Transcript linked

MONETARY POLICY
Lecture 1
Understanding money and
its historical development
Marijana Ivanov, Ph.D.
UNDERSTANDING MONEY

money makes the exchange of goods
much simpler by eliminating the
trouble and cost of barter
Barter
- „ is a system of
exchange where
goods or services are
directly exchanged for
other goods or services
without using a medium
of exchange, such
as money.”
What is 'Money'

„Money is defined as anything that is generally
accepted in payment for goods and services or in
the repayment of debt.” (Mishkin)
„Money is an officially-issued legal tender generally
consisting of notes and coin, and is the circulating medium of
exchange as defined by a government.
Money is often synonymous with cash and includes
various negotiable instruments such as checks.” (Investopedia)

Each country has its own money that is used as a
medium of exchange within that country.
Croatian kuna is
the official legal tender
in the Republic of
Croatia, introduced on 30
May 1994.
The euro is the
single currency shared
by 19 of the European
Union's Member States, which
together make up the euro area.
The euro is not the currency of all EU Member States.
The currency of one country can be exchanged for the currency of another
country. The exchange rate determines the value of one currency in term of the
other currency.
Exchange rate list
in Croatia applied 10.9.2016.
If you are buying 1
EUR, you will pay
7.50 HRK.
If you sell 1 EUR,
you will get 7.45
HRK.
Croatian kuna or HRK
If you are buying 1
CAD, you will pay
5.15 HRK.
If you sell 1 CAD,
you will get 5.12
HRK.
Source: http://old.hnb.hr/tecajn/etecajn.htm
Source: http://www.xe.com/currencycharts/?from=EUR&to=HRK&view=5Y
Be precise when you use the term "money".
• sometimes, everyday conversations regard money as a synonym for
wealth
• People say “He has a lot of money!” what means that he is wealthy,
…
… but not necessarily that he holds a lot of currency and
checking deposits
• in this unofficial conversation the term money also include real
estate, stocks, bonds, and all other types of wealth
For purpose of this course the distinguish between
money and other types of wealth is very important.



One of popular unofficial uses of the word
money is as income, by asking, for example:
“How much money does he earn?”
However, the money is a stock, which means
that it is a certain amount at any one moment
of time
while income is a flow over time (per year, per
week…)
MONEY TODAY
• in everyday conversation the term “money” is used to
mean currency (cash)
•
but in modern economy the definition of money
includes:
- currency (cash) in circulation
- and deposit money on current account, giro
account and similar transactional accounts (Europe)
/ on checking accounts (the.U.S.)
• checkable deposits (deposits on transactional accounts) - deposits
on which checks (cheques) can be written
Thus, currency and deposits on which checks
can be written do the same thing: they pay for
goods and services.
• in spite of this : the checks are not accepted
for small payments
• Deposit money (on current/ giro accounts of
the non-monetary agents) is not always
accepted for payments. There are shops and
other places where checks and/or debit
bank cards are not accepted.
Economists define money by its
functions (Mishkin):
1. as a medium of exchange
2. as a unit of account (standard of value )
3. as a store of value (extremely liquid store of wealth)
Additionally in some other books:
4. as a standard of deferred payment
Medium of exchange
Money is used to pay for goods and services.
We exchange goods and services for money,
and then exchange this money for those goods
and services we want to buy.

on this way, money solves the great
disadvantage of barter, the need for a socalled double coincidence of wants
• namely, in the circumstances of barter we have to find
someone who wants to obtain the goods we have to
offer, and at the same time, can provide the goods we
want to obtain in exchange
• This problem and the high cost of making transactions
were primary reasons of commodity money development
(in the forms of large stone, gold, silver, copper …)
Unit of account
(standard of value)
Money is used to express and
measure values in the economy. It
means that we use money as a way
of comparing the relative values of
various items
↔
• suppose that we have a very simple economy with only
five commodities A, B, C, D, and E
• if there is no standard of value, and we want to know the
exchange ratios of these five commodities in terms of
each other, we have to learn and remember ten different
exchange ratios
(A:B, A:C, A:D, A:E, B:C, B:D, B:E, C:D, C:E, D:E)
Store of value
(store of wealth)



money as a store of value is used to save
purchasing power from the time when the
income is received until the time it is spent.
Money is not unique as a store of value; any
asset – whether money, stocks, bonds, land,
houses, art or jewelry – can be used to store
wealth.
As a store of value, money is used as a liquid
asset.
This function of money is connected with
liquidity levels of different assets.

Liquidity refers to the ease of converting a
store of value into a medium of exchange.
Additional explanations
The liquidity of an asset depends on:



how easily it can be bought or sold
the transactions cost of buying or selling it, and
how stable and predictable its price is
In comparisons with other types of asset (wealth)
money has perfect liquidity.
• money is characterized by the virtual absence of
transactions costs and by fixity of its nominal
value in terms of most debts
• however, the real value of money fluctuates
relative to goods and services
• hence, in circumstance of inflation pressure,
money is certainly not the ideal store of wealth
• Many other form of assets have advantages
over money as a store of value (non-monetary
form of assets pay the owner some interest)
Sources:
http://www.inves
topedia.com/ter
ms/r/realrateofre
turn.asp
Real value of
100 HRK / EUR
/ USD/ … after
t years – if the
inflation rate is
2% per year
Additional explanations
or kuna or other currrency
Source: http://www.investopedia.com/university/inflation/inflation1.asp
deflation
deflation
Source: http://www.tradingeconomics.com
Standard of deferred payment
• that is a standard in which future payments (for
example debts) are expressed
for example:
DEBT = 10,000.00 CROATIAN KUNAS
It is not always the case that all functions of
money are fulfilled.
•
•
•
for example in Croatia, domestic money perfectly fulfills only its function of
medium of exchange while foreign currencies (euro mostly) play other
functions of money.
Croatia is an example of a country with a high rate of euroisation of
savings (citizens savings mainly held in foreign currency deposits), as well
as with the practice of indexation of long-term loans to the euro (or
possibly other foreign currencies).
For the most part this is a consequence of the bad memories on monetary
experiences in the distant past, and partly is related to expectations
about the possible introduction of the euro as the domestic currency
(when Croatia meets the conditions for it).
Source:
Additional explanations
Unofficial financial euroisation (or dollarization)
20
That have not adopted euro as the EU members of the euro area.
Source: Ivanov, M.;, Tkalec, M.; Vizek, M. (2011) „The Determinants of Financial Euroization in a Post-Transition
Country: Do Threshold Effects Matter?”, Finance a úvěr-Czech Journal of Economics and Finance, 61, 2011, no. 3
MONETARY STANDARDS DURING A HISTORY
TYPES OF MONEY
DURING A HISTORY




commodity money (consists of objects that have
value in themselves as well as value in their use as
money; gold, silver, copper, salt, peppercorns,
stones, shells, cigarettes, candy, cocoa)
coins (gold coins, silver coins)
paper money (gold certificates/banknotes as the
form or commodity-backed money; banknotes in
today fiat monetary system)
deposit money (checking/transactional account
deposit)
Full bodied
money
Representative
money - any type
of money that
has face value
greater than its
value as
material substance

„Money is defined as anything that is generally
accepted in payment for goods and services or in
the repayment of debt.” (Mishkin)
History of the Croatian
Currency - KUNA


„The name kuna (marten)
was chosen for the
Croatian currency because
of the important role of
marten pelts in the
monetary and fiscal
history of Croatia.
As the commodiy money,
marten pelts had originally
been used for payments in
kind.” (CNB)
Shell money
Commodity money is
money whose value comes
from a commodity of which
it is made.
MONETARY STANDARDS DURING A HISTORY
1)
BIMETALLIC STANDARD: In the same time gold and
silver coins are in the circulation.
2) SILVER STANDARD: Prices of domestic currencies
are fixed in the terms of a specific amount of silver.
3) GOLD STANDARD: Prices of domestic currencies are
fixed in the terms of a specific amount of gold.
4) THE FIAT STANDARD: The monetary system in
which the value or purchasing power of the monetary
unit is not kept equal to the value of a specific
quantity of particular metal.
England adopted a de facto gold
standard in 1717 and de jure in 1819.
The United States adopted a de facto
gold standard in 1834 and de jure in
1900.
The period form 1880 to 1914 is known as THE
CLASSICAL GOLD STANDARD.
The period form 1925 to 1931 represent so
called THE GOLD EXCHANGE STANDARD:
Countries could hold gold or dollars or pounds
as reserves, except for the U.S. and U.K. which
held reserves only in gold.
The period form 1946 to 1971 is known as THE
BRETTON WOODS SYSTEM.
Appendix:
THE CLASSICAL GOLD STANDARD
THE CLASSICAL GOLD
STANDARD


Authorities guaranteed free convertibility of gold into
non-gold money.
Gold coins and the other forms of money (money
substitutes - bank deposits and notes – BANKNOTES)
were freely converted into gold at the fixed price.

Quantity of gold regulates the quantity of money
supply.

Inflation averaged only 0.1 percent per year.

As long as the gold stock grew at steady rate, prices
would also follow a steady path.



New discoveries of gold would generate
instability of prices.
Price was highly unstable in the short run,
but stabile in the long run.
The new discoveries of gold increased U.S. money
supply.
→ Domestic expenditures and nominal income
increased.
→ the rise in the domestic price level.
The gold standard was a domestic and also an international MONETARY SYSTEM
OF FIXED EXCHANGE RATES.
Because each currency is defined in terms of its gold value, all currencies are
linked together in a system of fixed exchange rates.
Example:
Currency A is worth 0,10 ounce of gold.
Currency B is worth 0,20 ounce of gold.
→ 1 unit of currency B is worth 2 units of currency A.
Since London was the financial center of the world (and England the worlds
leading trader and source of financial capital), the pound also served as world
money. International trade was commonly priced in pounds and often paid with
pounds. The U.S. had risen to the status of world’s dominant financial leader
after World War I.
The classical gold standard broke down during World War I.
AUTOMATIC BALANCE OF PAYMENTS ADJUSTMENT
PROCESS AND BALANCED PRICES AMONG COUNTRIES
Example: Trading between the United States and the United Kingdom
Technological innovation and faster economic growth in U.S. accompanied by
unchanged money supply caused decrease of prices in the short run.
Prices of U.S. exports then fell relative to the prices of imports
→ U.S. export of goods increased
→ U.K. import of goods increased
U.S. balance of payment recorded surplus: Gold flows form United Kingdom to the
United States
U.K. balance of payment recorded deficit.
The gold inflow increased the U.S. money supply → the rise of prices in U.S.
In the U.K. the gold outflow reduced the money supply and lowered the price level.
NET RESULT: balanced prices among countries