TOPIC 4
MONETARY
ECONOMICS
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MONEY
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In the ancient time, where money is
not yet introduced,
transactions were done by
exchanging one goods with another
in a Barter System.
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Barter Trade System
• A barter system is a direct trading or
exchanging of goods between one person to
another.
• Barter system of course does not work
successfully in a modern economy.
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Problems in Barter System
• Double Coincidence of Wants.
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Problems in Barter System
• Double Coincidence of Wants.
• Value instability
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Problems in Barter System
• Double Coincidence of Wants.
• Value instability
• Storage are impossible
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Problems in Barter System
•
•
•
•
Double Coincidence of Wants.
Value instability
Storage are impossible
Indivisible
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Problems in Barter System
•
•
•
•
•
Double Coincidence of Wants.
Value instability
Storage are impossible
Indivisible
No Standard of unit of account
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Problems in Barter System
•
•
•
•
•
•
Double Coincidence of Wants.
Value instability
Storage are impossible
Indivisible
No Standard of unit of account
Difficulties in paying debt
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Problems in Barter System
•
•
•
•
•
•
Double Coincidence of Wants.
Value instability
Storage are impossible
Indivisible
No Standard of unit of account
Difficulties in paying debt
These problems may caused to:
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Problems in Barter System
•
•
•
•
•
•
Double Coincidence of Wants.
Value instability
Storage are impossible
Indivisible
No Standard of unit of account
Difficulties in paying debt
These problems may caused to:
waste of time,
inconvenience,
cumbersome and
difficulties in making an exchange.
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Due to limitations in the Barter System,
.
Money is needed in a modern economy which act as
a means of payment in the transaction of goods and
services.
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WHAT IS MONEY?
HOW DO YOU DEFINE MONEY?
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Definition of Money
• Money can be anything that is
generally accepted by the public as a
medium of exchange in the transaction
activities.
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Money act as a means of
payment:
Money act as:
a medium to transfer ownership of goods
and services from one person to another
 and for the repayment of debts.
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Evolution of Money
As time passed by, the money used varies
accordingly to meet the needs and
purpose of using money.
In the ancient time Commodity Money is used.
For example;
gold, silver, stones, seashells, corns, wool
and bones.
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The different types of commodity money.
Museum of Bank Negara Malaysia
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Commodity Money
In the use of gold, for example;
its:
Intrinsic value = Commodity Market Value.
Precious metal such as gold and silver had its
intrinsic value as a full-bodied money.
Thus, if its intrinsic value is stated on its face
therefore it is said that:
Face Value = Commodity Market Value.
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Modern Money
• But nowadays, in the modern
economy, there are many forms of
money:
Fiat money
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2. Fiat Money
Face Value (FV) > Commodity Market Value (CMV)
o Example: coins and paper money (banknotes).
o Although its FV is larger than its CMV, but still it
is acceptable as money because of the truth and
faith in its acceptance as a legal tender in each
specified country .
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• The Ringgit and Sen (as in the picture
above) are issued by Bank Negara
Malaysia (BNM) as a legal tender in
Malaysia.
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Modern Money
• But nowadays, in the modern economy,
there are many forms of money:
Fiat money
Bank money
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3. Bank Money
 A form of Near Money – i.e. a financial asset
which closely resemble money.
 Examples: Current/Demand Deposits in banks
(cheques),
Credit Cards,
Debit Cards,
Stored Valued Cards,
Smart Card
ATM Cards
and Saving Accounts.
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Modern Money
• But nowadays, in the modern economy,
there are many forms of money:
Fiat money
Bank money
Electronic Money
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4. Electronic Money/ e-money /
e-purse / e-cash.
Transfer of money electronically
made over the internet.
The acceptance of electronic
payment in the transactions
via internet.
Example: e-cash and e-cheques
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“Money is what money does”
• What does money can
do for you?
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• MONEY can does its FUNCTION
for you.
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What are the
FUNCTIONS
of MONEY ?
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Four Main Functions of Money:

As a Medium of Exchange
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Four Main Functions of Money:


As a Medium of Exchange
As a Standard Measurement / unit
of account
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Four Main Functions of Money:



As a Medium of Exchange
As a Standard Measurement / unit
of account
As a Store of Value
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Four Main Functions of Money:




As a Medium of Exchange
As a Standard Measurement / unit
of account
As a Store of Value
As a Standard of Deferred Payment
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1. As a Medium of Exchange
• For transactions purposes –
in purchasing and selling of
goods and services.
• It act as an instrument –
to make payment or to receive
payment in the transfer of
ownership.
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2. As a Standard of
Measurement
• Can be used in measuring the value of
goods and services in terms of its
monetary value.
• Have a standard monetary units (RM) – as
a unit of account.
For e.g. RM1, RM2, 0.50 cents 0.20 cents
etc.
• Comparing relative value of goods and
services transacted.
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3. As a Store of Value
• For saving purposes
– as a store of wealth.
• Has the ability to hold its value
– has the non-perishable
criterion.
• Can reserve for the purpose of future
purchasing.
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4. As a Standard of
Deferred Payment
• As a means of settling debts
maturing in the future.
• As money acts as a unit of account
and store of value, it makes easier to
settle debt.
• Lenders make loans and buyers
repay loans with money.
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Four Main Functions of Money:
As long as inflation does not exist in an
economy, money may does its
functions successfully.
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Four Main Functions of Money:
As long as inflation does not exist in an
economy, money may does its
functions successfully.
It is said that,
“money is what money does.”
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LETS THINK OF
• WHAT MONEY CAN BUYS?
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CAN MONEY BUYS
ANYTHING THAT YOU
WANT?
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CAN MONEY BUY YOUR
TRUE LOVE?
CAN MONEY BUY YOUR
FRIENDSHIP?
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LETS THINK OF WHAT
ACTUALLY MONEY CAN
DO FOR YOU?
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5 minutes
rest ,
Please !
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Money as the
Most Liquid Asset
• According to the Liquidity Approach :
Money is the most liquid asset.
• All assets have some degree of liquidity,
but some have more than others.
• Indeed, money is perfectly liquid although
in the real world money is not absolutely
liquid.
• Refer to a Simple Liquidity Spectrum.
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A Simple Liquidity Spectrum
CASH (most liquid asset)
More
liquid
CURRENT ACCOUNT
OTHER BANK DEPOSITS
DEPOSITS AT NON-BANKS
Less
liquid
SHORT-TERM SECURITIES
LONG-TERM SECURITIES
PHYSICAL ASSETS (least liquid asset)
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Liquid Assets and Near Money
• Liquid Assets refer to any financial
instruments that can be converted into
money easily.
• The most liquid asset is the cash –
coins and notes.
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Liquid Assets and Near Money
• Near Money are those financial
instruments or assets which are readily
convertible into money.
• Examples are;
current deposits (cheques),
savings deposits,
short term bills.
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Categorization of Monetary
Aggregates
A Measure of Monetary Aggregates according to a
Diamond Spectrum.
NARROW MONEY
BROAD MONEY
BROADER
MONEY
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NARROW MONEY, M1
Also known as Transaction Money
– can be used to make direct payments.
M1 constitute of:
 Currency in Circulation
(coins and paper money/notes/bank notes)
 Banks Till Money
 Current Deposits
 Traveler’s Checks issued by non-bank
companies.
 Other Checkable Deposits
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BROAD MONEY, M2
M2 constitute of:
 M1 +
 Fixed Deposits
 Saving Deposits
 Repurchase Agreements (REPOs)
 Negotiable Instrument of Deposits (NIDs)
 Bank Negara Certificate
all of which are held at commercial
banks only.
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BROADER MONEY, M3
 broader medium of exchange and as a store
of value.
Constitute of:
M2 +
Fixed Deposits
Saving Deposits
REPOs
NIDs
all of which are held at other financial
institutions.
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MONEY SUPPLY
Fiat money
(coins and notes)
Banks Till Money
Current Deposits
Traveler’s Checks.
Other Checkable Deposits
M1
Held at
commercial
banks only)
M2
 Fixed Deposits
Saving Deposits
REPOs
NIDs
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Narrow
Quasi
Money
(M2 – M1)
Held at
commercial
banks &
other
financial
institutions.
M3
Broad
Quasi
Money
(M3 –M1)
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Quasi Money
• Less liquid money which excludes the M1.
• Consists of fixed and savings deposits and
other financial instruments offered by
financial institutions, such as NIDs and
REPOs.
• Narrow Quasi Money = M2 – M1
• Broad Quasi Money = M3 – M1
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Exercise 1: Question To Ponder
ITEMS
RM mil
Coins
13,300
Fixed deposits in other financial institutions
26,880
Savings deposit in commercial banks
44,660
Fixed deposits in commercial bank
55,600
Negotiable certificates
25,000
Savings deposit in other financial institutions
Current deposits in commercial bank
25,580
30,650
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Calculate:
a.
Bank Notes if Fiat Money is RM39,000
millions.
b. M1
c. M2
d. M3
e. Narrow quasi-money
f. Broad quasi-money
g. Give 4 functions of money.
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ANSWERS:
a.
Bank Notes if Fiat Money is RM39,000
millions.
Bank Notes/dollars + coins = 39,000 mil.
Bank notes = 39,000 – 13,300
= 25,700 mil.
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ANSWERS:
b. M1 = fiat money/cash + Current deposits in
commercial/cheques.
= 39,000 + 30,650
= 69,650 mil.
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ANSWERS:
c.
M2 = M1 + Savings deposit in commercial bank
+ fixed deposits in commercial bank +
Negotiable certificates.
= 69,650 + 44,660 + 55,600 + 25,000
= 194,910
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ANSWERS:
d. M3 = M2 + Fixed deposits in other financial
institutions + Savings deposits in other
financial institutions.
= 194,910 + 26,880 + 25,580
= 247,370
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ANSWERS:
e.
Narrow quasi-money = M2 – M1
= 194,910 – 69,650
= 125,260 mil.
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ANSWERS:
f.
Broad quasi-money = M3 – M1
= 247,370 – 69,650
= 177,720 mil.
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FISHER’S
QUANTITY THEORY OF MONEY
• is given by:
the Equation of Exchange / Fisher’s identity
MV = PT
M = money in circulation
V = velocity of money
P = price
T = number of transactions (goods produced).
Look in Manual, page 71: topic 6 (Inflation)
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FISHER’S
QUANTITY THEORY OF MONEY
• Fisher’s assume that V and T are
constant in a specific period of time.
• Therefore, any changes to an increases in
money(M) would lead to a higher
increase in price (P) or inflation in an
economy.
• Excess of money supply would
caused to inflation.
Take this note
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FISHER’S
QUANTITY THEORY OF MONEY
• If, price increases by 10 %, Money supply
will increase by 10% too.
• Fisher’s equation is given as an identity,
where both sides must be identical.
• Therefore, there will always be a direct
and same change of Money Supply with
Prices (assuming that V and T are
constant.)
Take this note
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Relationship of Money and
Prices
• When there is inflation (price rises), it is
said that , the value of money falls since
the purchasing power of money falls.
• the purchasing power of dollar money is
said to fall as price increases.
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Purchasing Power of
Money
• is the ability of money that is used in
acquiring goods and services.
• So, the Value of Money is determined
by the quantity of goods and
services you can purchased with it.
• If price rises, then a given sum of
money will afford to buy less amount
of goods and services.
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Purchasing Power of
Money
For example:
with RM50 note here,
you can spent and purchased
5 flasks which cost you RM10 each.
RM10.00
Take this note
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Purchasing Power of
Money
For example:
with RM50 note here,
RM25.00
you can spent and purchased
5 flasks which cost you RM10 each.
But, let say now, PRICE RISES to
RM25 each.
Instead now, you can buy only 2 flasks.
Take this note
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Purchasing Power of
Money
• It is said that,
when price increases, the power that
you have to purchase goods with the
same amount of money that you have is
said to be less now;
In other words, the value of money falls.
Take this note
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Changes in Purchasing Power or
changes in the Value of Money
may affect money’s usefulness and
its ability to serve all the main
functions of money.
• Households lost their believe and
acceptance of money if hyperinflation
are expected to occur.
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Effects of Inflation on its Function:
May affects all the four main functions of
money:
Lost its ability as a role of a Medium of
Exchange – inflation reduced the
purchasing power of money.
Affects its usefulness as a Store of
Value –lost of trust and believe in
savings money.
Defeat the function as a Standard of
Measurement thus, cannot serve as a
Standard of Deferred Payment.
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To Measure Value of Money
 Price Index (PI) is used to measure
the change in the value of money
over time.
• If there is an increase in PI from 100
to 120 for example, it is said that
inflation had rises by 20 %.
• As price increases (inflation), value
of money falls. The higher the inflation the
lower is the value of money.
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In Islamic perspective:
• cost for holding money is minimum.
• Speculation purpose in Islam was still allowed
but is limited to certain condition following the
Islamic principles.
• Demand for money for transaction purpose is
because Muslims spends for sufficient
expenditure only.
• Excess money is used for investment
purposes.
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Islamic view regarding speculation
• The Syariah Law of Islam provides detailed
instructions for the Muslims for conducting
their business affair.
• In general, the requirements are as follows:
a) All business transactions must be free
as possible from riba, gharar, unfair
speculation, and deceit or dishonesty.
b) Production relations are based on the
principle of trust, mutual benefit and
cooperation.
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Risk takings:
• However, in Islam;
speculation in the form of risk takings is still
being allowed - as to attain profit as well as for
the benefit or welfare of the society.
• But, speculative activities that involve riba
must be avoided.
• Muslims are not allowed to freeze their wealth.
The objective of risk taking or investment is
not only to attain profit but Islam emphasis on
the welfare of the society.
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Riba is prohibited
• Speculations must not have any element
of riba.
• It refers to the excession to wealth and an
addition to the principle or capital stock or
increment on capital, such as the interest
payment on the principle savings and
interest-bearing credits available that
sometimes is expensive than they could
afford which denied the aim to serve for
the welfare of the society.
•
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“Gharar” sale
• The “Gharar” sale is a kind of sale in
which uncertainty is involved,
• such as the sales of goods and services
they have not produced.
• It involves speculative risk in the
contract.
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In Islamic framework, although speculation is
not lawful, but should not involve for the
reasons such as:
• non-physical delivery and riba.
Instead, for an interest that is paid on loans,
profit-sharing such as mudharabah, murabahah
and al-baibithamin-ajil could be the solutions for
investment loans in Islam.
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End of the Show
Thank You
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