| Money & Banking – MGT411 |
| VU |
| Lesson 4 |
| OTHER FORMS OF PAYMENTS |
| Debit Card |
| The money in your account is used for payments |
| Works like a cheque and there is usually a fee for the transaction |
| Credit card |
| It is a promise by a bank to lend the cardholder money with which to make purchases. |
| When the card is used to buy merchandise the seller receives payment immediately |
| The money that is used for payment does not belong to the buyer |
| Rather, the bank makes the payment, creating a loan that the buyer must repay. |
| So, they do not represent money; rather, they represent access to someone else’s money |
| Electronic Funds Transfer |
| Move funds directly from one account to another. |
| Banks use these transfers to handle transactions among themselves |
| Individuals may be familiar with such transfers through direct deposit of their paycheques and the |
| payment of their utility bills, etc |
| E-money |
| Used for purchases on the Internet. |
| You open an account by transferring funds to the issuer of the e-money |
| When shopping online, instruct the issuer to send your e-money to the merchant |
| It is really a form of private money. |
| Stored-value card |
| Retail businesses are experimenting with new forms of electronic payment |
| Prepaid cellular cards, Internet scratch cards, calling cards etc |
| The Future of Money |
| The time is rapidly approaching when safe and secure systems for payment will use virtually no |
| money at all |
| We will also likely see |
| Fewer “varieties” of currency, (a sort of standardization of money) and |
| A dramatic reduction in the number of units of account |
| Money as a store of value is clearly on the way out as many financial instruments have become |
| highly liquid. |
| Measuring Money |
| Different Definitions of money based upon degree of liquidity. Federal Reserve System defines |
| monetary aggregates. |
| Changes in the amount of money in the economy are related to changes in interest rates, economic |
| growth, and most important, inflation. |
| Inflation is a sustained rise in the general price level |
| With inflation you need more money to buy the same basket of goods because it costs more. |
| Inflation makes money less valuable |
| The primary cause of inflation is the issuance of too much money |
| Because money growth is related to inflation we need to be able to measure how much money is |
| circulating |
| Money as a means of payments |
| We measure the quantity of money as the quantity of currency in circulation – an unrealistically |
| limited measure, since there are other ways of payments |
| Alternatively, broadly categorize financial assets and sort them by the degree of liquidity |
| Sort them by the ease with which they can be converted into a means of payments |
| Arrange them from most liquid to least liquid |
| Draw a line and include everything on one side of the line in the measure of the money |
| Money & Banking – MGT411 |
| VU |
| Where to draw the line? |
| In reality, we draw line at different places and compute several measures of money called the |
| monetary aggregates |
| M1, M2, and M3 |
| M1 is the narrowest definition of money and includes only currency and various deposit accounts |
| on which people can write Cheques. |
| Currency in the hands of the public, |
| Traveler’s Cheques, |
| Demand deposits and |
| Other chequeable deposits |
| M2 includes everything that is in M1 plus assets that cannot be used directly as a means of payment |
| and are difficult to turn into currency quickly, |
| Small-denomination time deposits, |
| Money market deposit accounts, |
| Money market mutual fund shares |
| M2 is the most commonly quoted monetary aggregate since its movements are most closely related |
| to interest rate and economic growth. |
| M3 adds to M2 other assets that are important to large institutions |
| Large-denomination time deposits, |
| Institutional money market mutual fund shares, |
| Repurchase agreements and |
| Eurodollars |
| _Symbol |
| Assets included |
| C Currency |
| M1 C + demand deposits, travelers’ Cheques, |
| other chequeable deposits |
| M2 M1 + small time deposits, savings deposits, |
| money market mutual funds, money market deposit accounts |
| M3 M2 + large time deposits, repurchase agreements, institutional money market |
| mutual fund balances |
| © Copyright Virtual University of Pakistan |
| 10 |
| Money & Banking – MGT411 |
| VU |
| Monetar y Aggregates Figures in millions as of March 2005 |
| 1. |
| Currency issued 711,997 |
| 2. |
| Currency held by SBP 3,188 |
| 3. |
| Currency in tills of Scheduled Banks 43,914 |
| 4. |
| Currency in circulation (1 – 2 – 3) 664,895 |
| 5. |
| Scheduled Banks demand deposits 93,272 |
| 6. |
| Other Deposits with SBP 4,826 |
| 7. |
| M1 (4+5+6) 1,602,423 |
| 8. |
| Scheduled Banks Time Deposits 1,037,678 |
| 9. |
| Resident Foreign Currency Deposits 172,074 |
| 10. |
| Total Monetary Assets (M2) 2,812,175 |
| 11. |
| M3 |
| 3,833,686 |
| Source: State Bank of Pakistan |
| Table : The Monetary Aggregates |
| Monetary Aggregates Value as of August 2004 (U.S.$ billion) |
| M1 |
| = Currency in the hands of the public |
| 686.2 |
| + Traveler’s checks |
| 7.6 |
| + Demand deposits |
| 315.3 |
| + Other checkable deposits |
| 328.5 |
| Total M1 |
| 1,337.6 |
| M2 |
| =M1 |
| + Small-denomination time deposits |
| 794.7 |
| + Savings deposits including money market deposit |
| accounts |
| 3415.3 |
| + Retail money market mutual fund shares |
| 735.5 |
| Total M2 |
| 6,283.1 |
| M3 |
| =M2 |
| + Large-denomination time deposits |
| 1,036.3 |
| + Institutional money market mutual fund shares |
| 1,104.7 |
| + Repurchase agreements |
| 516.6 |
| + Eurodollars |
| 344.5 |
| Total M3 |
| 9,285.2 |
| © Copyright Virtual University of Pakistan |
| 11 |
| Money & Banking – MGT411 |
| VU |
| Figure: Growth Rates in Monetary Aggregates |
| 40 |
| 35 |
| 30 |
| 25 |
| M1 |
| 20 |
| M2 |
| 15 |
| M3 |
| 10 |
| 5 |
| 0 |
| -5 |
| Figure: Money Growth and Inflation |
| % |
| 30 |
| 25 |
| 20 |
| 15 |
| 10 |
| 5 |
| 0 |
| Years |
| Measures of Inflation |
| Fixed-weight Index - CPI |
| Deflator – GDP or Personal Consumption Expenditure Deflator |
| Consumer Price Index (CPI) |
| Measure of the overall level of prices used to |
| Track chang es in the typical household’s cost of living |
| Allow comparisons of dollar figures from different years |
| Survey consumers to determine composition of the typical consumer’s “basket” of goods. |
| Every month, collect data on prices of all items in the basket; compute cost of basket |
| CPI in any month equals |
| Cost of basket in that month |
| 100 Cost of basket in base period |
| × |
| © Copyright Virtual University of Pakistan |
| 12 |
| Money & Banking – MGT411 |
| VU |
| Example: |
| The basket contains 20 pizzas and 10 compact discs. |
| Prices |
| Years Pizza CDs |
| 2002 $10 $15 |
| 2003 $11 $15 |
| 2004 $12 $16 |
| 2005 $13 $15 |
| From this table, we can calculate the inflation rate as: |
| Years Cost of Basket CPI Inflation rate |
| 2002 $350 100.0 n.a. |
| 2003 370 105.7 5.7% |
| 2004 400 114.3 8.1% |
| 2005 410 117.1 2.5% |
| GDP Deflator |
| The GDP deflator, also called the implicit price deflator for GDP, measures the price of output relative to |
| its price in the base year. It reflects what’s happening to the overall level of prices in the economy |
| GDP Deflator = (Nominal GDP / Real GDP) ×100 |
| Years Nom. GDP Real GDP GDP Deflator Inflation Rate |
| 2001 Rs46, 200 Rs46, 200 100.0 n.a. |
| 2002 51,400 50,000 102.8 2.8% |
| 2003 58,300 52,000 112.1 9.1% |
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