EFES2714
MONEY AND INTEREST RATES
TEST 1
11 MARCH 2024
MARKS: 49
TIME: MINUTES
--------------------------------------------------------------------------------------------------------------------QUESTION 1 [17]
Complete the following multiple-choice questions:
1.1
1.2
1.3
1.4
1.5
1.6
1.7
1.8
1.9
1.10
1.11
1.12
1.13
1.14
1.15
1.16
1.17
B
B
B
C
D
D
C
A
A
A
D
D
C
A
C
–
A
QUESTION 2 [33]
2.1
Except for the prevalence of collateral and legal documentation in the use of debt
contracts, financial structures throughout the world are characterised by six other
“basic facts”. Shortly explain these six facts.
(6)
2.2
What is fiat money and what underlying value does fiat money have?
2.3
What does a fiat money system require to function effectively, how is this often
undermined and what is usually the result?
•
(2)
(2)
A Fiat money system requires TRUST IN THE ISSUING AUTHORITIES (i.e.
government and the central bank) to function effectively.
•
This TRUST is often undermined by issuing authorities that produce (print) more
money (government does not issue bonds to finance its needs, but simply prints money)
•
The result is that the required TRUST in FIAT money disappears, and the money
becomes worth less and even worthless.
2
2.4
Cryptocurrencies like Bitcoin rely on decentralised blockchain technology. Name
five advantages of the decentralised nature of blockchain.
2.5
(5)
Justify in detail why the following statement is true or false: “In South Africa, credit
card payments form part of the M2 money supply, but not the M1 money supply.”
(3)
•
The statement is FALSE for at least three reasons:
1) Credit card payments do not form part of any money supply measure because
credit cards represent a liability (not an asset) for the person who uses it. Money
is an asset for those who use it.
2) M1 money supply only includes M1(A) + other demand deposits
3) M2 money supply only includes M1 + other ST deposits and MT deposits
2.6
What are two main assumptions that classical economists (e.g. Fisher) had
regarding the equation of exchange, why did they assume this and what did they
3
conclude was the implication thereof?
(3)
Equation of Exchange: M x V = P x Y
Classical economists assumed that
1. Velocity of money (V) is fairly constant over the short run
▪ Why? V depends on institutional and technological features (e.g. payment technology)
that only change slowly over time.
2. Aggregate output (Y) is at the full-employment level
• Why? Wages and prices are completely flexible and thus output (Y) remains at fullemployment level
• Implication: If V and Y are relatively constant over the short run, then movements in
the price level (P) result solely from changes in the quantity of money (M)
2.7
Is there a clear short-run relationship between money and inflation? Use the
equation of exchange and simple examples to explain why the answer is not so
straightforward.
(6)
the answer is not
straightforward, because
it depends on the level of
inflation in a country
Short Run
%∆P = %∆M+ %∆V - %∆Y
High Inflation
countries
• %∆P & %∆M are so large that %∆V & %∆Y do not matter much
%∆P & %∆M
• Eg. 39% = 35% + 5% - 1%
are very high
• Clear Short Run relationship between money growth and inflation in highinflation countries.
Low Inflation
%∆P = %∆M+ %∆V - %∆Y
countries
• %∆P & %∆M are so low that %∆V & %∆Y do matter (determines if a country
%∆P & %∆M
are low
is above or below the 45° line)
• Eg. 4% = 9% - 4% - 1%
• No clear Short Run relationship between money growth and inflation
in low-inflation countries (because of %∆V & %∆Y)
4
2.8
Use Keynes’s liquidity preference theory to justify why many central banks believe
that controlling the money supply is not so important.
END
5
(6)