the real output (Y ) and the velocity (V ) remain unchanged.
14. The Fisher effect refers to the one-for-one adjustment of the nominal interest rate to the inflation rate in the presence of inflation. In other words, with inflation, the real interest rate remains unchanged and the nominal interest rate increases by the exact amount as the inflation rate.
15. When a government spends, it may pay:
* from tax revenues.
* borrow from the public by selling government bonds, i.e., by issuing government bonds and selling them in the open market and then using the proceeds to pay.
* by printing money to finance its spending , i.e., by issuing government bonds and selling them not in the open market but directly to the central bank, after which the central bank might issue new money to pay for the bonds to the government.
16. The inflation tax refers to the process of the government printing money to get revenue, which leads to inflation.
17. A tax is said to be progressive if the average tax rate is higher for people with a higher income. A tax is said to be regressive if the average tax rate is lower for people with a higher income. A tax is generally regarded to be fair if the tax is progressive and unfair if the tax is regressive.
18. The shoeleather costs are the costs associated with less money holding.
19. The menu costs are the costs associated with changing prices.
20. Taxes on nominal incomes from savings discourage savings in the presence of inflation more than in the absence of inflation. The inflation-induced tax distortions can be avoided if codes of taxes on incomes from savings are written such that these taxes are based on real incomes of savings instead of nominal incomes.
21. Money illusion refers to the phenomenon that people feel that they are richer when both their salaries and prices increase by the same percentage than when their salaries and prices stay as they were.
22. Inflation is good for debtors since it makes the real debts that debtors owe others smaller; and inflation is bad for creditors since it makes real debts others owe to creditors smaller " the creditors receive less .
23. Most problems associated with inflation arise only when inflation is unexpected. If inf lation is expected, i.e., the public knows exactly what the future inflation rate is, most of the problems associated with inflation will disappear.
24. If the government follows some simple and transparent monetary rules, it will be easy for the public to infer the future inflation rate correctly.
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