İKTİSADA GİRİŞ II - Deneme Sınavı - 18

Serving as a Store of Value: The third function of money is to be a store of value. Money, as a store of value, ensures to keep purchasing power on hand. For example, you hold an amount of purchasing power equal to the amount of money in your pocket right now. If you have 20 TL in your pocket, you can imagine your purchasing power by thinking about the goods and services you may purchase with this amount of money and understand this function of money easily.

In an economy with commodity money, for instance, if both gold and silver coins are in use (in circulation) at the same time, an interesting situation emerges. Since gold as a commodity has a greater value than silver, nobody wants to spend coins in his/her pouch and everyone tries to spend silver coins first. If everybody behaves like that, the money passing from hand to hand will be silver coins and gold coins will stay in people’s pouch. If we call silver coins as bad money and gold coins as good money, we can easily say that bad money drives out good money in the market. This phenomenon is known as Gresham’s Law.

M3 = M2 + Repo + Money Market Funds + Debt Securities Issued

In this definition, repo (repurchasing agreements) accounts include funds used as a very short term financial tool, money market funds include B type liquid investment funds and debt securities issued include bonds and bills issued domestically in TL by banks with maturity up to 2 years.

Bank’s basic business principles and especially the reserves they hold as we try to outline above demonstrate another important function of banks they undertake in the economy: Money creation. In fact banks create money by collecting deposits from people and using them to make loans and investments. This money created in form of demand deposits as a result of banks’ credit transactions is called as deposit money. To understand and follow the topic easily, we will try to review with rounded and exemplary figures. To comprehend this function of banks, consider the following scenario.

If we denote the amount of deposit money which banking system can create, that is, change in in demand deposits, as ΔD, change in reserves of banking system as ΔR and required reserve ratio as r, we can calculate the deposit money amount that can be created with the formula:

If we denote the amount of deposit money which banking system can create, that is, change in in demand deposits, as ΔD, change in reserves of banking system as ΔR and required reserve ratio as r, we can calculate the deposit money amount that can be created with the formula:

Transaction demand for money is the quantity of money that economic agents want to hold with the intent of spending for goods and services.

Money Demand Function

As we saw the reasons why economic units want to hold money, it is much easier to review the factors causing changes on this amount. As we just mentioned, economic units desire to hold money for three purposes: For transactions, as a precaution and speculatively. According to our explanations above, there are two factors determining the amount of money demanded: Nominal income and interest rate. The Keynesian approach reviewing the relationship between quantity of money and economic activities via indirect channel, accepts money demand (Md) as a function of interest rate (i) in an environment having a constant nominal income rate.

According to classical economists effect of money on the economy occurs only by effecting price. Because of this feature, classical economists resemble the money as a veil covering the economic activities. In other words, according to classical economists money is neutral; that is, it has no impact on output and only affects the prices.

General tools of monetary policy are tools that central banks use to direct reserves of banking system in a country consisting of required reserve ratios, discount rates and open market operations.

Gresham’s Law states that the bad money drives out the good money in the market.

M1 = Currency in Circulation + Demand Deposits - Time Deposits

M1 = Currency in Circulation + Demand Deposits

The demand deposits in this definition include TL and foreign currency deposits in commercial banks, participation banks, investment and development banks operating in Turkey.

Central banks force commercial banks to hold a certain rate of their deposits as reserves. This mandatory reserve rate is called as required reserve ratio and can vary according to type of deposits and each country may have different regulations.

Money, as a store of value, ensures to keep purchasing power on hand.