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Money and Banking
Professor Chris Adam
Australian Graduate School of Management
University of Sydney and University of New
South Wales
1
INTRODUCTION
• What is money?
• What are the forms of money?
• How does banking work?
• How does the government influence
money?
2
MEANING OF MONEY
• Money is set of assets used in economy to
buy goods and services from people
• Three functions of money:
1. Medium of exchange
• Universally accepted for exchange
• Can be used to pay taxes
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MEANING OF MONEY
• Three functions of money:
2. Unit of account
• Yardstick of measuring value
3. Store of value
• Transfer purchasing power from present to
future
• Concept of liquidity: ease of converting
asset into medium of exchange
4
KINDS OF MONEY
• Commodity money has intrinsic value
– Gold standard
– Cigarettes
• Fiat money has value established by
decree
• Economic conditions can induce people to
substitute first for second
5
MONEY IN ECONOMY
• Money supply as circulating volume of
purchasing power
• Basic type as currency: notes and coins in
hands of public
– Includes EFTPOS (“debit” cards)
– Also called money base or high powered money
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MONEY IN ECONOMY
• Broader definitions (M1, M2, etc.,) include
– cheque accounts
– savings accounts
– time deposits (Certificates of Deposit)
– deposits in non-bank financial intermediaries
• Credit cards are means of deferring
payment: not part of current money supply
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AUSTRALIAN MONETARY
AGGREGATES CHANGES
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AUSTRALIAN MONEY
AND CREDIT CHANGES
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RESERVE BANK OF
AUSTRALIA
• RBA is Australian central bank
– Created in 1959 from Commonwealth Bank
– Established to manage financial system stability
for good of economy
– Policy maker for banking system and money
supply functions
– RBA Board as guide to RBA Governor
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RESERVE BANK OF
AUSTRALIA
• RBA functions:
1. Originally to monitor bank financial conditions
and recommend actions to keep solvent –
prudential supervision
• Now with APRA
2. Guarantor of banking system stability but not
lender of last resort
• Operates cheque clearance process
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RESERVE BANK OF
AUSTRALIA
• RBA functions:
3. Monetary policy design and implementation, to
influence growth rate of economy and inflation
• Through open-market operations
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BANKS AND MONEY
SUPPLY
• Bank balance sheet model to demonstrate
credit creation with 100% reserves
– no credit creation!
• Bank balance sheet model to demonstrate
credit creation with frational reserves
– Allows creation of credit
– Money multiplier
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AUSTRALIAN BANK
INTEREST SPREADS
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AUSTRALIAN BANK FEE
INCOME
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AUSTRALIAN BANK
EQUITY RETURNS
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AUSTRALIAN MONETARY
POLICY
• RBA uses changes to cash rate to adjust
level of interest rates in economy
– overnight loans among intermediaries
– shifts base of yield curve
• Open-market operations to adjust to excess
supply or demand of overnight funds
– buying and selling government securities from
own portfolio
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AUSTRALIAN CASH RATE
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AUSTRALIAN INTEREST
RATES
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AUSTRALIAN MONETARY
POLICY
• RBA also oversees reserve requirements for
banks
– Basel Agreement: Tier 1 and Tier 2 reserves held
against assets with appropriate risk classes
• Problems for RBA in monetary policy:
– Household deposits at banks are discretionary
– Bank lending as decisions of banks
– Confidence in banks: role of bank runs
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AUSTRALIAN CREDIT
AND GDP CHANGES
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