Money Demand, Banks, and the Spanish Financial System
Money Demand
Money has three functions: It is a medium of exchange, accepted by the community for transactions and debt cancellation. It is a unit of account, used to calculate the value of goods and services. It is a store of value, a way of keeping wealth; families and businesses keep a portion of their assets in cash. These features highlight the importance of liquid funds for traders. However, cash has an opportunity cost. This opportunity cost is determined by the interest sacrificed because money in a liquid savings account would earn interest, and if we don’t obtain that interest, that’s the opportunity cost.
Why demand money? Individuals and companies demand money to make transactions—to purchase goods and services.
What determines the demand for more or less money?
Income and property prices: Higher income and property prices increase the demand for money because people want to buy more goods and services. The opposite occurs if incomes fall and prices drop. Interest rates: Higher interest rates increase the opportunity cost of holding liquid money, thus decreasing demand. Conversely, lower interest rates decrease the opportunity cost, increasing the demand for liquid money.
Why demand money? Individuals and companies demand money to make transactions—to purchase goods and services.
What determines the demand for more or less money?
Income and property prices: Higher income and property prices increase the demand for money because people want to buy more goods and services. The opposite occurs if incomes fall and prices drop. Interest rates: Higher interest rates increase the opportunity cost of holding liquid money, thus decreasing demand. Conversely, lower interest rates decrease the opportunity cost, increasing the demand for liquid money.
Banks and Money Creation
Financial institutions channel funds from lenders to borrowers and create financial instruments, most importantly, money or bank accounts. Commercial banks accept deposits and make loans. Their assets are immediately available to meet depositors’ demands. The minimum reserve ratio (Reserves/Deposits) is crucial. Deposits are the amounts customers lend to the bank in exchange for interest. Reserves include cash on hand and bank deposits at the central bank. Reserves serve two purposes: 1. To meet customer withdrawals. 2. To comply with monetary authority requirements. Reserves are not considered part of a country’s money supply. Banks create money by lending out a portion of their deposits, keeping only a percentage in cash.The Spanish Financial System
The financial system comprises institutions mediating between suppliers and demanders of financial resources. We distinguish between bank and non-bank financial intermediaries.
Bank financial intermediaries issue financial assets generally accepted as payment.
The banking system influences the money supply, impacting aggregate demand. Financial intermediaries include:
The Bank of Spain: Primarily funds the public sector and other financial intermediaries, issuing banknotes and coins as legal tender.
Private Banks: Hold cash reserves and finance the private and public sectors, the latter through public debt securities. They receive funds from deposits and issuing fixed-income securities and equities.
Savings Banks: Specialize in raising funds from small savers through deposit accounts, enabling long-term loans.
Credit Unions: Provide funds to members and the public.
The Stock Market (Stock Exchange): Supply is determined by new share issues and existing securities sales; demand stems from the desire to buy these securities. The primary market handles new issues, channeling savings into investment. The secondary market allows for the resale of securities. Investment decisions are driven by factors such as potential capital gains, unsatisfactory returns, or mitigating losses. Securities include:Fixed-income bonds: Debt instruments with a predetermined interest rate. Equities: Corporate shares with returns dependent on company profits.
Bank financial intermediaries issue financial assets generally accepted as payment.
The banking system influences the money supply, impacting aggregate demand. Financial intermediaries include:
The Bank of Spain: Primarily funds the public sector and other financial intermediaries, issuing banknotes and coins as legal tender.
Private Banks: Hold cash reserves and finance the private and public sectors, the latter through public debt securities. They receive funds from deposits and issuing fixed-income securities and equities.
Savings Banks: Specialize in raising funds from small savers through deposit accounts, enabling long-term loans.
Credit Unions: Provide funds to members and the public.
The Stock Market (Stock Exchange): Supply is determined by new share issues and existing securities sales; demand stems from the desire to buy these securities. The primary market handles new issues, channeling savings into investment. The secondary market allows for the resale of securities. Investment decisions are driven by factors such as potential capital gains, unsatisfactory returns, or mitigating losses. Securities include:Fixed-income bonds: Debt instruments with a predetermined interest rate. Equities: Corporate shares with returns dependent on company profits.