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Monetary economics

Chapter No # 2

Forms of money

Instructor: M.N Nasrat

All materials related to monetary

economics are available in:

nasirnasrat.wordpress.com

Terms to Known

1.Metallic money

2.Paper money

3.Kinds of paper money

4.Merits and demerits of paper

money

5.Significance & evils of money

(advantage of money)

6. Role of money

Metallic Money

o It consists of coins, made of gold, silver, copper ornickel. It varies in weight, fineness and value.

oMetallic money is in full bodied money or tokenmoney.

1. full bodied money: The Full bodied money is thatwhose face value is equal to its intrinsic value ofmetal.

Govt. retains a monopoly of the issue of full bodiedcoins. Full bodied money also called standard Money

Metallic Money

2. Token money: It is subsidiary money whichits face value is higher than its intrinsicvalue. Its generally limited legal tendermoney.

o Issuance of token money depends upon theneeds of the people.

Legal Tender vs. optional money

Legal tender money: Any means of paymentwhich has state’s sanction (Approved) behind itand a debtor can legally compel his creditor toaccept in settlement of dues, is called legal tendermoney. It is of two kinds:

a) Unlimited Legal Tender

b) Limited Legal Tender

Legal Tender vs. optional money

a) Unlimited Legal Tender: Unlimited legaltender money is one in terms of which debtscan be legally paid up to any amount

o In Afghanistan the currency notes of Afn. 10,Afs. 20, Afn. 50, Afs. 100Afn etc.

Legal Tender vs. optional money

b) Limited legal tender money: is that which a

creditor can accept in settlement of claims up to a certainlimit only.

For example Mr. A owes Mr. B Afn. 1321 only to be paid, soMr. B may pay in following denominations:

1. Afn. 1000 x 1, Afn. 100 x3, Afn. 20 x 1 and coin of Afn. 1 x1

2. Afn. 500 x 2, Afn. 50 x 6, Afn. 10 x 2 and coin of Afn. 1 x 1.

3. But A may Refuse to accept Coins Afn 5 x 264 and Afn 1x1.

Legal Tender vs. optional money

Optional money: it refers to that money which may or may

not be accepted in the discharge of debts. Bank cheque is an

example of optional money. In this case, the creditor need not

accept cheque from the debtor since this type of money does

not possess the characteristic of general acceptability. No one

can be forced to accept cheque against the wishes of the

people. It has no legal sanction behind it.

Paper Money

Definition: Paper money refers to note of

different denominations made of paper and

issued by the central bank or Government

of the Country.

There are two kinds of Paper money:

1. Representative paper money

2. Fiat paper money

Representative paper money

Representative money refers to that money which

is made either of cheap metal or convertible paper

money. It is cared not for its own sake but for the

sake of the commodity money whom it represents.

It may either be representative full-bodied money

or representative token money or fiat money.

The holder of the bank note can easily get it

converted in standard metal money on demand.

Fiat money (inconvertible paper money)

o It is that money which is not redeemableinto gold or silver on demand. It isaccepted because it has been declaredlegal tender by the issuing authority andhas general acceptance as a medium ofexchange. The intrinsic value of fiat moneyis nil.

o Fiat money in the words of Keynes is thatwhich is created and issued by the statebut is not convertible by law into any thingother than itself and has no fixed value interms of an objective standard.

Characteristics of the fiat money

The main characteristics of the fiat money

are:

1. It has significantly less intrinsic value than

its face value,

2. It is not convertible into any valuable asset,

3. It is accepted in transactions at face value

because it is legal tender.

Merits of Paper Money

Class activity: work in pair, and

make a list of merits of paper

money.

Merits of Paper Money

1. Economical

2. Elasticity of money supply

3. Promotes economic growth

4. Internal price stability

5. Helpful in emergency

6. Regulation of exchange rates

7. Uniform quality

Merits of Paper Money

1. Economical:

Under paper standard, the central

bank has not to keep gold or silver for

issuing of the paper notes.

The cost of printing paper notes is also

very small.

It is thus, most economical form of

monetary standard.

Merits of Paper Money

2. Elasticity Of Money Supply:

As the money supply is not backed

with gold or silver, therefore, the

monetary authority can easily

manage its supply according to the

requirements of trade and industry

in the country.

Merits of Paper Money

3. Promotes Economic Growth:

Under paper standard, the monetary

authority is free to determine its monetary

policy.

It therefore regulates the money supply in

such a way that productive resources of

the country are utilized to their maximum

and greater economic growth achieved.

Merits of Paper Money

4. Internal Price Stability:

Under paper standard, the monetary

authority can maintain stability in internal

price level by making necessary

expansion or contraction in money

supply according to the economic

conditions.

Merits of Paper Money

5. Helpful In Emergency:

Paper money is also useful in times of war

when huge funds are needed to finance it.

It is also helpful to meet any financial

crises.

The monetary authority by expanding or

contracting the money supply achieve this

objective.

Merits of Paper Money

6. Regulation of Exchange Rates:

o Under paper standard, the international

exchange rates are fixed by purchasing

power of the respective countries.

o Paper currency is an effective and

automatic regulator of exchange rates

between the countries.

Merits of Paper Money

7. Uniform quality:

o The paper money has a uniform quality

and the holder least bothers for

possession of new money coins.

o With the use of paper money, the loss of

precious metals due to wear and tear is

also solved.

Demerits of Paper money

1. Danger of inflation

2. Exchange rate instability

3. Dangers of mismanagement

4. Fear of demonetization

5. Use within the country

Demerits of Paper money

1. Danger of inflation:

o Under paper money, the increase in money

supply is not difficult because it requires no

backing of gold or silver.

o The government of the country, to cover the

deficit financing, over issues paper currency.

o This results in inflationary rise in prices with

all its evil effects.

Demerits of Paper money

2. Exchange rates instability:

o Under paper standard, there are also

wide fluctuations in the foreign exchange

rates.

o The internal prices do not move in line

with the external prices.

o As such external instability arises which

directly effects the foreign trade.

Demerits of Paper money

3. Dangers of mismanagement:

o Paper standard is useful only when it is

efficiently managed.

o If the monetary authority is not vigilant

and does not issue the paper currency as

required, it often leads to inflation or

deflation.

Demerits of Paper money

4. Fear of demonetization:

o The paper money has no intrinsic value of its

own. The monetary authority also does not

promise to convert it into precious metal.

o If the government at any time orders the

demonetization of the currency, And the

holders of the demonetized notes fail to

deposit these notes in times, they have then

no value.

Class activity:

Why the governments demonetized

their money?

Demerits of Paper money

5. Use within the country:

o As the intrinsic value of paper money is

zero, it can only be used in the country

issuing it.

o Outside the country only stable paper

money has the value.

Significance & evils of money

1. Money and consumption: money

enables every consumer to generalize

his purchasing power. It gives the

consumer to command over anything he

wants to buy. It provides him the

freedom of choice of consumption.

2. Money and production: money

enables the producer to concentrate his

attention on the organization of the

production process. This will add

effectively to the general flow of goods

and services. Money has made division of

labor in the modern industrial production

possible.

Significance & evils of money

3. Money and exchange: money

facilitates exchange of goods and services

on easy terms without any difficulty. It has

been the basis of price mechanism in the

modern society.

4. Money and distribution: money

enables the organizer to distribute the

shares of all factors of production in the

form of rent, wage, interest and profit.

Significance & evils of money

5. Money and public finance: without

the use of money, no policy can be

devised and implemented by the

government. Government activities can be

expanded only with the use of money.

Money helps in achieving economic

stability in the economy. Therefore, plays

a significant role in shaping the economic

life of a country.

Significance & evils of money

Significance & evils of money

Money is a good servant but a

bad master.

- Henry G. Bohn

1. Instability of value: the main evil

of money is its instability. Even though

money was invented to measure the

value of all goods and services,

sometimes the value of money does not

remain stable. Such instability of its

value is mainly due to inflation and

deflation.

Significance & evils of money

2. Inequality of income: there is an

inequality in the distribution of income

among people. It gives rise to two classes

of people, namely, rich and poor. The rich

class saves a large part of their income,

whereas the poor class spends most of

their income and saves only less.

Significance & evils of money

3. Root of all vices: those people who

earn more generally spend their income

on vices. It is the root cause for many

vices such as corruption, bribery,

prostitution, theft, murder and other

social evils.

Significance & evils of money

1. Role of money in a capitalist economy: Price

mechanism is, in fact, the main pillar of the

capitalist economy. This price mechanism is

expressed in terms of money. All important

decisions are made with the help of price

mechanism under capitalist economy. Money plays

a significant role in a capitalist economy. Consumer

are free to choose within certain limits what goods

to buy and how much to buy. Consumer are also

free to spend money as they like.

Role of money

2. Role of money in a socialist

economy: all economic activities in a

socialist economy are planned, regulated

and controlled by the state. The only

difference between capitalist and socialist

economies are that money plays a minor

role in a socialist economy as compared

with its role in a capitalist economy.

Role of money

د دوهم څپرکی پاي

د درسونو څخه د بشپړ اخذ له پاره لیکچر ته توجه : یادونه

وش ئ، په صنفې بحثونو کي دې برخه واخیستل ش ئ او د خارجې او !ضمنې مطالعې ترڅنګ کتاب دې مطالعه ش ئ

: کتابMoney and banking, E. Narayanan Nadar