NOTE FROM SLIDES
W1 L1
Definition of money : ‘’ Money is defined as asocial artifact created to facilitate market trading between individuals
that weren’t bound otherwise by family , in fact money are unnecessary in an exchange of value between two
members of the same family ‘’
• Transactions taking place in families, communes, religious communities, group of friends and (up to a point)
transactions within firms do not require monetary transfers. The price mechanism is suppressed and the
allocation of goods and resources is organized internally on the basis of authoritative mechanisms,
reciprocity, gifts etc.
In an economic system where exchange are impersonal and decentralized there is the need of an instrument that
reduce costs of transaction that are bond in this type of exchange; and the best instrument is money
There are three things that identifies a market economy :
1) Well-defined property rights over available resources (Property rights identification and protection)
and freedom to transfer them from seller to buyer (Decentralized exchange)
2) Division of labour: the separation of a work process into a number of tasks, with each task performed
by a separate person or group of persons, who need each another but do not necessarily know each
other
3) Market definition: “A mechanism for effecting purchases and sales in a relatively public manner. Thus
a market entails a way of carrying out transactions and some means of collecting and disseminating
information on the terms of the transactions, particularly price. These two aspects are inherently
interrelated.”
We can identify two types of transaction/trading :
1) Centralized trading/transaction : in a world characterized by centralized trading the transactions/trading
are frictionless and there is certainty about resources . In this type of world trading counterparts ,
contracts enforcement and money wouldn’t be essential and can be replaced by multilateral barter
and/or credit arrangements.
2) Decentralized trading : in reality trading works as a decentralized system , which includes transaction
friction and so the need of a instrument to facilitate impersonal transaction .
there are three primary friction in a transaction :
1) Coincidence of wants : both of the counterparts to engage a transaction , must be able to satisfy their
needs thanks to it
2) Long-run commitment to contracts cannot be enforced : penso facia riferimento al fatto che I contratti
a lungo termine nonn è sicuro che vengano rispettati
3) Agents are anonymous and their trading histories are not public information (lack of information
between the agents in the transaction )
In addition to the friction of a transaction there are also the transaction cost :
1) Search and information costs : Trading place, counterparty, market rules, market conditions
2) Bargaining ( contrattazione) and decision cost : (Quality assessment, price fixing, contract drafting,
clearing, settlement, contract registration)
3) Policy and enforcement costs : Compliance, litigation in case of breach of contract, frau
The presence of frictions, uncertainty and transaction costs, makes it logical (and rational) to search for ways
to reduce those frictions and in this way improve the quality of exchnage … Money are the result of a trial and
error process in a decentralized trading system which were made to reduce frictions uncertainty ana
transaction cost in trading
There are 2 main views of the story and functions of money :
1) ORTHODOX VIEW : it s a current of thoughts which believe that money were the result of trial an
error … and so are the result of actions in markets . they built a lot of models like Monetry
equilibrium , money as a medium of exchange , but at the end of the day are pointless
2) Heterodox view : this view goes against the orthodox view because it say s that money came from
state activity and it is a tool made to accomplish it s purpose in fact for them Precious metals
become «money» only if officially minted / standardized. Otherwise, verification costs can be very
high and reduce their value as medium of exchange. Moreover, the fact that gold is valuable is
itself the result of a social convention. Arguments against search models :
a. Minting is a public activity, which the government regulates (and uses as a source of income).
Minting requires holding large inventories of precious metals (which require protection) and can
be time inconsistent (unless a credible government with a long-run horizon takes care of it).
b. Society needs istitutions to regulate conflicts and obligations between its members (including
conflicts over property rights). Means of payment makes compensation possible, contributiong
to the maintenance of law and order and the regulation of economic activities.
c. Strong governments make strong currencies and successful monetary reforms. (E.G. monetary
reforms of Charlemagne). Weak governments on the other hand often mismanage the currency,
debase it, reduce its quality etc.
d. The collapse of the State brings about the collapse of the currency and the possible reversal to
barter / non monetary exchange / self-sufficiency.
e. How do you explain fiat currency without bringing in the State (or some equivalent authority)
into the picture.
Monetary instruments embody an abstract standard of value and money cannot exist without an authority
regulating it and enforcing its use.
In The heterodox view Once the State establishes an official means of payment and medium of exchange (legal
tender) it has an instrument that makes it easier to pay taxes (alternatives being goods and labour), manage
government expenditure (eg. Paying soldiers) and regulate transactions in the private sector. Power of the State in
monetary matters is not unlimited (monetary mismanagement leads to instability, financial crisis and in some cases
to hyperinflation, which is end of the monetary system
Attempts to escape government regulation/taxation contribute significantly to the evolution of money (e.g. virtual
currencies and in general financial innovation).
In conclusion there are Two views on money and its origins :
•
•
ORTHODOX : Money as an «object» created to facilitate trading / exchange. Money as the result of a
collective trial-and-error discovery process rooted in multilateral decentralized exchange. The outcome of
this process is a free monetary order based on trust.
•
Money supply, money velocity, QTM …
•
Metallism is one version of this view (The M-Team)
•
COINS and substitutes
HETERODOX : Money as a «standard of value» created to facilitate the quantification / settlement of
debts (tax debts in particular). Money as the result of the ‘State’ introducing a standard to regulate tax
payments and the economic life of the community in a centralized way. The outcome of this process is a
regulated monetary order based on authority. (Heterodox view)
•
Money and debt, MMT
•
Cartalism is one version of this view (The C-Team)
•
Money (Unit of account) before COINS
•
The state introduced money to facilitate tax payments
•
Through tax the state forced it s civilians to adopt money as a means of payment for every day
transaction
Relevant things :
•
Medium of exchange is the primary function of money (logically and chronologically) and money can be
thought of as a connector between buyer and seller trading commodities
•
Unit of account and means of payment are the primary functions of money (logically and chronologically)
and money can be thought of as a connector between payor and payee, debtor and creditor (not necessarily
backed by anything real)
W1 L2
FUNCTIONS OF MONEY :
1) Unit of account / Standard of value: The existence of a unit of account simplifies transactions and enhances
the quality of economic decisions
a. Accounting (costs, revenues, credit, debts)
b. Units of account need not have a physical dimension and was neither minted nor represented by
paper documents as exemplified by imaginary money in Medieval times
c. Generally, some kind of authority is necessary to establish a unit of account
2) Means of payment: Money as a means of payment guarantees finality. Payment, from payer to payee, is a
unilateral transfer that extinguishes obligations / debts including tax debts and, in old times, wergeld
(blood money).
3)
4) Medium of exchange
5) Store of value
Other functions
6) Political functions
7) Symbolic functions
IN QUESTA LEZIONE C è L ESERCIZIO DEL PREZZO
P2019 is an arbitrary number
SLIDE 3 W1 L3
We can say that money has 4 primary funcionts :
1)
2)
3)
4)
Standard of value
Means of payment
Medium of exchange
Store of value
Money As a means of paymant garantees the finality
Payment is a unilateral transfer, payor to payee , that extinguishes debts / obligation (so it s
an action which finality is to extinghuish debts )
everything can be quantify with a sum of money
Money as means of payment can be defined as legal tender ; something became legal tender
and so a mean of payment with the decision of a local authority which decide :
- What it s used as a legal tender
- To enforce( assicura ) it use , giving payment system through it
- to making it the only instrument with legal tender and so the only tool that can be used
as a medium of exchange
Means of payments (material) embodies units of account (immaterial)
PAYMANT METHODS
Payment exist independently from exchange , but this two are connected with a transaction
between two individuals in fact : ‘’ Payment in connection with exchange is made whenever a
seller of a good, or service, or another asset, receives something of equal value from the
purchaser, which leaves the seller with no further claim on the buyer’’
The payment of the transaction can be :
- With cash payment whenever we ha the payment with money on the spot (spot prices )
- It can also be with credits , that means future payments ( future prices )
Money as a medium of exchange is that particular “object” which everybody accepts in return
for selling something on the basis of the expectation that it will be possible to use the same
“object” to buy goods or services in the future.
• If payment is bilateral (from payor to payee) and static (final); exchange is multilateral
and dynamic (the seller accepts money from the buyer expecting that he will be able to
use the same money to buy something at a later stage)
As a medium of exchange money facilitates the functioning of markets by reducing transaction
costs associated to the transfer of property rights
Market transactions require an exchange in which both sides believe they will benefit from
obtaining from the other party something of greater or equal value to whatever they have
given up.
• An exchange of goods for goods (barter) will either require the unlikely occurrence of
the double coincidences of wants, endowments and timing (bilateral barter) or leave
one party to the exchange holding a good which that party will want to exchange later
for some other good (multilateral barter).
• When exchange is anonymous, decentralized and multilateral, transaction costs in the
case of barter exceed transaction costs in the case of monetary exchange. So in a
decentralized system is preferable use Money as a medium of exchange
When we have barter ( an exchange of goods for goods ) it requires the unlikely occurrence of
the double coincidences of wants, endowments and timing
n a world characteri ed by centralised trading, fric onless
transac ons and certainty about resources, trading
counterpartsand contract enforcement, money would be
non essen al and could be replaced with mul lateralbarter
and or credit arrangements.
owever, fric ons in decentrali edtrading e ist
Double coincidence of wants problems otherwise barter
ong run commitment to contracts cannot be enforced
gents are anonymousand their trading historiesare not
public informa on uncertainty
Money as a medium of exchange must posses certain features which are :
- Standardization : everyone must accept that medium of exchange , with which must be easy
asses the value of an asset
- Wide general acceptance (either as a result of an implicit social agreement between market
participants or of legal enforcement by the State)
- Divisibility ; to make it possible to make change)
- Low carry cost (money must be easy to transport, transfer, protect, store)
- Durability( Slow deterioration)
Money can be defined as a commodity ( merce) , which has the same proprieties listed above ,
which circulate the market with a certain velocity
The notion of money velocity is essential to the quantitative theory of money, which we will
discuss in Part II, and more generally to orthodox views about money
Trilateral exchange and money velocity
o 3 individuals
o M = 100 EUR (money supply)
o PT = 300 EUR (value of transactions)
o MV = PT therefore V = PT/M = 3
STORE OF VALUE
The store of value ( propriety of money ) can be defined as the general purchasing power
over the time (Money = Frozen desires)
Whereas as unit of account and means of payment money has no rivals, as a store of value it
competes with financial assets (e.g. bonds, equity, investment fund shares) and real assets
(gold ingots, jewels, artwork, realt estate).As a store of value, money has a big advantage
over the alternatives: Liquidity. The spectrum of liquidity (Hicks 1963
LIQUIDITY : The quality of being readily convertible into cash: an investment with high
liquidity.
Cash, cash equivalents and other assets (liquid assets) that can be easily converted into cash
(liquidated). In the case of a market, a stock or a commodity, the extent to which there are
sufficient buyers and sellers to ensure that a few buy or sell orders would not move prices
very much. Some markets are highly liquid; some are relatively illiquid
A liquid security, such as a share in a large listed company or a sovereign bond, is easy to price
and can be bought or sold without significant price impact
The three aspects of liquidity: easy to buy and sell, at low or nihil cost and at a predetermined value in terms of money
The role of markets as providers of liquidity (think about secondary financial markets in
particular). The term also means how easy it is to perform a transaction in a particular security
or instrument.
Money performs economic (material) and non economic functions (symbolic, strategic,
political)
• Functions, performed by money only: unit of account / means of payment (legal
tender)
• Functions which money performs alongside other assets: medium of exchange /
store of value / non economic functions
ORTHODOX VIEW OF MONEY
oney, the result of a decentrali ed trial and error process
leading to an order based on trust, e ists to reduce transac on
costs and make decentrali ed anonymous market trading work
more e ciently
ccording to this view, medium of e change which includes
means of payment is the primary func on of money.
oney is the outcome of a bo om up search process, which at
some point the tate regulates as it regultes general economic
ac vity.
s long as buyers and sellers agree to use a given medium of
e change, money can e ist independently of the tate.
HETERODOX VIEW OF MONEY
oney, the result of a centrali ed process based on
authority,e ists to facilitate the uan ca on payment of
ta es and other obliga onswithin a given community.
ccording to this view, unit of account means of payment
are the primary func ons of money.
oney is the outcome of a top down process, origina ng
from the tate.
y regula ng money, the tate in uences income
distribu onwithin the community, anddebt credit rela ons.
W2 L1
Types of money in the past
Commodity money : they are items (commodity) that have some futures of money and there
so where use as a medium of exchange in the past and still today ( in barater). is based on
some real units (commodities ) that are freely obtainable , non monopolized and well
accepted between agents in a exchange . Their value is base on the intrinsic value ( which
comprehend anche l utilizzo ) of the commodity
•
Commodity money is money whose value comes from a commodity of which it is
made. Commodity money consists of objects having value or use in themselves (intrinsic
value) as well as their value in buying goods. Sono merci il quale valore intrinseco (
basato anche sul suo uso ) combacia con il suo valore nominale ( face value ) , un
esempio è l oro
• Commodity money consists of items that may be in common everyday use,
endowed (dotato) with intrinsic (use) value and used primarily as medium of
exchange in the context of rural subsistence economies (Orthodox view reflecting
commodity theory of money)
• It s a type of barter
• In primitive exchange, however, commodity money often consists of highly ranked
treasure items, used “to create social relationships … prevent group hostility or
warfare … elevate one’s political position… and restore peaceful social relationships
between persons and groups disrupted by conflict.” Dalton 1982, uoted by Wray
2012: 10) (Heterodox view reflecting claim theory of money, because it serves the
society )
Over the time this type of medium of exchange evolved in METAL COINS because ‘’ pieces of
metals were found more convenient for the purpose. They were easily carried, easily identified,
and easily divided; they did not decay and could easily be weighted. Hence( da qui ) names for
weights often passed into names for coins: the shekel, the livre, the lire, the pound and so on.”
• Initially metals were used as money in the form of bars, bricks, rings and estimated by
bulk and weight. Afterwards, metal bars were stamped to save the trouble of weighing
and measuring them.
• This in turn led to coinage, Earliest coins were minted around 700 b.C in the kingdom of
Lydia ) and were made of electron (alloy of gold and silver).
METAL COINs
Metal coins like gold and silver are commodity money
Gold and silver have histories that go back in centuries as the money of choice of many societies
and as international media of exchange. Copper coinage antedates them, but copper became
too abundant and was relegated to subsidiary coins. The precious metals are durable. They are
divisible not convenient denominations. The can be made into ingots, bars and coins of
standard weight.
Coinage immediately became a prerogative of governments and sovereigns and has remained
so ever since (seigneurs – seignorage) . Minting by the government as a guarantee against
forgery and counterfeiting, but not necessarily against debasement (
deprezzamento/svalutazione ) engineered by the government itself (exploitation of seignorage)
ni al situa on
1 o of silver ore 1 coins silver coins
ach coin contains .1 o of silver each plus some vile metal
9
1
silver 1
1
vile metal
ossible ways todebase the currency
ess silver per coin . 9 o instead of .1 but same propor on
of silver and vile metal lighter coin
educe neness: same coin appearance, weight but 8 1
silver and 2 1
vile metal
ore coins per o of silver 12 instead of 1
ombina ons of these means
Different types of metal coins were used for different purposes. Gold (and heavy silver) coins
were used for large / international payments, were valued according to their metallic content
and were rarely debased. Silver, copper, bronze coins, instead, were used for small / domestic
payments and circulated at face value.
From Florence, Venice and Genoa to Amsterdam and London. The age of the Gold Standard
h ps: www.britannica.com topic goldstandard
Gold standard is a monetary system based on monometallism that sees gold as the only metal
in which money could be converted in a predeterminate rate ( like 5 dollars can be exchange
with one gram of gold ) . This monetary system was introduced first in England in the 1821 and
ended with the start of the first world war 1914 ; it was reestablished in the 1928 for a short
period of time .
BIMETALLISM
Monetary standard or system based upon the use of two metals. The typical 19th-century
bimetallic system defined a nation’s monetary unit by law in terms of fi ed uantities of gold
and silver (thus automatically establishing a rate of exchange between the two metals
FIAT CURRANCY = VALUTA FIDUCIARIA
Fiat money = this is a legal currency that does not have an intrinsic value but its value is
guaranteed and recognized by the state and corrispond to its monetary face value ( valuta
legale , cioè una valuta che non ha un valore intrinseco ma il suo valore e garantito e
riconosciuto dallo stato )
This is the evolution of coinage based on precious metals
Fiat currency definition : “Fiat currency is a representative (or token) Money (i.e. something the
intrinsic value of the material substance of which is divorced from its monetary face vale) – now
generally made of paper except in the case of small denominations – which is created and
issued by the State, but is not convertible by law into anything other than itself, and has no fixed
value in terms of an objective standard”
anaged money is similar to iat oney, except that the tate
underta es to manage the condi ons of its issue in such a way
that, by conver bility or otherwise, it shall have adeterminate
value in terms of an ob ec ve standard
ommodity oney and anaged oney are ali e in that they
are related to an ob ec ve standard of value
anaged oney and iat oney are ali e in that they are
representa ve or paper money, having rela vely li le or no
intrinsic value apart from the law or prac ce of the state
eynes 19 , p.8
Managed money : si riferisce a un sistema in cui lo Stato o un'autorità centrale gestisce
attivamente le condizioni di emissione della moneta al fine di garantire un valore stabile o
determinato. In pratica, ciò potrebbe significare che la moneta è legata a un valore di
riferimento specifico, come una determinata quantità di oro o una valuta estera stabile.
L'obiettivo della gestione della moneta è quello di mantenere la stabilità del valore nel tempo,
prevenendo l'inflazione e garantendo la fiducia nel sistema monetario. Ciò può essere realizzato
attraverso politiche monetarie come la regolamentazione del tasso di cambio, la gestione delle
riserve di valuta estera o l'adozione di regole specifiche per la creazione e l'emissione di
moneta.
Fiat currency : La fiat currency (o valuta fiduciaria) è una forma di moneta emessa da un
governo centrale ed è accettata come mezzo di scambio legale all'interno di un paese. La
caratteristica chiave della fiat currency è che il suo valore è stabilito e sostenuto dalla fiducia
dei cittadini e dalla legge, piuttosto che da un supporto fisico come l'oro o altre materie prime.
A differenza di altri tipi di monete, come l'oro o le valute digitali basate sulla blockchain, la fiat
currency non ha un valore intrinseco. Il suo valore deriva dalla fiducia che la gente ha
nell'autorità emittente, solitamente un governo centrale o un'autorità monetaria come una
banca centrale. La fiat currency può essere soggetta a inflazione o svalutazione a causa di
fattori come la politica monetaria, l'inflazione, il deficit di bilancio o eventi economici globali.
Inoltre, le valute fiat possono essere soggette a rischi di contraffazione, motivo per cui vengono
spesso dotate di misure di sicurezza per prevenire frodi.
The difference between this two type of money is that managed money ha its value fixed while
the fiat currency’s value is subject to changes due to monetary policy actions
Managed Money and Fiat Money are alike in that they are representative or paper money,
having relatively little or no intrinsic value apart from the law or practice of the state.”
W2. L2
old and silver coins
an notes issued by
To en coins (vile metal)
eynes 19
an deposits
an onotes issued by private ban s
, rea se on
oney, h. 1, p. 9
In the past there were 4 types of money :
1) Commodity money :
a. Gold and silver coins
2) Managed money : money which value isn t based on the intrinsic value of the
representative banknote , but on the commodity which the banknote represent. Manage
money can be converted in the commodity which represent. The value of this instrument
is connected to the value of the commodity or something behind it like gold.
a. Proper money: are managed money because their value are fixed to the value of
the commoditie chosen by the state
b. Bank money : this are private banknotes issued by banks whish represented a
credit owned by a person towards the bank that issued the banknotes. banknotes
were menage money , in fact they were convertible
3) Fiat money/ fiduciary money : proper money with legal tender , The face value of base
metal coins is higher than the value of the metal they contained (token / fiat currency).
Bank money : this are private banknotes issued by banks whish represented a credit
owned by a person towards the bank that issued the banknotes. banknotes were menage
money , in fact they were convertible in BOE money which could be converted into gold
Keynes distinguishes between two types of money: Money-proper and Bank money resulting
from the acknowledgment of debts
• Traduzione : Keynes distingue tra due tipi di denaro: moneta vera e propria e
moneta bancaria derivante dal riconoscimento dei debiti da parte della banca
verso l individuo
• Money proper was issued by the State and consisted of metal coins and banknotes
issued by the Bank of England (BOE, a private institution with public functions in
Keynes' time). BOE banknotes were convertible into metal unless declared
inconvertible (e.g. wartime).
o The banknotes issued by the BOE were an alternative to metal coins, which
they represented (representatative money). The BOE kept a reserve of
precious metals to ensure convertibility of its banknotes into gold.
• Bank money originated from the acknowledgement of debts that privates banks
contract with the depositors
o This type of banknotes were born before the banknotes issued by the central
bank ( which are proper money ) ; and when the state decided to built this
type of institute , privates banks couldn t issue private banknotes anymore
o For a while private and central bank both issued banknotes , and people could
convert in private banks the banknotes of central bank (that were legal
tender ) with banknotes of the private bank and some interest for the
conversion
o Households and firms could deposit coins and banknotes with private banks
that offer them payment services (cheques, giro and financial services
(granting loans with possible concomitant issuance of private banknotes).
o Bank deposits and banknotes issued by private banks could be converted into
coins and BOE banknotes on request.
o Every private bank had gold reserve
o at any time the holder of the current account deposit, if it is at sight, can
convert the amount of his account into fiat currency (State money). From this
point of view, the circulation of Bank Money and of State Money are not
independent”.
tate money held by the public: oins and
banknotes issued by
the ank of ngland, conver ble into gold, held by the public as an
alterna ve to coins, private banknotes and bank deposits handled by
che ues .
tate money held by member banks: oins and
banknotes issued
by the ank of ngland, conver ble into gold, held as a guarantee
against private banknotes conver ble into coins and
bankontes
and bank deposits handled by che ues .
tate money held by entral bank: oins and gold ingots held as a
guarantee against
banknotes and eserve money held by private
banks with the
.
eserve money: metal coins and ingots held as a guarantee against
banknotes and bank deposits.
ember bank money ank deposits handled by banknotes,
che ues and other scriptural instruments.
Metal oins and
ban notes conver ble into
gold
Metal coins
ban notes conver ble into gold
eld by the public
old and silver coins
and ingots held against
ban notes conver ble into gold
Metal coins
ban notes conver ble into gold
eld by ban s
an deposits handled by
private ban notes , ban
che ues and other
scriptural instruments
eynes 19
, rea se on
oney, h. 1, p. 9
Bank deposits held by the public with private banks and with private banks with the Central
bank have no physical dimension but only exist as a ledger-record ( leger = registro) and a book
value on the balance sheets of the institutions that issue those deposits. Payments and
collections are no longer made by delivering physical currency (If not occasionally), but only
through recordings in different current accounts and via bank cheques or other scriptural
instruments ( nel senso che le transazioni non avvengono più in modo fisico ma virtualmente
tra I depositi delle controparti)
TU
N Y: “Scriptural or book money is the money available on the current accounts
of households and businesses. It is a simple accounting entry made by a financial institution
(usually a bank). Scriptural money is therefore intangible, unlike fiduciary money (bank notes
and coins). However, it can be converted into liquidity at any time. If an economic agent
(household or business) does the opposite and deposits cash into their bank account, so the
money is converted into virtual currency to appear on their account”.
• Money deposited in a current account with a bank can be used at any time to make
payments. To this end, the bank provides households and businesses with various
means of payment, the main ones being: credit card, cheque, bank transfer or
electronic money. Scriptural money can then circulate between economic agents.
These non-cash means of payment are defined by the Monetary and Financial Code
scriptural money : si riferiscono a forme di denaro che esistono solo in forma digitale o
elettronica, senza una rappresentazione fisica come monete o banconote. Questo tipo di
denaro esiste come registrazione contabile o elettronica all'interno di sistemi finanziari e
bancari. L'uso di "scriptural money" è comune nelle transazioni finanziarie e nei pagamenti
elettronici. Ad esempio, quando si effettua un bonifico bancario, si trasferisce denaro
elettronicamente da un conto all'altro senza coinvolgere monete o banconote fisiche. Allo
stesso modo, quando si utilizza una carta di credito o un'app di pagamento elettronico per
effettuare un acquisto, si sta utilizzando "scriptural money" per completare la transazione.
L'avvento delle criptovalute e delle tecnologie blockchain ha introdotto anche forme di
"scriptural money" decentralizzato, in cui i registri delle transazioni sono mantenuti in modo
distribuito sulla rete e non controllati da una singola entità centrale come una banca.
In sintesi, gli "scriptural money" rappresentano forme di denaro digitali o elettroniche,
registrate all'interno dei sistemi finanziari, che facilitano le transazioni e i pagamenti senza la
necessità di monete o banconote fisiche.
Now days :
Scriptural money : money in the credit card ( virtual money ) that hasn’t ha physical dimension
and is electronic , and very liquid
Conclusions on monetary instruments in the past:
• Different types of monetary instruments co-exist, circulate together and are used for
different purposes (problem of converting one monetary instrument into the other).
Historically, coins came first, banks second and banknotes third in Europe.
• Monetary instruments evolve with exchange and payment mechanisms.
• Commodity money is there from the start and reappears together with token money
(substitutes for physical currency) anytime other (official) monetary instruments are not
available.
• With the emergence of banks the process of monetary de-materialization begins
W2.L3.21
Types of money today
Today, as in the past, money materialises in a number of different instruments that circulate
alongside each other and are used for different specific purposes within the general functions
of unit of account, means of payment, intermediary of exchange, store of value.
• Today, as in the past, some of these instruments are issued and regulated by the
State, others are issued by the private sector (mainly but not only commercial
banks) and regulated directly by the state, and still others are issued by the private
sector and not regulated directly by the state
According to the orthodox view, the evolution of monetary instruments over time can be
explained as the result of a continuous process of innovation aimed at reducing transaction
costs and at providing a growing economy with enough medium of exchange means of
payment
According to, the heterodox view, the evolution of monetary instruments over time is the result
of a kind of tit-for-tat mechanism whereby private individuals are engaged in trying to escape
state control and State-induced inflation and the State is engaged in frustrating these attempts
in order not to lose control over money and taxes.
Now days this are the main types of money «State-money» today consists of three monetary
instruments issued / regulated by the Central bank which are coins, banknotes, bank reserves
1) Metal coins (fiat currency) made of vile metal and mainly used for small retail payments,
to buy goods and services sold through automatic machines, to solve the 'change
problem'. Coins are convertible into other coins, banknotes, bank deposits (more rarely).
2) Paper banknotes (special paper, watermark) mainly used for small and medium retail
payments, to buy goods and services sold through automatic machines, to solve the
'change problem', for transactions in the black economy. Banknotes are convertible into
coins, banknotes, bank deposits. Metal coins and banknotes together represent cash /
currency.
3) Central bank deposits a.k.a. as bank reserves, a monetary instrument reserved for banks
and used by them to settle inter-bank payments. Bank reserves are the cash minimums that
financial institutions must have on hand in order to meet central bank requirements. This is real paper
money that must be kept by the bank in a vault on-site or held in its account at the central bank.
4) In addition to the money issued by the central bank (coins, banknotes, bank reserves),
money today includes current account and savings bank deposits issued/settled by
commercial banks, legally recognized electronic money convertible into state money,
electronic money without legal recognition issued by private entities on a decentralised
and/or centralised basis, private money issued in the form of tokens.
a. Electronic money without legal recognition, issued by private entities on a
decentralised and/or centralised basis, can replace legally recognised digital money
to a certain extent.
b. Private currencies in the form of tokens can replace central bank-issued cash
within certain limits.
5) Traditional money consists of state money, bank deposits, legally recognised e-money.
E-money stands for Electronic – money : this type of money are regulated by the state and
there so are legal tender. Eletonic money include deposits, current, This type of money can be
used for payment or exchange thanks to electronic payment instrument such us electronic
cards , e-wallet which are able to transfer eltronic money from a deposit to another without the
exchange of physical currencies
Beyond the description of their properties, legal status, and identity of the issuer, monetary
instruments can also be classified on the basis of the nature of the different
exchange/payment mechanisms they use:
1) Peer-to-peer mechanisms refer to the exchange or sharing of information, data, or assets
between parties without the involvement of a central authority. Peer-to-peer (P2P)
involves decentralized interactions among individuals and groups. This approach
characterizes the use of private token, coins and banknotes issued by the central bank,
virtual currencies.
2) Third-party based mechanisms. Payer and payee interact through one or more
intermediaries whose task it is to ensure the successful completion of the payment
through the various clearing and settlement operations . For example payment between
tow individuals through bank deposits , in this case the payment occurs through e money
because we have the transfer of e money from the deposit of the payor to the deposit of
the payee
Now lets discuss about 2 types of digital currency (no physical currency )
1) Crypto currency are characterized by :
a. Not liability of enyone : non hanno la responsabilità di qualcuno ,
b. They don’ t are legal tender
c. The transaction are peer to peer
d. They are electronic
2) Central bank digital currency :
a. They are issued by the central bank
b. They are legal tender
c. They are universally accessible
d. They are electronic
ource ech arrat 2 1
entral ank ryptocurrencies
uarterly eview eptember
CBCC= Central Bank Crypto Currency ; New cryptocurrencies are emerging almost daily, and many interested
parties are wondering whether central banks should issue their own versions. But what might central bank
cryptocurrencies (CBCCs) look like and would they be useful? This feature provides a taxonomy of money that
identifies two types of CBCC - retail and wholesale - and differentiates them from other forms of central bank
money such as cash and reserves. It discusses the different characteristics of CBCCs and compares them with
existing payment options.1
Wholesale = all ingrosso
Retail = al dettaglio
Electronic money
L'"electronic money" (denaro elettronico) è una forma di denaro digitale che esiste
esclusivamente sotto forma elettronica. È una rappresentazione digitale di valore monetario che
viene utilizzata per effettuare transazioni elettroniche. A differenza delle forme tradizionali di
denaro, come le banconote e le monete fisiche, l'elettronic money non ha una forma tangibile ed
esiste solo in forma digitale.
L'elettronic money può essere archiviato e trasferito attraverso vari mezzi elettronici, come carte
di credito, carte di debito, servizi di pagamento online, applicazioni mobili, e-wallet (portafogli
elettronici) e altri strumenti digitali. Questi mezzi consentono agli individui di effettuare
pagamenti e transazioni finanziarie in modo rapido e conveniente, senza dover maneggiare
denaro fisico.
Un esempio comune di elettronic money è rappresentato dalle carte di credito e di debito.
Quando si effettua un pagamento con una carta di credito, si trasferisce l'autorizzazione a
utilizzare una determinata somma di denaro dal proprio conto bancario o dalla linea di credito
associata alla carta. Questa transazione avviene attraverso reti di pagamento elettroniche che
garantiscono la sicurezza e la tracciabilità delle transazioni.
In sintesi, l'elettronic money è una forma di denaro digitale che consente pagamenti e transazioni
finanziarie attraverso mezzi elettronici, senza richiedere la manipolazione di denaro fisico.
Bank money has become the first monetary instrument in most countries. It is convenient (low
carrying cost), it is safe does not get lost and is pre-eminently the means of the bank credit. In
some countries the circulation of scriptural money can represent as much as 80% of the total
money circulation. Bank money today can be transferred via bills of change, checks, gyro
transfers and more importantly ELECTRONIC PAYMENT.
• Scriptural or book money is the money available on the current accounts of
households and businesses. It is a simple accounting entry( registrazione contabile)
made by a financial institution (usually a bank), so it’s the number that represent
the credit of a individual towards the bank . Scriptural money is therefore
intangible, unlike fiduciary money (bank notes and coins). However, it can be
converted into liquidity at any time. If an economic agent (household or business)
does the opposite and deposits cash into their bank account, so the money is
converted into virtual currency to appear on their account.
Electronic money is broadly defined as an electronic store of monetary value on a technical
device that widely used for making payments to undertakings other than the issuer without
necessarily involving bank accounts in the transactions, acting as a prepaid bearer
• Traduzione : La moneta elettronica è generalmente definita come una riserva
elettronica di valore monetario su un dispositivo tecnico che può essere
ampiamente utilizzato per effettuare pagamenti da imprese diverse dall'emittente
senza necessariamente coinvolgere conti bancari nelle operazioni, agendo come
uno strumento al portatore prepagato . un esempio è paypal , cioè la carta
prepagata , che rappresenta un conto a parte presso società , rispetto ai depositi in
banca,
Quindi gli scriptural money sono riferiti ai depositi bancari mentre gli electronic money
rappresentano i soldi sulle carte prepagate e quindi fondi presso società diverse da banche con
le quali non hanno i fondi collegati con il deposito bancario del cliente .
Il denaro scripturale e il denaro elettronico sono due concetti correlati ma distinti. Ecco una
spiegazione delle loro differenze:
Denaro scripturale: Il denaro scripturale si riferisce a denaro che viene registrato e trasferito
tramite i sistemi bancari e finanziari tradizionali. È una forma di denaro digitale che esiste
all'interno dei registri contabili delle istituzioni finanziarie. Il denaro scripturale viene creato
quando vengono effettuate transazioni come bonifici, assegni bancari o addebiti diretti, che
coinvolgono l'uso dei conti bancari degli individui o delle imprese. È chiamato "scripturale"
perché esiste solo come scrittura o registrazione e non ha una forma fisica.
Ad esempio, quando si effettua un bonifico bancario per pagare un bene o un servizio, il denaro
viene trasferito dal proprio conto bancario al conto del beneficiario tramite un sistema di
registri contabili. Il denaro scripturale può essere visualizzato attraverso estratti conto bancari o
altri strumenti simili, ma non esiste come forma fisica.
Denaro elettronico: Il denaro elettronico, come menzionato nella risposta precedente, si
riferisce a una forma di denaro digitale che esiste esclusivamente in forma elettronica. È un
concetto più ampio che include non solo le transazioni bancarie tradizionali, ma anche altre
forme di denaro digitale utilizzate per pagamenti elettronici. Il denaro elettronico può essere
archiviato e trasferito tramite carte di credito, carte di debito, servizi di pagamento online,
applicazioni mobili e altre piattaforme digitali.
A differenza del denaro scripturale, il denaro elettronico non si limita ai sistemi bancari
tradizionali e può essere utilizzato per transazioni in diversi contesti, come negozi online,
pagamenti senza contatto, trasferimenti di denaro peer-to-peer e altro ancora. Il denaro
elettronico è caratterizzato dalla sua natura digitale e può essere utilizzato in modo più
immediato e conveniente rispetto al denaro scripturale.
In sintesi, la principale differenza tra denaro scripturale e denaro elettronico è che il denaro
scripturale si riferisce specificamente al denaro registrato e trasferito attraverso i sistemi
bancari tradizionali, mentre il denaro elettronico è un termine più ampio che include tutte le
forme di denaro digitale utilizzate per transazioni elettroniche, indipendentemente dal sistema
o dalla piattaforma utilizzata.
lectronic money usescomputer networks, the internet and
digital stored value systems. Types of electronic money
include:
redit cards, Debit cards, mart cards
lectronic purse
entralisedsystems aypal, Webmoney e ash
ayments via mobile phone
irtual currency schemes
The comparison between scriptural and electronic instrument of payment is :
1) Type of money : both use intangible money in the transaction ,
2) Both transfer digital money from an account to another
3) They are both centralized systems because they have information on each other
4) The instrument :
a. Scriptural money uses cheque in the transfer of money
b. Electronic money uses cards
5) The both use money that are legal tender
6) The transaction : for scriptural is maid by the bank using scriptural payment , while with
electronic payment is maid by a company that simplify the transaction
7) Quindi in pratica con gli scriptural money si usano gli assegni e prevendo come
certificazione del pagamento
8) Electronic money for the transaction can use other company to facilitate the
transaction such as paypal
9) Electronic money can use the deposit of the user’s bank account or onother found
created with the company that makes the transaction
10) Electronic payment is more private than scriptural payment , because through scripturale
payment the counterparts must share their bank account information, while with
electronic payment it isn t needed
Un esempio misto è pay pal
aypal is ane commerce company that facilitatespayments between par es
through online funds transfers.
ay al allows customers to establish an account on its website, which is
connected to a user s credit cards or checking account. nce iden ca on
and proof of funds have been con rmed, a user may begin sending or
receiving payments to and from other ay al accounts. ay al a empts to
make online purchases safer by providing a form of payment that does not
re uire the payor or payee to disclose credit card or bankaccount numbers.
ay al broke into the mainstream when it appeared as a payment facilitator
for e ay auc ons. The service became so popular that e ay decided to
ac uire ay al in 2 2, making it the o cial transfer service for its website.
lthough ay al is not a bank, it is s ll subject to many of the same
consumer protec on regula ons by which banks are governed. or e ample,
under banking regula ons, the e tent of your liability for an unauthori ed
transac on is determined by how promptly you no fy the bank that
unauthori ed ac vity has occurred in your account. No fying ay al uickly
when you have concerns will help to limit your liability, and it is
recommended that ay al users check their accounts regularly.
ay al h p: www.investopedia.com terms p paypal.asp i
t r
ollow us: nvestopedia on acebook
VIRTUAL CURRENCY
This is a specific type of money which has not legal tender by itself and is used in transaction
in the online world , they can be based on an invented currency ( apex coins ) . There are
virtual currency that can become fiduciary money and so money with legal tender , they are
called cryptocurrency
There are 3 types of virtual currency
1) Type one : a virtual currency that :
a. an’t come from real money and can t become real money ( per esempio I punti
guadagnati in un videogioco come fruit ninja )
b. Can be used only to buy virtual goods and service ( come le skin sui videogiochi )
2) Type 2 : virtual currency that :
a. Can come from real money , but can t become real money ( come quando compri
gli apex coins con soldi veri , però questi non possono essre trasformati in soldi veri
)
b. Can be used to buy virtual goods and real goods
3) Type 3 : virtual currency that
a. Can come from real money , and can become real money
b. Can be used to buy virtual goods and real goods
In the third type are included BITCOINS AND THE OTHER CRYPTO CURRENCY
BITCOIN
• Bitcoins are not pegged to any real-world currency. The exchange rate is determined by
supply and demand in the market.
• Bitcoin is based on a decentralised, peer to-peer (P2P) network
W3.L2.22 MONEY AGGREGATES
Coins and
banknotes (Fiat
currency, legal
tender used by
the Public)
Bank
reserves
(Digital
currency
reserved to
Banks)
Bank deposits
Regulated Emoney (often
(scriptural /
linked to Bank
digital money
deposits, CC,
convertible into
DC, DPS)
Fiat)
Non regulated
E-money (VC1,
VC2, VC3
convertible
into Real world
money)
Denominated in
Unit of account
YES
YES
YES
NO
Means of
payment
Small P2P
payments,
possibly non
traceable
All interbank Medium / Large All types of INT Potentially all
payments
INT payments
payments
types of P2P
(traceable)
(traceable)
payments
Medium of
exchange
Small
transactions
and
Used to
settle
Purchases /
sales via
bank
accounts
Medium / Large All types of
transactions in transactions
the regular
economy
Online
trasactions,
limited /
difficul
traceability
YES (banks)
YES
?
Shadow
economy
Store of Value
NO
YES
YES
We can say that BASE MONEY is composed by :
M= base money= CURRANCY +BANK RESERVES
• A.k.a. Monetary base or high-powered money
• Issued by the central bank (State money)
• Might include CBDC in the near future
• Currency = Coins + Banknotes
• A.k.a.( Also Known as ) Cash
• Held by the Public to settle cash transactions
• Used for “small” payments and payments in the shadow economy
• Bank Reserves = Required Reserves + Voluntary Reserves
• Held by commercial banks with the central bank (bank of the banks)
• Used to settle inter-bank payments
• Central to monetary policy
Bank Deposits = Current Accounts + T/S Deposits
• Current account deposits a.k.a. Sight deposits, Demand deposits
• Held by the public and companies to settle all types of payments
• Time / Saving deposits (Less liquid that current accounts) held as a saving
instrument
Money Supply = Currency + Bank Deposits
• Part of the money supply comes directly from the State (via the central bank), part
comes from the Private sector (commercial banking system)
All this type of money are contained in the notion of Money Aggregates = Money aggregates
are broad categories that measure the money supply in an economy = Gli aggregati
monetari sono categorie generali che misurano l'offerta di moneta in un'economia.
• The notion of monetary aggregate is coherent with the orthodox view that money is
a ‘thing’, an economic variable that can be uantified in terms of outstanding stocks,
flows (absolute change in stocks), rates of change (Flow divided by stock).
• At the same time, by looking at the counterparts of monetary aggregates, the close
nexus between money and debts emerges clearly. This is coherent with the
heterodox view.
Every country uses different type of money aggregates based on their necessity , we will discuss
the money aggregates of ECB( European central bank) . These aggregates include only positions
of residents in the euro area which are held with MFIs located in the euro area.
The Eurosystem has defined a narrow aggregate (M1), an intermediate aggregate (M2) and a
broad aggregate (M3). Tis aggregates differ themselves by the liquidity of the asset contained
in each one ; in fact we star with an aggregate that has asset with high level of liquidity (M1) ,
and we finish with ( M3) that comprehend M1 and M2 but also other asset that are less
liquid
Narrow money (M1) : this is the most liquid aggregate , in fact it contains coins banknotes and
balaces that can be immediately converted into money ; it s composed of : currency + overnight
deposit
Intermediate money (M2) : it contains narrow money M1 and other asset that are less liquid ,
like deposit up to (con massimo )2 year of maturity and other deposit redeemable at a period
of notice up to 3 months . In some cases there are deposit that are even less liquid , and this
appends when there are restrictions on the convertibility The definition of M2 reflects the
particular interest in analysing and monitoring a monetary aggregate that, in addition to
currency, consists of deposits which are liquid. Its composed of : M1+ time/saving deposit
Broad money (M3) : this is the less liquid one and comprises M2 and in addition it contains
marketable instrument issued by the MFI( Main Financial Institute ) sector . we are talking
about financial instrument like Share- Bond-units (quote ). It composes : M2+ financial assets
The ECB( European Central Bank ) calculates the growth rates of monetary aggregates and of
the components and the counterparts to monetary aggregates on the basis of adjusted flows
rather than the simple comparison of end-of-period levels.
The money aggregates are instrument used and studied by the monetary authorities to
introduce their monetary policy in the European system or just analyze it
• STOCK : data referred to a moment in time
• FLOWS : difference between the stock of this period and the stock of the last period
Each monetary aggregate contains monetary instruments characterised by different liquidity
Different instruments perform different functions: Narrow money is pre-eminently linked to
transactions and to the medium of exchange function. Broad money is is pre-eminently linked
to saving and to store of value function. Analysis of composition of aggregates gives
information on the activities of the different money-holding and money issuing sectors
• EX2: M1 rising and M2 falling may indicate falling confidence in banks
• EX3 : M1 remain stable and M3 is rising may indicate that people are investing their
time saving deposit because they expect a future improvement of the economical
situation and so the growth of the rates of interests
W3.L3.22 The logic of financial operations
Time in finance is a fundamental variable ; the payment for a transaction doesn’t need to
happen on the spot , but the payer can make an agreement with the payee in which he promise
to pay value of the object of the transaction plus interest . the same thing happens when
someone request for funds to a bank , which transaction creates a credit ( the right to be paid
back ) for the financier while creates a debt for the financed , this can led to intertemporal
choices for enterprises and households :
• Credit enables households to reconcile their desired intertemporal spending path
with their actual income path (intertemporal choice):
o Borrowing (Acquisition of net liabilities ) makes it possible to spend in excess
of present income.=Il prestito (Acquisizione di passività nette ) consente di
spendere in eccesso rispetto al reddito attuale.
o Saving (Acquisition of net assets) makes it possible to spend in excess of
future income.= Risparmio (Acquisizione di attività nette) permette di
spendere in eccesso di reddito futuro.
• Credit enables companies to bridge the temporal gap between costs and revenues
and to accumulate capital (durable productive assets).
o Short/medium term credit and circulating capital
o Long-term credit and fixed capital
• Credit enables States to finance the gap between government spending and tax
revenues (budget defict), accumulating public debt
Credit availability influences aggregate demand, GDP and employment, often in a procyclical
way. When GDP is rising and risk premiums low, abundant credit stimulates spending and
GDP. When GDP is stagnant / falling and risk premiums high, scarce credit hampers spending
and GDP.
• GDP= Gross Domestic Product = prodotto interno lordo = PIL
• So when we have a lot of credit in the economy it means that the GDP is rising
because enterprise-households-… re uest to be founded to finance their
investment/costs , in this case we have a low risk premium( premio di rischio ,
sarebbe quell Guadagno in piu generato dall investimento rischioso , dalla
prosepttiva del finazniato rappresenta un costo maggiore ) because the GDP is
rising
Credit impacts on aggregate supply through its influence on production, investment,
infrastructure and innovation
There is a tight relation between money and credit in fact:
• Money is «created» via credit operations.
o Banks create bank money (deposits) by making loans to firms and
households, that spend those loans giving rise to new deposits
o The central bank creates money (base money) by lending liquid reserves to
banks and governments (where possible)
CREDIT is defined by 6 important elements :
1) Time :
a. A lot of transaction cost are related to time like negotiation , finding the
counterpart , contract drafting this cost recalls all to the beginning of the credit
b. Time in the end of the credit in sense of maturity is the period in which credit
matures , but also the end of the credit where the lender gets paid by the
borrower
i. Short-term (maturity a year or less);
ii. Medium-term (maturity between one and five years);
iii. Long-term (maturity above five years)
iv. Infinite maturity (consols)
c. Time is linked to Risk dimension , in fact risks increase whith the increase of the
maturity of the credit
2) Identity of the lender and the borrower : Lenders and borrowers can be individuals, nonfinancial companies, banks, financial intermediaries, State and local authorities, supranational institutions and he borrower’s identity is one of the main features defining the
contract
a. Lender owns something valuable (money, financial assets, goods) that he is willing
to part with between Time 0 and Time 1.
i. He is the principal , because he selects the agent (borrower) to whom
he/she entrusts his/her funds for the agent to make a proper return on
them. He must acquire information about the agent, give the agent
instructions, and monitor his/her actions.
b. Borrower needs what L owns and is willing to pay a premium (interest +
guarantees) in order to have it.
i. . He/she is selected /hired by the pricipal (lender). The angent is not
personally related to the principal and may have his/her own agend / golas,
which do not necessarily coincide with the principal’s own
c. borrowers know more about themselves and their prospects than lenders, and
may try to exploit this information to their advantage and the detriment of
lenders. Lenders know this and react accordingly.
d. The interaction between them can be peer-to-peer or through financial
intermediation
i. P2P lending enables individuals and companies to lend and borrow money by
connecting lenders with borrowers directly through an online peer-to-peer lending
platform instead of using a traditional bank as an intermediary.
e. Once L and B have reached an agreement, B receives the valuables from L and
signs a debt contract whereby he assumes the obligation to pay back her/his debt
in accordance with mutually agreed terms. The debt contract embodies ’s
promise to pay back his debt. L will not begin a credit transaction with B unless he
trusts B (or unless rapid securitization is possible).
i. Trust is a key element because in an decentralized system it encourage the
lender to contract the credit
ii. The relationship between L and B as a principal-agent relationship
f. When there isn’t a relationship between the borrower and the lender , there could
be asymmetric information ( which characterize the decentralized system of
transaction ) . This enhances risk
i. Because of asymmetric information, credit markets cannot function as
anonymous price-taking markets. In general both the identity of the seller
and the quantity sold are crucial determinants of its value (possibility of
default increases with the level of indebtedness fro external and internal
reasons).
How can the lender be sure that the borrower will not simply run away with the funds or take
on unsustainable risks? How can the lender be sure the borrower is honest in the first place?
o
o
o
o
o
o
3)
-
Screening (ex ante) / monitoring (ex post)
Guarantees / Collateral
Shorten maturity
Reduce exposure
Long-term customer relation
Credit rationing
The debt contract : a debt is a obligation contracted by the borrower in which he
promise to pay back the guarantees + interest in the future , in exchange of founds from
the lender at the time of contraction of the debt . Elements of the contract:
Identification of lender and borrower
Description of what is being transferred
Loan duration (maturity)
Payback conditions
Periodic payments – normal case in case of long-term loans; no intermediate payment = zero
coupon bond.
Interest may be forbidden as is the Middle Ages or in the case of Islamic finance)
Additional clauses (e.g. marketability, guarantees)
a. The pay back condition can be:
i. Periodic payments – normal case in case of long-term loans; no
intermediate payment = zero coupon bond.
ii. Interest may be forbidden as is the Middle Ages or in the case of Islamic
finance)
b. The debt contract can be marketable (e.g. government and corporate bonds) i.e.
liquid or non-marketable (e.g. bank loan, consumer credit) i.e. illiquid. Nel senso
che il creditore può vendere il credito sul mercato e quindi può avere forma liquida
quel credito , mentre i crediti dei clienti e i prestiti bancari non possono essre
venduti sul mercato
i. Non-marketable debt contracts can be turned into marketable securities
through securitization
c. Marketability (Liquidity) mitigates the importance of the personal element and the
need for guarantees from B to L.
i. Marketability (Liquidity) requires standardization, low carrying costs, wide
acceptance …
ii. Marketability (Liquidity) as an antidote to credit risk . If L loses confidence in
B, he can always sell the contract to some one else (possibly at a discount) as
long as the debt contract is liquid enough (if at all)
4) Maturity and payback clauses : As the loan reaches maturity, B pays back his debt
(principal and interest) to L or to someone else if in the meantime L sold the contract to
’. Payback requires a means of payment to be discharged of the obligation. Cases when
payback does not take place as agreed:
a. Renegotiation (extended maturity, interest reduction) a.k.a debt restructuring
b. Debt forgiveness / redemption
c. Debt insolvency (Default partial or total)
Default occurs when repayment is not made on time. It may be due to feasibility constraints, if
the debtor has insufficient resources to meet the terms of the contract (even if enforcement is
perfect), or incentive constraints, if the creditor cannot adequately enforce the contract
(limited liability plus costly state verification)
5) Credit risk and information asymmetry : The credit risk is composed of : lender’s risk +
borrower’s risk .
6) Interest : nterest is the e tra, agrees to pay to in return for the possibility of using ’s
resources
a. Interest is paid in many different ways
i. One instalment at maturity,
ii. Several instalments between 0 and 1
iii. By borrowing at discount.
b. Interest can be zero! in this case the borrower returns exactly what s/he borrowed
from the lender
c. Interest can be negative !!! in this case the borrower returns less than what he
borrowed from the lender
Credit institutions
The two main functions of credit institutions
• Risk consolidation or transformation (law of large numbers)
• Delegated monitoring and provision of liquidity services
The existence and functions of credit institutions is linked essentially to the presence of
uncertainty, imperfect information and transaction costs
W4.L1.22
INTEREST RATES
The interest rate in nominal terms measures the Time Value of Money in terms of money
itself (TVM), i.e. the value of money «today» (time 0) measured in terms of money
«tomorrow» (time 1).
lends to at me
pays back
to at me 1, one year later
1+i gross interest rate in nominal terms
i
Net interest rate in nominal terms
.
i
1 €,
1 5€
1+i 1 5 1
1. 5
. 5 5
In the example above, the value of 1 euro at time zero in terms of euros available at time 1 (one
year later is 1 euro and 5 cents 1. 5 € . is willing to pay back 1 euro and 5 cents in 12
months in order to have 1 euro today. L is willing to give up 1 euro today in return fo 1 euro and
5 cents in 12 months time.
• If the rate of interest in nominal terms rises (e.g. from 5 to 6%), the value of money
today increases relative to the value of money in the future. B's need (to have
money today) is more intense and with it the willingness to pay higher interest. L
knows this and profits from it.
• If the rate of interest in nominal terms falls (e.g. from 5 to 4%), the value of money
today decreases relative to the value of money in the future. B's need (to have
money today) is less intense and with it the willingness to pay higher interest. L
must accept it.
Similarly, the discount rate in nominal terms 1/(1+i) indicates the of money «tomorrow» in
terms of money «today».
• In the example above, the discount rate is 1/(1+i) = 1/(1.05)=0.95. This means that
one euro available in one year’s time is e uivalent to 95 euro cents today.
o If the rate of interest in nominal terms rises, the discount rate falls and the
value of money tomorrow decreases relative to the value of money today.
o If the rate of interest in nominal terms falls, the discount rate rises and the
value of money available tomorrow increases relative to the value of money
available today.
i r
+
+
+
r
pected return on the loan at constant prices net of
all risks. t measures the pure remunera on for wai ng as
emphasi ed by the Time preference theory
pected in a on risk premium as in a on erodes
the purchasing power of money over me
redit risk premium depends on the borrower s
iden ty, on the presence of collateral and guarantees, on
me to maturity, on cyclical condi ons.
i uidity premium depends on the marketability of
the debt contract, on the si e of the market, on the distance
between and 1. i uidity premium increases as li uidity of
the credit contract declines.
Theories which explain why interest is paid:
1) Productivity theory: interest is paid on capital because capital is productive. The
borrower can get additional income from borrowed capital and in easily afford to pay
interest.
2) Abstinence or Waiting theory: The lender of capital has to be compensated for
abstinence or for not immediately using his own capital. He has to do the waiting. But
some people will wait and save even if there is no interest.
3) Austrian or Agio theory: Theory according to which interest is paid to equate the future
satisfaction to the present satisfaction.
4) Time preference theory: isher’s Time reference Theory says that interest is the price
for time preference. This time preference depends on the si e of a man’s income, the
distribution of income over time, the degree of certainty regarding its enjoyment in the
future and the temperament and character of the individual.
5) Liquidity preference theory: According to Keynes, who propounded this theory, interest
is not a reward for waiting, nor is it a payment for time preference, but it is a reward for
parting with liquidity. This theory not only explains why interest is paid; it also explains
how the rate of interest is determined.
Theories hich explain ho interest is determined
lassical or eal Theory, which e plains interest as determined by the
demand for and supply of capital.
oanable unds Theory or Neo classical Theory, which e plains interest
as determined by demand for and supply ofloanable funds.
eynes s i uidity reference Theory, which e plains that the rate of
interest is determined by the demand for and supply of money.
h ps: www.economicsdiscussion.net theoriesof interest
6)
W4.L2.22
Interest rates (Part 2)
In the last power point we have discussed about nominal interest rates , in this part we will
discuss about real interest rate
Inflation can grow – decrease- remain stable over the time ; when we devide P1/P0 we obtain
the gross rate of inflation (1+pgrec)
• P1 / P0 = (1+ π) = gross rate of inflation = change in the purchasing power of money
between time 0 and 1
• The interest rate in real terms measures the value of money over time taking into
account the change in its purchasing power (TVM in terms of goods). So in a sense it
measures how the purchasing power of people change with the variation of the
rate of inflation over the time
The gross interest rate in real terms is
1+r
.i
. 5 5
,
1+i 1+
. 2 2
, 1+r
1. 5 1. 2 1. 29
ubtrac ng 1 from both sides we obtain the net real interest rate r
r i
1+
f is close to ero, the net real interest rate is appro imatelye ual to
r i
f in a on is higher than e pected, the real interest rate is lower
than e pected for a given interest rate in nominal terms
re
p
re p i
ra ct i
ra ct
e p
a ct
a ct
e p
igher than e pected in a on is bad for creditors and good for
debtors including the tate
ower than e pected in a on is good for creditors and bad for
debtors including the tate
We have a negative real interest rate when the inflation is higher than the nominal interest rate
, this happens can happen when the expected inflation rate used in the nominal interest rate is
lower than the actual rate of inflation .
• Financial repression is when the government imposes specific protfolio restrictions
and regulations on investors and banks.
o Caps or ceilings ceilings on interest rates, Government ownership or control
of domestic banks and financial institutions
o Creation or maintenance of a captive domestic market for government debt
o Restrictions on entry to the financial industry
o Directing credit to certain industries
The problem of negative interest rate notion :
• It is a phenomenon that has had economists scratching their heads. In fact there is a
well-known (to economists) term for the idea that interest rates shouldn't go below
zero. It's the "zero lower bound".
• The reason it is so strange is this: normally a potential lender can choose not to lend
and just sit on the funds. That is equivalent to getting a nominal interest rate of
zero. Not great, but surely better than an interest rate of less than zero. That is the
basic idea behind the concept of the zero lower bound.
• Some examples are central bank policies. In the eurozone, in Denmark, Sweden,
Switzerland and Japan, central banks have decided to have a negative rate on
commercial banks' excess funds held on deposit at the central bank. In effect,
private sector banks have to pay to park their money.
• In the case of Sweden, the central bank has gone below zero on the rate it lends
money to the banks, its main policy tool. The aim in the eurozone is to stimulate
economic growth and to raise inflation, which is also below zero and even further
adrift of the European Central Bank's target of below but close to 2%. In Sweden
too, it is about raising inflation.
• In Denmark and Switzerland the immediate objective has been to prevent the
currency rising too much. The idea of lower and negative interest rates is to
discourage investors from buying the local currency, which tends to push its value
up.
W4.L3.22
Bonds and the bond market
Coupon bond are obligation issued by the government ( government bonds ) or corporation (
corporate bonds ) , this type of obligation guarantee coupon (cedole ) through the maturation
of the bond at times choose in the contract which lenders agree . the face value of the coupon
bases on a coupon rate fixed in the contract
• Bond with maturity N (ex. N = 10 years), ace alue e .
1.
€ and fi ed
coupon rate (ic = 5% annual)
• B issues the bond at par and L underwrites it
o t time , pays 1.
€ to
o t time 1, pays 5 € to
oupon
ic
o t time 2, pays 5 € to
oupon
ic
o …
o t time N, pays 1 5 € to
+
ic
• Bonds may be issued at par, below par, above par
o If bond is issued below par, L pays less than FV and receives and extra return
o If bond is issued above par, L pays more than FV and receives and extra return
• The coupon rate and coupons may vary over time
o ic can be indexed to money market rates (Ex. CCT in Italy)
o ic can be indexed to inflation (Ex. CTR in Italy)
there are 2 special bond :
1) consols bonds : perpetual bonds , they don t exist anymore
2) zerocoupon bond : all the interest are maturate in the redemption value
Instantaneous return of the bond I (inst) = C / PBOND
Yield( tasso di rendimento / rendimento ) to maturity is the nominal interest rate that
equates the present value of the future payments that bondholders are entitled to receive to
the market price of the PBOND = SAREBBE IL TIR
• PBOND = C1 / (1+i) + C2 / (1+i)2 + … (
n
+ FV) / (1+i)n
Both the instantaneous return and the yield to maturity vary inversely with PBOND (for a
given cash flow
eriod bond return: f an investor buys the bond at met on the
secondary market paying ND,t and sells it at met + 1
receiveing ND,t+1 and receives 1 couponthe ec ve return
on her investment willbe
ND,t
+
where
ND,t+1
g
capital gain
g
capital loss
ND,t+1
ND, t
ND, t
ND,t
ND,t
g
apital loss can be so largeas to lead to
Nega ve return
As interest rates change, for example in response to monetary policy, so do bond prices and
bond returns.
• Typically, a rise in interest rate is associated with a fall in bond prices, resulting in
capital losses on bonds whose terms to maturity are longer than the holding period.
• The more distant a bond’s maturity, the greater the si e of the percentage price
change associated with a given interest rate change , resulting in capital losses on
bonds whose terms to maturity are longer than the holding period
o Più la scadenza di un'obbligazione è lontana, maggiore è l'entità della
variazione percentuale dei prezzi associata a una determinata variazione del
tasso di interesse
ishkin 2
If the rate of inflation is expected to increase , we have :
1)
2)
3)
Decrease of the demand of Bonds
Increase of the supply of bond
We will have a new point of equilibrium , where the price is lower and the interest are
higher ; this because the yield is related to the risk of the financial instrument ; and
therefore with an higher interest rate the lender is going to pay a lower price for it
ishkin 2
Instead with an increase of the general wealth :
1) We will have an increase of the supply of bons
2) And an increase of the demand of bonds
The structure of interest rate of bonds changes with :
• Default risk, liquidity premiums and different tax treatment are the main
determinants of domestic rate interest rate differentials.
o Changes in default risk affect demand and supply of underlying assets (credit
contracts) in opposite directions and interact with liquidity risk.
o E.g. a large corporations issuing a series of very negative quarterly reports,
default risk increases, bond prices fall, investors fly to quality, demand
declines, supply increases and liquidity diminishes.
o Rating agencies provide information on default risk (recall problems posed by
asymmetric information in credit markets).
NOTA : security = titolo
YIELD CURVE = curva dei rendimenti
The yield curve: A line that plots the interest rates, at a set point in time, of bonds having
equal credit quality, but differing maturity dates. = La curva dei rendimenti: Una linea che
traccia i tassi di interesse, in un determinato momento, delle obbligazioni aventi uguale
qualità creditizia, ma diverse date di scadenza
• The Pure expectation theory: Long-term interest rates reflect market expectations
about short-term interest rates in the future.
• Liquidity premium theory: This theory asserts that bond-holders want to be
compensated for the interest rate risk associated with holding longer-term bonds given
that (The longer the maturity, the greater the price volatility).
W5.L1.22
BANKS
Banks are monetary financial institution MFI whose role in the economy is to receive deposits
and or close substitute for deposit from entities other than monetary financial institutions
and, for their o n account, to grant credits and or to ma e investment in securities”.
The EU recognizes three main types of MFI:
1) Central banks
2) Deposit-taking corporations other than central banks: credit institutions, financial
intermediaries other than credit institutions, electronic money institutions EMI
a. EMI (Pay Pal ) : Le Electronic Money Institutions (EMI) sono istituzioni finanziarie
che offrono servizi di pagamento elettronico e di gestione dell'Electronic Money
(denaro elettronico). Queste istituzioni sono autorizzate dalle autorità di
regolamentazione finanziaria a emettere, gestire e distribuire denaro elettronico.
Il denaro elettronico è una forma di denaro digitale che viene archiviata e
scambiata elettronicamente. Le EMI consentono ai propri clienti di effettuare
pagamenti elettronici, trasferire denaro e conservare fondi in conti digitali.
Solitamente forniscono anche carte di pagamento elettroniche, come carte di
debito prepagate o virtuali, che consentono ai clienti di effettuare pagamenti
online o in negozi fisici.Le EMI operano in modo simile alle banche tradizionali, ma
si distinguono per il fatto che non offrono servizi bancari completi come prestiti e
investimenti. La loro principale attività riguarda la gestione del denaro elettronico
e la facilitazione dei pagamenti digitali.Le EMI sono soggette a normative
finanziarie e di sicurezza molto rigide, volte a proteggere i fondi dei clienti e
prevenire frodi e riciclaggio di denaro. Di solito devono ottenere una licenza dalle
autorità di regolamentazione finanziaria del paese in cui operano, dimostrando di
avere i requisiti adeguati in termini di capitale, governance e sicurezza dei dati. Le
EMI hanno guadagnato popolarità negli ultimi anni grazie all'avanzamento della
tecnologia e all'aumento delle transazioni finanziarie digitali. Sono diventate una
scelta conveniente e sicura per molti consumatori e aziende che preferiscono
effettuare pagamenti e gestire il loro denaro in modo digitale.
3) Money market-funds (SGR)
MFIs form the money-issuing sector
Basic banking services include:
1)
2)
3)
4)
5)
6)
Collect and transfer deposit (provision of liquidity services),
Grant loans and credit lines (provision of financial services)
Security trading (link with financial markets),
Organize and manage mutual investment funds,
Operate on the FOREX market,
Off-balance sheet activities.
Basic banking services can be provided on
1) Wholesale scale (low volume, high value): banking services provided to other banks,
large corporations, pension and investment funds (connected to investment banking).
2) Retail scale (high volume, low value): households, small and medium-sized companies
(connected to commercial banking).
Main type of banks
1) Savings banks: banks that specialise in collecting saving deposits and in providing retail
banking services (payment services, credit and insurance to individuals, and small and
medium-sized enteprises) – conservative business model and investment strategies –
mutual ownership and no shareholders.
2) Cooperative banks: close in spirit and substance to savings banks (esp. Mutual
ownership), connection with specific trades or professions (eg. Agriculture).
3) Mortgage banks: banks that deal specifically with the real estate sector and with
mortgages. In the UK, building societies were societies that collect small savings and use
them to fund domestic mortgages and building activity. Often theyr are subsidiaries of
normal banks.
4) Other types of banks: Girobanks, credit unions, Islamic banks, clearing banks, public
banks (public owenrship, often support specific activities) but also
5) Shadow banks and Investment banks
6) Online banks
7) Central banks
8) Mutual banks
9) Investment banks
BALANCE SHEET OF A BANK
In the activities we have :
ash items and li uid reserves deposited with
i uid reserves e uired reserves + oluntary reserves
ecuri es connec on with nancial markets
Treasury bills, notes and bonds; municipal bonds
orporate bonds, hares, nvestment fund shares
oans connec on withbanks, businesses, households
nterbank loans
onsumer loans
ommercial short term and ndustrial long term loans
eal estate long term
Deriva ves connec on with nancialmarkets
eal assets property
old, Works of art
eal estate including premises , other assets
The asset side indicates the uses of funding by the bank.
• Bank assets can be distinguished according to their maturity, liquidity and riskiness:
• Cash and bank reserves (very liquid, very safe, yield no interest)
• Securities: varying degrees of liquidity, risk (mainly market risk, i.e risk of depreciation in
nominal terms but also interest rate risk, and default risk), interest (or dividend) bearing
as a compensation against risk.
• Loans: illiquid especially if medium to long-run maturity (unless the bank resorts to
securitization), risky (mainly credit risk), interest-bearing.
• Real assets / property
A bank letter Is a sort of guarantee in which the bank ensure the creditor stating that the
payment will be on time and with the correct amount by the borrower . This is also a sort of
enforcement because in the case the buyer at the maturity can t pay back , the bank has the
duty of cover the payment . Letters of credit are often used in international transactions to
ensure that payment will be received. Due to the nature of international dealings including
factors such as distance, differing laws in each country and difficulty in knowing each party
personally, the use of letters of credit has become a very important aspect of international
trade. The bank also acts on behalf of the buyer (holder of letter of credit) by ensuring that the
supplier will not be paid until the bank receives a confirmation that the goods have been
shipped.
Structured Investment Vehicles
A pool of investment assets that attempts to profit from credit spreads between short-term
debt and long-term structured finance products such as asset-backed securities (ABS). SIVs are
less regulated than other investment pools, and are typically held off the balance sheet by large
financial institutions such as commercial banks and investment houses
Loans commitment/ credit lines
Loan commitments are found at commercial banks and other lending institutions and consist of
both open-end and closed-end loans. Open-end loan commitments act like revolving credit
lines, whereby if a portion of the loan is paid off, the principle repayment amount is added
back to the allowable loan limit. Closed-end loans are reduced once any repayments are
made.
Bank income statement
Bank revenues :
- Interest margin = Interest on loans –Interest on deposits (similar to the bid ask spread)
- Return on securities investment
- Fees(tasse) for specialised service and off-balance sheet activities.
Bank cost
- Operational costs (Salaries, operational expenses, advertisment, real estate maintenance)
- Provision for losses on loans and investment
- Other costs (depreciation)
ank pro ts
r +r +r
rDD
+ ees
r
risk free rate bank reserves held borrowed
r
return on securi es securi es
nterest margin r rD and risk premium r r
1+r
1+r 1 p + 1+r p g
r contractual rate, r e pected loan rate, p probability
of default possibly a direct func on of r ,
g recovery rate in case of default
ees come from o balance sheet ac vi es
income in 2 1 , source
Balance Sheet of a bank
of total U bank
ash items and li uid reserves deposited with
i uid reserves e uired reserves + oluntary reserves
ecuri es connec on with nancial markets
Treasury bills, notes and bonds; municipal bonds
orporate bonds, hares, nvestment fund shares
oans connec on withbanks, businesses, households
nterbank loans
onsumer loans
ommercial short term and ndustrial long term loans
eal estate long term
Deriva ves connec on with nancialmarkets
eal assets property
old, Works of art
eal estate including premises , other assets
orrowings
rom the central bank bank re nancing opera ons
rom other banks interbank market
Deposits
urrent accountdeposits ight deposits Demand deposits
aving deposits
Time deposits er catesof deposit
ank bonds and bank hybrid securi es
Non interest bearing liabili es
ank apital Networth
hareholders ni al capital
New capital recapitalisa on
etainedearnings, eservesagainst risks, evalua onreserves
W5.L2.22
banking risks and regulation
The interbank market enables banks to manage and redistribute their funds, and so provide
liquidity services and financial intermediation more efficiently. Any bank short of liquid reserves
may borrow them from another bank on the interbank market
this graphic shows the increase of liquidity level
for each institution
Interbank markets smooth(attenua ) idiosyncratic liquidity risks faced by individual banks
The central bank smooths aggregate liquidity shocks
• If all banks are short of bank reserves simultaneously, they can borrow them from
the CB (LoLR)
Financial intermediation between ultimate lenders (depositors) and ultimate borrowers
(borrowers). This is the work of a financial intermediator
Risk of banks
Banking risks can be defined and classified in many ways. In this lecture we examine five main
types of risk:
1) Credit risk: the risk that the borrower fails to comply with its obligations to service debt
or looses its credit standing.:
a. CR is related to the intertemporal nature of credit borrower’s and lender’s risk
and to difficulties in discerning between good and bad borrowers (asymmetric
information)
b. Credit risk = Expected Loss + Unexpected Loss
c. Expected Loss = PD * LGD * EAD (Basel II definition)
i. PD = Probability of default within a given time period (calculated on the
basis of past experience within each risk class)
ii. LGD = Loss given default (share of exposure affected in case of default)
iii. EAD = Exposure at risk
d. Unepected Loss = Variance (and covariance) around expected loss
e. Banks tries to decrease credit risk by Screening (prior to lending) and Monitoring
(During)
i. Screening = Collecting information about potential borrowers (income
statement, assets, outstanding loans) to limit the impact of adverse
selection
ii. Monitoring = actions through which the bank tries to prevent the borrower
from taking risky actions (restrictive covenants)
f. They can reduce the credit risk by portfolio diversification (general guarantee
against risks if different risks are independent of each other)
g. Establish / Maintain Long-term customer relationship (substitute for screening)
creates the incentive for a client to become a prime client.
h. Other way to low risk :
i. Shorten maturity (prefer commercial loans to industrial loans)
ii. Concentrate on prime clients (even if sub-prime clients may be willing to pay
a higher interest rate)
iii. Loan commitment (off-balance sheet activity) instead of loan (on-balance
sheet activity subject to prudential capital requirements)
iv. Limit large exposure (and declare it)
v. Credit rationing (Exogenous – Endogenous)
vi. Increase reserves against risks (costly)
vii. Improve risk monitoring / management
2) Liquidity risk: the risk covers all risks that are associated with a bank finding itself unable
to meet its commitments on time, or only being able to do so by recourse to emergency
borrowing. Banks activates implies a constant outflow and inflow of liquidity , so the
liquidity level change very frequently and it must be continually monitored
a. We have a liquidity shortage when the outflows of liquidity is major than the
inflows of it . Liquidity shortages are dangerous because:
i. hamper the normal operations of the bank,
ii. may force the bank to sell assets at a loss,
iii. are likely to undermine the confidence of bank depositors and can
precipitate a bank run.
iv. Can lead to insolvency
b. To low the liquidity risk the banks can :
i. Holding liquid reserves with the central bank (can be costly in terms of
foregone interest)
ii. Preferring safe / liquid securities (not always a guarantee as the recent Euro
area sovereign debt crisis showed)
iii. Short-term loans (rapidly revolving loans)
iv. Requiring liquidity premiums (but can be damaging in terms of adverse
selection and moral hazard) .
v. Liquidity provision by the central bank:
1. Ordinary refinancing operations
2. Marginal lending facilities
3. Lender of last resort
Banks transform liquid deposits (liabilities) into risky securities and illiquid loans (assets):
MATURITY / LIQUIDITY TRANSFORMATION
3) Interest rate risk: is the risk that the market value of a bank’s securities changes
adversely in response to changing market conditions or the risk that interest margin falls
(iLoans – iDeposit) . Risk of loss due to, for example, reduced interest margins on outstanding
loans or reduction in the capital values of marketable assets.
4) Market risk: risk of loss associated with adverse deviations in the value of the trading
portfolio.
5) Solvency risk: risk of having insufficient capital to cover losses generated by all types of
risks
anking ac vity is e posed to manyinterrelatedrisks whose
cotrol re uires regula on and supervision. These risks derive
from the following market failures
symmetric informa on ustomers are generally unable to
fully assess the safety and soundness of a nancial ins tu on
and its behaviour icro pruden al supervision addresses the
rst problem onduct of business supervision focuses on the
second one
xternali es inancial ins tu ons are lin ed to one another
and to nancial mar ets f one ins tu on runs into trouble,
the trouble is li ely to spread spillover e ects
acropruden al spervision fosters nancial stability and is
there to contain the e ects of systemic failure
ar et power here are nancial ac vi es where
concentra on is ood economies of scale, networ e ects,
merger of trading venues he exercise of mar et power is to
the detriment of consumers ompe on policy ta es care of
this aspect
h p: ec.europa .eu i nterna l ma rket na nces docs genera l 2 1erfra
515
worki ngdocument en.pdf
There are many kind of regulation of the bank activity , one of which is the microprudential
regulation . This type of regulation aims to rpotect bank s clients by ensuring the safety and
soundeness (solidità) of financial institutions and by creating incentives for correct behaviour
by these institutions. Micro-prudential objective can be seen as limiting the
likelihood(rischio/probabilità) of default of individual institutions. This means limiting
“idiosyncratic ris ”, as a means of protecting depositors The micro-prudential dimension
considers each institution in its own right,
• The micro-prudential standard would be derived from a bottom-up approach, from
the aggregation of the uniform solvency standard that would apply to a
“representative” institution