Forms of Money, Financial Systems, and Monetary Policy
Forms of Money
1. Commodity Money
Has value in itself and also as a medium of exchange (e.g., diamonds, gold).
2. Money Mark
2.1. Paper Money
Receipt issued by a depository for valuables, promising to repay them upon reinstatement.
2.2. Fiat Money
Money used as a medium of exchange because of the trust it generates (e.g., coins, banknotes).
Functions of Money
1. Medium of Exchange
An alternative to bartering.
2. Deposit of Value
A good that can be used when needed.
3. Unit of Common Account
The type of measurement in the economy.
4. Average Price Level
The average price level and money demand.
5. Income and Wealth
Income, demand for luxury goods, and normal goods demand.
6. Market Interest Rate
Interest and money demand.
7. Risk
Risk and money demand.
The Price of Money (Interest)
Payment for the services received from the capital of a loan.
Factors to Consider for a Loan
1. Risk of the Transaction
The possibility of not returning the loan.
2. Liquidity
The ability of assets to become lawful money.
3. Duration of the Loan
A longer loan term typically means higher interest.
Classes of Fiat Money
1. Legal Money
Consists of banknotes and coins in circulation within an economy.
2. Cash at Bank
Money becomes virtual when deposited in a bank, disappearing physically.
Difference Between Deposits
1. Demand Deposits
Allow holders to have immediate access to their money.
2. Time Deposits
Holders commit to keeping their money deposited for a certain time period in exchange for remuneration.
Money Supply
The total quantity of different kinds of money.
Fractional Reserve Banking
1. Fractional Reserve Banking
The percentage of money that a bank keeps inactive to cover potential withdrawals.
2. Banking
Accepting lawful money from savers and lending it to traders who need funding.
Creation of Bank Money
1. Cash Ratio
The percentage of lawful money held inactive by banking entities to cover customer withdrawals.
2. Investment Multiplier
The increase in lawful money within the banking system resulting from an initial deposit.
Monetary Policy
Measures taken by the European Central Bank (ECB) to achieve monetary authority objectives by controlling the amount of money in circulation.
Types of Monetary Policy
1. Monetary Instruments
1.1. Reserve Requirements
Determining the cash ratio.
1.2. Open Market Operations
Controlling interest rates and the amount of money in circulation.
1.3. Standing Facilities
Liquidity facilities for banks.
2. Impact on the Economy
2.1. Expansionary
Increasing the amount of money in circulation or decreasing interest rates, leading to increased disposable income, consumption, investment, aggregate demand, production, and jobs.
2.2. Contractionary
The opposite of expansionary policy.
The Financial System
A structure composed of intermediaries that channel resources towards financing private consumption, business investment, and public spending.
1. Funds or Financial Assets
Products that provide a means to store wealth for those who possess them (assets) and a liability for those who owe them.
They differ by:
1.1. Liquidity
Measures the ease and certainty of realizing short-term assets without incurring losses.
1.2. Risk
Probability that what is owed will not be paid.
1.3. Performance
The capacity of an asset to produce interest.
2. Financial Intermediaries
Institutions that specialize in mediating between savers and investors.
Types
2.1. Banking
Offer financial products like checking or savings accounts that are accepted as means of payment.
2.2. Non-bank
Insurers cannot offer financial products that are valid as money.
Functions of the Bank of Spain
1. Hold and Manage Foreign Reserves
Manage foreign reserves and precious metals that are not transferable to the ECB.
2. Promote the Stability of International Payment Systems
3. Circulate Coins
4. Be the Financial Agent of the Public Debt
5. Monitor the Performance of Credit Institutions
Difference Between Private Banking and Savings Banks
1. Private Banking
Provides financing to operators, maintaining a portion of their funds in cash to cover potential withdrawals, with funding given as loans.
2. Savings Banks
Cannot raise funds by issuing equity securities and receive beneficial tax treatment because they perform charitable activities.
Non-bank Financial Intermediaries
1. Instituto de Crédito Oficial (ICO)
Subsidizes economic sectors and funds infrastructure projects facing difficulties.
2. Insurance Companies
Issue insurance policies.
3. Pension Funds
Mutual funds that complement the state retirement pension paid by social security.
4. Leasing Companies
Offer a financing system where a company can acquire a capital asset in exchange for periodic lease payments.
5. Factoring Companies
Involve the sale of all rights represented by receivable invoices.
6. Brokerages in the Money Market
Manage highly liquid assets in the stock market.
7. Stock Market
Civil partnerships that provide a public service, facilitating the competitive trading of securities. The most important securities are fixed-income securities with a fixed salary agreed upon beforehand and equities (shares).
8. Stock Market Index
An indicator of market behavior based on the performance of the most representative securities.
Equity Market
1. Primary Market
Where assets are created and savings are channeled into investment.
2. Secondary Market
Where shares are sold after being acquired in the primary market, without directly affecting the company.
Business Financing
1. Own Financing
1.1. Contributions from Owners
When buying company shares, owners contribute their own resources.
1.2. Reserves
Profits that are not distributed and remain in the firm as self-financing.
2. Other Financing
2.1. Trade Credit
Automatic financing that occurs when a company delays payment to its suppliers.
2.2. Loans
Involve interest payments and are repaid with company profits.
2.3. Bonds
Loans to individuals by issuing bonds.
Shares
Entitle the holder to dividends, a share of ownership proportional to the assets owned, and self-financing.
Bonds
Entitle the holder to interest payments, representing a loan made to the company, and are a form of external finance.