Monetary System a Comparative Study

8/18/2019 Monetary System a Comparative Study

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THE MONETARY SYSTEM


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What is Money?

Money is any commodity that is generallyacceptable in exchange for goods and services

Money as defined by Oxford Advanced

Learners Dictionary of Current English is Coinsstamped from metal! printed notes! given andaccepted "hen buying and selling#$ %n other"ords anything that functions as a means of

payment &medium of exchange'! unit ofaccount! and store of value( somethingacceptable and generally used as payment forgoods and services is )no"n as money$


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*roperties of Money

Portability+ Money must be easy tocarry around and easy to transfer inorder to ma)e purchase in different

locations$ %f money is not easilyportable! people "ill not "idely use it$

Durability+ Money that does not

have the ,uality of physical durability"ill lose its value as money$


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*roperties of Money

Divisibility: We must be able to dividemoney easily into e,ual parts to allo" forpurchase of small units$ Co" cannot be

money because it is not divisible$ Standardizability+ Each unit of money

should be of e,ual ,uality andindistinguishable$ %f "e can standardi-e

money can individual be certain of "hat theyare receiving "hen they ma)e economicexchanges$ American colonists used tobaccoas money but they could never

standardardi-e tobacco$


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*roperties of Money

Recognisibility+ Money must be easilyrecognised$ %f people cannot easilyrecognise money then they "ill find it

difficult to determine "hether they aredealing "ith money or some inferiorasset$

Accetability: Money must beacceptable by the people in general$ %fpeople in general decline to acceptanything as a means of payment that can

be treated as money$


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.unctions of Money


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.unctions of Money

Money fulfills four functions

Money is a medium of exchange Money is a unit of account

Money is a store of value

Money is a standard of deferredpayment


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/$ Money is a Medium of Exchange

Anything that facilitates trade by beinggenerally accepted by all parties inpayment for goods or services

%t facilitates trade by providing amedium! "hich everyone is "illing toaccept in exchange for goods andservices or in paayment of debts$%ndividuals can sell their output formoney and use that money to buy goodsand services in the future$


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/$Money is a Medium of Exchange

%n the process money ma)esspeciali-ation possible$ 0peciali-ation isessential to any efficient economy( it

allo"s individuals to purchase mostproduct rather than producingtheproducts themselves$

Money functioning as a medium ofexchange has! perfected the pricemechanism$


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1$ Money is a 2nit of Account

As a common measure of value! moneyexpresses the values of all commodities$3he common measure of value function

of money has been given many names!of "hich the most common are 4unit ofvalue4! 4standard of value4! 4and unit of

account and common denominator ofvalue4$ %t serves as the unit in terms of"hich the value of all goods and servicesis measured and expressed as a 4price4$


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1$ Money is a 2nit of Account

%f there "ere only /!555 goods and servicesto be compared! there "ould be 677!855different exchange ratios$ 9ut "ith the use

of money the number of prices or exchangeratios needed is reduced to 777$

We may say that money measures thevalue! :ust as "e say that feet! inches andmeters and used to measure lineardistance( ounces! pounds! grams and tonsto measure "eight( gallons! liters and

barrels to measure li,uid volume(


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;$Money is a 0tore of


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;$Money is a 0tore of


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Money is a 0tandard ofDeferred *ayment

An agreed unit of measure thatenables people to contract for futurepayments and receipts

%t also serves as a standard ofdeferred payments "hen obligationsto ma)e future payments are stated

in terms of it$ 3his functionsimultaneously involves the use ofmoney as a medium of exchange andas a unit of account$


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Money is a 0tandard ofDeferred *ayment

We typically state debts in terms of aunit of account( "e pay these debts"ith a monetary medium of

exchange$ A corporate bond! forexample! has a face value stated indollar$ When the bond comes due at

maturity! that corporation pays theface face value to holders of the b


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!inds o" Money


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#$ %urrency Money vs$ DeositMoney

3here are t"o principal )inds of money+#$%urrency Money: 3he coins and paper

money issued by the =ovt$ are

commonly grouped together anddesignated as >currency>$

&$Deosit Money +Deposit money isissued by commercial ban)s on thebasis of their demand liabilities ordeposits! "hich are transferable! byche,ue$


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0tandard or .ullbodied vs$ 3o)enMoney

Metallic coins are further classified as

0tandard or .ullbodied money+ $ Astandard coin is that coin "hose facevalue is e,ual &or almost e,ual'&to itsintrinsic value

3o)en Money+$ 3o)en money on the

other hand is one "here intrinsicvalue does not represent the facevalue of the money$


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'egal Tender Money vs$ Otional

Money /$ Legal 3ender Money+ Legal tender is that money

"hich is officially designated by the government asan ade,uate instrument for the discharge ofobligations stand to be payable in domestic money$

Limited Legal 3ender and 2nlimited Legal 3ender1$ Optional Money+ Optional money is that money

"hich is ordinarily accepted by the people in finalpayments! but has no legal sanction behind it$

Credit instruments li)e che,ue! drafts! bills ofexchange! promissory notes etc$ are optionalmoney$ @o one can be forced to accept them( butthey are generally accepted because people haveconfidence in the credit of the paper$


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Narro( Money vs$ )roadMoney

#$ Narro( Money: @arro" money issum total of the money in circulationand the demand deposits &current savings deposit'$

&$ )road Money: On the other hand9road Money implies the narro"

money plus all other credit instrumentthat are convertible to li,uidity"ithout any decrease to its nominal

value$


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M#* M& and M+

M#: M/ composed of

/$ Currency in circulation!

1$ Demand deposits!;$ Other chec)able deposits and

6$ traveler4s chec)s$

M# is based on t,e transactionaroac, o" -oney$


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M#* M& and M+

M& composed of M/ plus the follo"ing

0avings and money mar)et deposit accounts

0mall denomination time deposit at all

depository institutions Overnight repurchase agreements at

commercial ban)s$

Overnight Eurodollars held by 20 residents

&other than ban)s ' at Caribbean branches of.ed member ban)s$

Money mar)et mutual funds$

Money mar)et deposit accounts$


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M#* M& and M+

M+ composed of M1 plus the follo"ing+

/$ Large denomination of time deposits atall depository institutions$

1$ 3erm repurchase agreements atcommercial ban)s and savings andloan associations

;$ 3erm Eurodollars

6$ %nstitutiononly money mar)et mutualfund balances


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.iat Money

.iat Money is the type of money thathas a -ero mar)et value or "hoseface value is more than its mar)etvalue$

*aper money! for example! notbac)ed by anything but faith in itsuniversal acceptance$


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/sla-ic Attitude to(ards.iat Money

/$ .iat Money "as not supported by earlyscholars li)e %mam %bn 3aymiah$

1$ Modern scholars support fiat money"ith reservation$

;$ As such fiat money supply should be

strictly controlled$6$ 0peculative use of fiat money should

be stopped$


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.inancial %ntermediaries %nstitutions that serve as a gobet"een!

accepting funds from savers and lendingthem to borro"ers$


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3ypes of intermediaries

Commercial ban)s

3hrift institutions0avings BLoan Associations

0avings 9an)s

Credit 2nions


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i$ Commercial ban)s largest in total assets

ii$ 0avings B Loans

originally restricting to savings deposits and

mortgages

less restricted today

iii$ Credit 2nions

consumer loans

nonprofit

organi-ed around a group


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iv$Contractual savings institutions

ac,uire funds through payments inreturn for obligations

life insurance

pension funds


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property and casualty insurance

1$ %nvestment intermediaries

indirect investment

;$ finance companies issue commercial paper

consumer B commercial loans

6$ mutual funds sell shares to stoc)bond portfolios

ta)en a"ay ban) business in past ;5 years


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Demand Deposits

Chec)ing accounts that pay nointerest


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3he 9an)ing %ndustry

9an)s exist to provide mutually beneficialtrades+

Depositors lend deposits to ban)s for t"oreasons+

.or the service that demand deposit accountsoffer

3o earn interest on savings 9an)s loan deposits to borro"ers in

exchange for interest on the loan$


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9an) Deposits %nclude Demand deposits &Chec)ing Accounts'

0aving Deposits &0aving Accounts

3ime Deposits &Certificates of Deposit orCDs'

Money Mar)et Deposit Accounts

@egotiable order of "ithdra"al &@OW'accounts


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Monetary Aggregates Each type of ban) deposit serves as a store of

value and can be converted into hard currency$

.inancial assets are instruments that can serve

as a store of value and can be converted intocurrency

0ince financial assets are so close to money! "ecall them money under broader definitions

A monetary aggregate is a measure of theeconomy#s money! "hich includes differentfinancial assets$


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'i0uidity

Li,uidity is the ease "ith "hich anasset can be converted into currency"ithout significant loss of its value

%n other "ords! Li,uidity is theability to pay short term obligationsof a firm or entity$

M/! M1! and M; are progressivelyless li,uid$

%n other "ords M; is less li,uid thanM1 and M1 is less li,uid than M/


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o" Does Money =et Created?

@o" that "e )no" the differentdefinitions of money! ho" is moneycreated in our economy?


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3he Origins and 0tructure ofthe .ederal eserve 0ystem

3he .ederal eserve 0ystem &the F.edG' "asestablished "ith the .ederal eserve Act of/7/6

3he .ederal eserve 0ystem is the central

ban) and monetary authority of the 2$0$ /1 .ederal eserve districts "ere established

around the country

3he 9oard of =overnors &H members appointedby the *resident and confirmed by the 0enate'sets and implements the nation#s monetarypolicy


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3he *o"ers of the .ederaleserve 0ystem .ederal eserve Act of /7/6 authori-ed Fto

exercise general supervisionG over the /1eserve ban)s

3he .ed "as given the po"er to issue ban)notes &paper currency'

3he .ed "as also given the po"er to buy andsell government securities! to extend loans to

member ban)s! to clear chec)s! and to re,uirethat member ban)s hold reserves e,ual atleast to a specified fraction of their deposits


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3he 9an)ing 0ystem is the ealCreator of Money 3hrough ta)ing deposits and ma)ing loans

the ban) "ill increase the amount ofmoney in the economy$

Assumptions+ 3he ban) must hold reserves+ e,uired eserves is the amount of currency the

ban) is must legally to hold

e,uired reserve ratio is the percentage of ban)deposits the ban) must hold in reserve$

9orro"ers do not let funds sit idle

3he public holds no cash


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3he Money Multiplier

3he money multiplier is the multipleby "hich the money supply increaseas a result of an increase in excess

reserves in the ban)ing system

3he simple money multiplier is thereciprocal of the re,uired reserve

ratio! or /r


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3he Actual Money Multiplier

3he simple money multiplier issub:ect to cash drain and excessreserves Cash drainIincreased cash holdings by

the public

Excess reservesIban)s may not lend all

excess reserves Each of these has the effect of

reducing the money multiplier


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Monetary 3heory and *olicy


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Monetary *olicy and 3heory Monetary policy is controlled by the .ed

and it is used to control the nationssupply of money

Monetary theory focuses on the effectsof money on the economy$

Most importantly monetary theoryfocuses on the effects of money supplyon the level prices and output$


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3he Demand for Money 3he demand for money is the relationship

bet"een themoney people desire to hold and the interest rate

3he demand for money also depends on theamount of money people "ant to hold fortransaction purposes

What is the cost of holding money in the form ofcash or in demand deposits &chec)ing accounts'?


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Money as a .orm of Wealth Money is one "ay in "hich individuals

hold "ealth due to its li,uidity o"ever! there is a cost to holding money in

the form of the interest rate

Due to opportunity cost of holdingmoney! people may decide to hold theirmoney in interest bearing financial

assets


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3he Demand for Money

1uantity o" -oney

/nterestrate

D3he demand formoney curveslopes do"n"ardsince as theinterest ratefalls! so does theopportunity costof holding money

3he demand formoney curveslopes do"n"ardsince as the

interest ratefalls! so does theopportunity costof holding money


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3he 0upply of Money

3he supply of money is the amount of money in theeconomy and is independent of the interest rate 3he .ederal eserve Controls the money supply

1uantity o" -oney

/nterest

rateS


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3ools of the .ederal eserve0ystem to Control the Money

0upply T,e discount rate is the interest ratecharged to member ban)s by the .ed fordiscount loans

Oen2-ar3et oerations are purchasesand sales of government securities by the.ed in an effort to influence the moneysupply

A reserve re0uire-ent ratio thatcontrols the amount of currency thatmust be held in reserves by ban)s


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3he Ob:ectives of the Central9an)ing 0ystem

A high level of employment

Economic gro"th

*rice stability %nterest rate stability

0tability in financial mar)ets

0tability in foreign exchange mar)ets


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/sla-ic vs$ %onventional4ie( o" Money

%slamic concept of

money

Conventional concept

of money

Money is considered

as servant

Money is considered

as Master &nest to=od'

Money is considered

as only the medium of

exchange

Money is considered

as both commodity

and medium of

exchange


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%slamic concept of

money


of money

Money should not be

stored or used forspeculative purpose

Money should be

stored and used forspeculative purpose

Money is not

considered as

commodity and hence

can not be traded

Money is considered

as commodity and

hence can be traded


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%slamic concept of

money


of money


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%slamic concept of

money


of money

0upply of money is

controlled andconditional

0upply of money is

uncontrolled andalmost unconditional

Credit Money is

discouraged

Credit Money is

encouraged


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5,y according to /sla- -oney isnot a co--odity

6a7Money ,as no intrinsic utility$ %t cannot beutili-ed in direct fulfillment of human needs$ %t canonly be used for ac,uiring some goods or services$A commodity! on the other hand! has intrinsic

utility and can be utili-ed directly "ithoutexchanging it for some other thing$ .or example!rice! cloth! chair! pen etc$ are commodity becausethey are used directly to satisfy human need$ %f aperson is hungry he cannot eat money directlyrather he has to use money to buy food for eating$

A thirsty person has to buy a glass of "ater againstmoney to drin)$ One cannot "rite by money ratherhe has to buy a pen to "rite anything$


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&b' Money Has no variety o" 1uality+ 3hecommodities can be of different ,ualities "hilemoney has no ,uality except that it is a measureof value or a medium of exchange$ 3herefore! all

the units of money of the same denominationare hundred percent e,ual to each other$ An oldand dirty note of s$/555 has the same value asa brand ne" note of s$/555$ On the other handgoods li)e clothe! food! furniture! household

appliances have got variety of ,ualities andcategories$ Each ,uality of goods and serviceshad different value or price$


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8 Money ,as no /ndividual /dentity: %ncommodities! the transactions of sale and purchaseare effected on an identified particular good$ Abuyer of a car! for example! agrees to buy a of a

particular brand! model! color etc$ and the selleragreeing thereupon! is obliged to supply thatparticular car$ 3he seller cannot compel the buyerto ta)e the delivery of another car! though of thesame type or ,uality$ Money! on the contrary!cannot be pinpointed in a transaction of exchange$

%f A has purchased a commodity from 9 by sho"inghim a particular note of s$/555 he can still payhim another note of the same denomination$


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/sla-ic verdict on use o" -oney

.irstly! money &of the same denomination' isnot held to be the sub:ect matter of trade!li)e other commodities$ %ts use has beenrestricted to its basic purpose i$e$ to act as a

medium of exchange and a measure of value$ Secondly! if for exceptional reasons! money

has to be exchanged for money or if it isborro"ed! the payment on both sides must

be e,ual! so that it is not used for thepurpose it is not meant for i$e$ trade inmoney itself$


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THE )AN!/N9 SYSTEM


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De"ining a %onventional )an3

A ban) is a trader of short term loans

FA ban) is dealer in debt J his o"nand of other peopleG J Cro"ther

F We can define a ban) as aninstitution "hose debts are "idelyaccepted in settlement of other

peoples# debt to each otherG J 0ayers


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De"ining a %onventional )an3

/$ F A commercial ban) is dealer incapital or more properly a dealer inmoney$ e is intermediate party

bet"een the borro"er and thelender$ e borro"s from one partyand lends to another and thedifference bet"een the terms at

"hich he borro"s and those at "hichhe lends form the source of hisprofit$G *rof$ =ilbert


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De"ining an /sla-ic )an3

F%slamic 9an) is a financial institution"hose statutes! rules and proceduresexpressly state its commitment to theprinciples of %slamic 0hariah and to thebanning of the receipt and payment ofinterest on any of its operations$G J &O%C$April of /7HK Da)ar the capital of 0enegal$'

%slamic ban)ing is essentially a normative

concept and could be defined as conduct ofban)ing in consonance "ith the ethics ofthe value system of %slam$

/ l i % ti l


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/sla-ic vs$ %onventional)an3ing %o-ared

%slamic 9an) Conventional 9an)

3he functions and

operating modes of

%slamic ban)s arebased on %slamic

0hariah

3he functions and

operating modes of

conventional ban)sare based on

manmade principles

%9 promotes ris)

sharing bet"eenprovider of capital and

the entrepreneur

3he investor is

assured of apredetermined rate of

interest

/ l i % ti l


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Maximi-ing profit

should not be

ob:ective of an %9

%t aims at maximi-ing

profit "ithout any

restriction

%slamic ban)s collect

and distribute Zakat.

%t does not deal "ith

Zakat.

/ l i % ti l


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*articipation in

partnership business

is the fundamentalfunction of the %slamic

ban)s$

Lending money and

getting it bac) "ith

interest is thefundamental function

of the conventional

ban)s

"ider scope ofactivities compared to

a conventional ban)$ A

multipurpose ban)

@arro"er scope ofactivities "hen

compared "ith an

%slamic ban)$

/ l i % ti l


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3he %slamic ban)s

have no provision to

charge any extramoney from the

defaulters

%t can charge

additional money

&compound rate ofinterest' in case of

defaulters$

%t gives importance to

the public interest$ %tsultimate aim is to

ensure gro"th "ith

e,uity$

9an)#s o"n interest

becomes prominent$ %tma)es no effort to

ensure gro"th "ith

e,uity$

/ l i % ti l


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.or %slamic ban)s! it is

comparatively difficult

to borro" money fromthe money mar)et$

9orro"ing from the

money mar)et is

relatively easier

0ince it shares profit

and loss! the %slamic

ban)s pay greaterattention to developing

pro:ect appraisal and

evaluations$

0ince return from loan

is fixed! it gives little

importance to pro:ectappraisal and

evaluations$

/ l i % ti l


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%slamic ban)s give

greater emphasis on

the viability of thepro:ects

Conventional ban)s

give greater emphasis

on credit"orthinessof the clients $

3he status of %slamic

ban) in relation to its

clients is that ofpartners! investors

and trader$

3he status of a

conventional ban)! in

relation to its clients!is that of creditor and

debtors

/ l i % i l


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0trictly spea)ing

there is no guaranteefor deposit money

A conventional ban)

has to guarantee all itsdeposits$

An %slamic ban) can

never be a ban)rupt

A conventional ban)

has every possibility tobe a ban)rupt

*romotes mass

ban)ing

*romotes class ban)ing

. ti l Di"" b t


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.unctional Di""erences bet(een%onventional and /sla-ic )an3s


Collection of deposit

on the basis of profit

sharing

Collection of deposit

on the basis of

interest

%nvestment follo"ing

9uy modeinvestment

mode lease mode

Extending credit on

the basis of interest

%ssues letter of

guarantee

%ssues letter of credit

. ti l Di"" b t


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.unctional Di""erences bet(een%onventional and /sla-ic )an3s


Acting against

Creation of medium

of exchange and credit

Creating medium of

exchange and credit

%nvestment in shares

and Mudarabah bond

%nvestment in shares

and securities having

coupon rate of interest

@o discounting of bill Discounting of bill


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'endinginvest-ent o" /sla-ic ;%onventional ban3 co-ared

*oint of diff$ Conv$ 9an) %slamic 9an)

Mode of

%nvestment

Lending %nvestment

&buileaseD$

inv'0afety of the

loan

*rime

consideration

@o guarantee

for investment

Collateral

0ecurity

9ase of the loan @ot re,uired

Less important

di i " l i


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Character of

the loan

applicant

%mportant to be

considered


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.inancial

strength of

the client

%mportant

consideration

0hould be less

impotant

pro:ect

*rofitability

Less important


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@ational

interest

0econdary

consideration

*rimary

consideration

Close

supervision

@ot a routine

"or)

Must be a

routine "or)

Observation

of 0hariah

@ot follo"ed 0trictly

follo"ed

Monetary System a Comparative Study

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