Subject 4: MONEY CIRCULATION CIOBU Stela Assoc. Prof., Ph.D. Content of the subject I. ORGANIZATION OF MONETARY CIRCULATION II. BROAD MONEY III. MONETARY EQUILIBRIUM AND INFLATION 1. ORGANIZATION OF MONETARY CIRCULATION Concept of money circulation Economic existence is due to the circulation of value in the diversity of its forms. Money emerged as a tool to facilitate trade in goods, to later become the general means of transferring value. Currency, being itself a bearer of value, is in motion, generating the phenomenon of monetary circulation. Qualitative aspect of monetary circulation The qualitative side of monetary circulation is characterized by the expansion of the range of currency forms and types of payment instruments and the breadth of the diversity of payment methods and settlement forms. The quantitative aspect of monetary circulation The quantitative side of money circulation is defined by the indicators of money supply and monetary circuit. The monetary circuit represents the sum of all payments made in a certain period of time. Forms of monetary circulation Monetary circulation takes place in: cash circulation in cash - banknotes, dividing coins; cash circulation without cash - account money, also called scriptural currency. Monetary circulation in cash Instruments of monetary circulation in cash: main currency; divisional currency. The method of payment in cash means the direct transmission of money. Monetary circulation without cash Instruments of cash circulation without cash: Cheque; Bill of exchange; Promissory note; Bank card etc. Methods of payment by bank transfer: Payment order; Payment disposition; The letter of credit; Incasso etc. 2. Broad money Concept of broad money The concept of broad money has evolved from one period to another depending on the knowledge of the monetary phenomenon and the formation of management capacities both of the money sector and, through it, of the economy as a whole. Thus, for a long time it was considered that the broad money would consist only of currency with full value. Then banknotes and treasury notes were included in the broad money. Subsequently, the inclusion in the broad money and the account money was accepted. At present, the broad money is a sufficiently large aggregation of funds. Opinions about broad money Broad money in circulation - consisting of the sum of assets that can be used on the territory of a country for the purchase of goods and services and for the payment of debts. Broad money - the total means of purchase, payment and accumulation, which serve various relations and which belong to individuals and legal entities and the state. Broad money represents the set of means of payment, respectively of liquidity, existing at a certain moment within an economy. Broad money represents the totality of the means of liquidity existing at a given moment within an economy (O. Stratulat). Components of broad money actual currency or cash (main and divisional currency); account currency (cash in current accounts); term deposits; other assets. Features on broad money Broad money is the most flexible method for measuring an economy's money supply, accounting for cash and other assets easily converted into currency. The formula for calculating money supply varies from country to country, so the term broad money is always defined to avoid misinterpretation. Central banks tend to keep tabs on broad money growth to help forecast inflation. Monetary aggregates The reasoning behind measuring the amount of money is the following axiom: since money is the reserve of liquid assets used to carry out transactions, the amount of money is, in fact, the amount of these assets. Conceptually, the idea is simple, but the technique of realization in practice is quite difficult. This is conditioned by the fact that the mentioned assets possess a different degree of liquidity. However, in order to measure the amount of money in the economy, certain indicators are used, resulting from the grouping of liquid assets, which have been called monetary aggregates. Opinions on monetary aggregates Monetary aggregates until the 1970s had a relatively simple structure, being considered as currency, the means of payment with short-term liquid investments, included in the liabilities of banks. Monetary aggregates are one of several groups of liquid assets that serve as an alternative measure of money supply. Acceptances regarding monetary aggregates Monetary aggregates comprise both the means of payment (actual currency, deposits in current accounts) held by resident non-financial agents and those financial investments that can be easily and quickly converted into payment instruments without the risk capital losses. Monetary aggregates in developed countries Cash - groups all means of payment in the form of actual currency (banknotes and currency) M1 - includes Cash + deposits in current accounts M2 - consists of M1 + term deposits and savings accounts in commercial banks; M3 - includes M2 + assets with different degrees of liquidity and in the structure of which certificates of deposit, receipts, medium-term savings accounts, etc. can be included titles. L - consists of M3 + securities issued in the medium and long term negotiable and which can be converted faster or slower into means of payment, respectively into liquidity. Monetary aggregate M 1 M1 is a narrow measure of the money supply that includes physical currency, demand deposits, traveler’s checks, and other checkable deposits. M1 does not include financial assets, such as savings accounts and bonds. The M1 is no longer used as a guide for monetary policy in the United States due to the lack of correlation between it and other economic variables. Monetary aggregate M 2 M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money. M2 is a broader measure of the money supply than M1, which just includes cash and checking deposits. M2 is closely watched as an indicator of money supply and future inflation, and as a target of central bank monetary policy. Monetary aggregate M 3 M3 is a collection of the other M classifications of money. M3 has largely been replaced by MZM as a measure of money supply. M3 is still published as a source of economic data, but mostly for ease of historical comparisons. Monetary indicators Monetary indicators are the indicators with the help of which it is possible to dimension the money supply, to follow its evolution and effects. CATEGORIES OF INDICATORS The first category includes indicators that directly estimate the parameters of the money supply and its evolution. The second category of indicators is used to estimate the effects of money supply on economic parameters. Indicators for estimating broad money parameters and their evolution The broad money level represents its size on each money aggregate at a given date. A special level indicator is the share of money in GDP. It is calculated according to the ratio: MM / GDP x 100%. The monetary base indicator (WB) is also used to assess the level of money supply, which is calculated as the sum of cash (C) and commercial banks' reserves at the Central Bank (R). BM = C + R. Money structure indicators The broad money structure represents the share of each constituent in its total. The structure of the broad money (Smm) is determined according to the relation: Smm = Ci / MM x 100%, where: Ci - the component of the broad money i; MM – broad money; i - component type Broad money dynamics indicators Money market dynamics notice the change of its quantitative parameters from one period to another. The main dynamics indicators are the absolute increase (AM) and the relative increase (AMI) of the broad money and are calculated according to the relation: AM = AM i1 - AM i0, where: AM i1 - the monetary aggregate of type i at the reference date; AM i0 the monetary aggregate of type i at the base date; i - the type of monetary aggregate. IAM = AM i1 / AM i0 x 100%. Indicators of evaluation of money effects (1) INTEREST RATE The effects of the change in the interest rate indicator on the money supply are manifested depending on the time period, namely: in the short term - an increase in interest rates accelerates the growth of broad money, and a decrease slows it down. in the medium term, an increase in interest rates slows down the growth of the broad money and vice versa. CALCULATION FORMULA The main effect indicator is the interest rate (r). It expresses the percentage ratio between the interest paid for the loan commitment and the loan amount: R = D / Cx100%. Indicators of evaluation of money effects (2) VELOCITY is the indicator that expresses the average number of uses of the monetary unit in transactions for the payment of goods and services, the fulfillment of obligations, the transfer of capital in a certain period of time. FACTORS THAT INFLUENCE VELOCITY - economic environment, monetary aggregates, organization of payments, psychological factor, etc. EQUATION M x V = P x Y, where: M - the amount of money in circulation (broad money); V - speed of money circulation; P - price level (average size); Y - the actual volume of production. Broad money in RM Monetary aggregates are calculated according to the Regulations of the National Bank of Moldova. In this way, the composition of the money supply has its authenticity. COMPOSITION OF BROAD MONEY IN RM (M 0) - cash M 1 - M 0 + current deposits; M 2 - M 1 + time deposits + money market instruments; M 3 - M 2 + foreign currency deposits + instruments of capital market. 3. Monetary equilibrium and inflation MONETARY EQUILIBRIUM CONCEPT Monetary equilibrium is that state in which there is no excess of money, no shortage of money in circulation, that state in which there is neither inflation nor deflation. Monetary equilibrium is the neutral point between inflation and deflation. The monetary equilibrium is given in terms of the relationship between the amount of money in circulation and the amount of money objectively needed in circulation. The condition of the monetary equilibrium is the equality between the money supply and demand of the economy. MONETARY EQUILIBRIUM EQUATION C+S+M=C+I+L where: C + S + M - money supply, the amount of money in circulation; C + I + L - the demand for money, the objective amount of money necessary to be in circulation under the given conditions. C+I+M=C+I+L where: C - consumption; I - investments; M - cash flow (supply); L - demand for liquidity. FEATURES OF MONETARY EQUILIBRIUM The monetary equilibrium does not require the money supply in circulation to remain constant, but to adapt to the needs of the economy. The monetary equilibrium by its nature is unstable, i.e. once the confidence in money is eroded, it can become the cause of inflation, of rising prices. Monetary equilibrium does not imply unchanged prices. The monetary equilibrium is related to the general economic balance, it being another facet of it. Concept of inflation Inflation or price inflation is a general rise in price level relative to available goods resulting in a substantial and continuing drop in purchasing power in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy. EFFECTS OF INFLATION Increase in money supply; Decreased purchasing power of money. EFFECTS OF INFLATION Inflation like any complex phenomenon is explained by multiple causes: excessive credit growth, rising budget deficits and external balance of payments; salary increases; decrease in the production of goods and services, etc. Causes of Inflation Rising prices are the root of inflation, though this can be attributed to different factors. In the context of causes, inflation is classified into three types: Demand-Pull inflation Cost-Push inflation Built-In inflation. Demand-pull inflation Demand-pull inflation occurs when the overall demand for goods and services in an economy increases more rapidly than the economy's production capacity. It creates a demand-supply gap with higher demand and lower supply, which results in higher prices. For instance, when the oil producing nations decide to cut down on oil production, the supply diminishes. This lower supply for existing demand leads to a rise in price and contributes to inflation. Additionally, an increase in money supply in an economy also leads to inflation. With more money available to individuals, positive consumer sentiment leads to higher spending. This increases demand and leads to price rises. Money supply can be increased by the monetary authorities either by printing and giving away more money to the individuals, or by devaluing (reducing the value of) the currency. In all such cases of demand increase, the money loses its purchasing power. Cost-push inflation Cost-push inflation is a result of the increase in the prices of production process inputs. Examples include an increase in labor costs to manufacture a good or offer a service or increase in the cost of raw material. These developments lead to higher cost for the finished product or service and contribute to inflation. Built-In Inflation Built-in inflation is the third cause that links to adaptive expectations. As the price of goods and services rises, labor expects and demands more costs/wages to maintain their cost of living. Their increased wages result in higher cost of goods and services, and this wage-price spiral continues as one factor induces the other and vice-versa. FORMS OF INFLATION BY ITS INTENSITY Creeping inflation, expressed by an average annual rate of increase in consumer prices of up to 3%; Moderate inflation, if the respective prices increase at a rate of up to 6%; Rapid inflation, when the rate approaches 10%; Galloping inflation, when the increase in consumer prices exceeds 15%. Hyperinflation price increase exceeds 50%. CONSEQUENCES OF INFLATION the decrease of the economies of the economic agents diminishing the resources due to the decrease of the purchasing power of the money; disadvantage for creditors; the decrease of the production, because the increase of the prices leads to the uncertainty of the development of the production in the future; elimination of a part of the accumulated resources; discouraging long-term productive investments; generating and expanding unemployment; depreciation of the national currency; the penetration of capital from the production process into trade and intermediate operations, where a higher speed of working capital is produced and a higher income is achieved; the increase of speculation as a result of the disproportionate increase of prices; depreciation of state financial resources; redistribution of wealth and income, in which case the income is not indexed and the loans are granted without taking into account the price index. Deflation Deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0% (a negative inflation rate). Inflation reduces the value of currency over time, but sudden deflation increases it. This allows more goods and services to be bought than before with the same amount of currency. Deflation is distinct from disinflation, a slow-down in the inflation rate, i.e. when inflation declines to a lower rate but is still positive. Deflation usually happens when supply is high (when excess production occurs), when demand is low (when consumption decreases), or when the money supply decreases (sometimes in response to a contraction created from careless investment or a credit crunch) or because of a net capital outflow from the economy. Stagflation Stagflation is a term used by economists to define an economy that has inflation, a slow or stagnant economic growth rate, and a relatively high unemployment rate. Economic policymakers across the globe try to avoid stagflation at all costs. With stagflation, a country's citizens are affected by high rates of inflation and unemployment. High unemployment rates further contribute to the slowdown of a country's economy, causing the economic growth rate to fluctuate no more than a single percentage point above or below zero. Thank you very much for your attention!!!
