ECF 320 – MONEY,

BANKING AND
FINANCIAL MARKETS
OUTLINE
 Objectives
 Learning outcomes
 Introduction
 Money and its characteristics and functions
 Measures of money
 Evolution of the payment system
Objectives
This topic aims at:
 Introducing students to money, banking and
financial markets as a separate discipline of
economics
 Defining money and discussing its various
characteristics and functions
 Explaining how money is measured
 Discussing the evolution of the payment
system
 Learning outcomes
At the end of this topic, you should be able to:
 Explain the importance of money, banks and
other financial institutions in an economy
 Outline the characteristics and functions of
money
 Distinguish the various measures of money
 Explain the evolution of the payments system
Introduction
 As the name of the course suggests, there are three
important components that need to be understood :
1. Money and Monetary Policy
2. Banking
3. Financial Institutions

 By looking at the three components, we try to

understand the role of money, monetary policy,
banks and financial institutions in an economy
 In addition, we look at how these three
factors affect other macroeconomic
variables such as interest rates,
economic growth, inflation,
employment, exchange rates, etc

 Therefore, this course is an exciting

field of economics that directly affects
your life.
 For instance, interest rates influence earnings on
savings and the payments on loans on a car or a
house, and monetary policy may affect job
prospects and the prices of goods in the future.

 Financial markets and institutions not only

affect your everyday life but also involve huge
flows of funds throughout the economy, which
in turn affects business profits, the production
of goods and services, and even the economic
well being of countries
Your study of this course will introduce you to
many of the controversies about the conduct of
economic policy and will help you gain a
clearer understanding of economic phenomena
you frequently hear about in the news media.

The knowledge you gain will stay with you

and benefit you long after the course is done.
 Money and its Functions
 Money, also referred to as money supply is
defined as anything that is generally accepted in
payment for goods and services or in the
repayment of debts.

 Money is linked to changes in economic variables

that affect all of us and are important to the health
of the economy

 However, for anything to qualify as money it

should the following characteristics:
1. Acceptability

2. Portability

3. Homogeneity/standard/identical

4. Scarcity

5. Divisibility

6. Durability
 Functions of Money
Money performs the following functions in an economy:
I. Medium of exchange: Money is used to purchase
goods and services e.g. producers sell their produce to
wholesalers in exchange for money and wholesalers
sale to consumers in exchange for money.

 This function distinguishes it from other assets such as

bonds, stocks and houses

 Use of money as a medium of exchange promotes

efficiency by minimizing the time spent in exchanging
goods and services. E.g. consider a barter system
II. Store of Value: Money allows people to store
surplus purchasing power and use it whenever
they want.

In this way, money is used as a liquid asset.

Liquidity refers to the ease of converting a

store of value into a medium of exchange.
III. Unit of account (measure of value): money
is used to express values of various products and
services produced in an economy

If for example the economy has only three

goods, then we need only three prices to tell us
how to exchange one for another

As such money reduces transaction costs by

reducing the number of prices that need to be
considered
The benefit of this function of money grows as
the economy becomes more complex

IV. Standard of deferred payments: Money is

used to settle future payments.

For instance, modern economies are based on

credit e.g. people get loans such as financing
loans, mortgages and settlement of these is
done using money.
Evolution of the Payment System
Coin Money: With time, the gold bars used as
commodity were transformed into coins.

People started using gold coins and silver

coins as money.

Bank Notes: paper money started in form of

representative money.
Those with gold would deposit their gold with
the bank and the bank would issue a receipt
and/or note to the depositor that was
redeemable for whatever gold or silver they
had stored.

Since having a receipt or note was as good as

having gold, these notes/receipts started being
traded and with time these notes/receipts were
legalized as money.
Bank Credit: as banks and paper money
increased, banks realized that they could make
money by loaning out money trusting that not
everyone would want their money back at the
same time.

The idea of fractional reserves was introduced

and banks started extending credit to those
who wanted to borrow.
Checks: Given some challenge posed by coins
and paper money that it becomes bulky if the
payment is too big, checks were introduced.

A check is an instruction from you to your

bank to transfer money from your account to
someone else’s account when she deposits the
check
 However, because checks could bounce and also
took time to clear before one can access the
money, other methods of payment have continued
to emerge including credit cards, interest
payment, mobile banking, electronic payments

Measuring Money
 Three measures have been identified:
1. M1: this is a very narrow definition of money. It
constitutes money (notes + coins) in circulation,
which is money outside the central bank plus
commercial bank deposits with the central bank.
 This emphasizes the medium of exchange function.

 It also includes demand deposits and traveller’s

checks

2. M2: M1 + Savings Deposits +Time deposits + Money

market mutual funds

3. M3: M2 + other non-personal fixed term deposits +

foreign currency deposits by residents of the country
ACTIVITY
Explain the following components of money:
a. Demand deposits
b. Traveller’s checks
c. Time deposits
d. Money market mutual funds
e. Non-personal fixed term deposits
~THE END~