The document discusses monetary policy and the money supply. It defines money as having four key functions: medium of exchange, store of value, unit of account, and standard of deferred payment. It also discusses the spectrum of liquidity and defines the money supply. The document contrasts broad and narrow definitions of money supply and explains how monetary policy aims to control inflation by managing the money supply and interest rates, which influence demand for money.

1. Aquinas College Economics Department
Monetary Policy for A2
Building on ECON2
ECON4

2. Aquinas College Economics Department
Functions of Money
A medium of exchange
– Used the for the exchange of goods/services
A store of value or wealth
– Good way of holding purchasing power
A unit of account
– Expressions of value allow comparison
A standard of deferred payment
– Allows the function of credit

3. Aquinas College Economics Department
Defining the Money Supply
No one part of money can fulfil
all the functions of money
Therefore there must be a
spectrum of liquidity
Money Supply:
The total amount of
money circulating in an
economy
Cash
Current
Accounts
Deposit
Accounts
Treasury
Bills
Property
Spectrum of Liquidity
More Liquid Least Liquid
Liquidity:
The degree to which
financial assets can be
easily converted into
money

4. Aquinas College Economics Department
Broad or Narrow?
Broad
Includes money held in
banks that is not readily
accessible
Narrow
Includes money that is
readily available in banks
or cash
Monetarism is one of the
economic theories that states
inflation should be controlled
using the money supply

5. Aquinas College Economics Department
Demand for Money
Determined by two key factors
1. Income – Higher levels of income cause
people to demand higher levels of
money in an economy
2. Rate of Interest – High rates = high
opportunity cost for holding money

6. Aquinas College Economics Department
The Rate of Interest
Interest Rates
are the price of
holding money
InterestRate
S
Quantity of Money
D1
As interest rates
rise, demand for
money falls
The Money Supply is
drawn as a straight
line as the Central
Bank should be able
to control the
supply, irrespective of
priceD

7. Aquinas College Economics Department
Nominal or Real Interest
Nominal – not adjusted for inflation
Real – adjusted for inflation
Calculation of Real Rate (Correct as of June 2013)
Nominal Rate of Interest – Rate of Inflation Real Interest Rate
0.5% - 2.4% -1.9%=

8. Aquinas College Economics Department
Monetary Policy Objectives
These are a target set by the Bank of England
Controlling inflation is the main target of the
BoE
1980s – Focus on Money Supply
1985-1992 – Focus on Exchange Rate
Post 1992 Control on inflation directly

9. Aquinas College Economics Department
Monetary Policy Instruments
Method used to achieve the objectives.
Sometimes called Weapons
Two main groups
1. Altering the Money Supply
2. Influencing the Demand for Money

10. Aquinas College Economics Department
Controlling the Money Supply
Credit Limits through base controls
– Places limits on the amount of money
commercial banks could lend out
– Also through Reserve Asset
Ratios, which defined how much a
bank must hold in cash to their assets
Buying and selling of Government
Bonds

11. Aquinas College Economics Department
Demand for Money
Done mainly through the changing of
interest rates
Lower rates should increase the demand for
money as its cheaper to borrow and there
is no incentive to save