Understanding Money and Interest Rates: Characteristics, Evolution, and Impact, Summaries of Accounting

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Introducing

Money, and

Interest Rate

CHAPTER 2

Money

• (^) is composed of the bills and coins which have been printed by the National Government (called currency). *FED or Federal Reserve is a central bank in the US that issues currency, it determines how much the circulation and how much the interest it will charge banks to borrow it’s money. CHARACTERISTICS AND KEY FUNCTION OF MONEY  (^) Store Value- money acts as means by which people can store their wealth for future use.  (^) Item of worth- most money has a originally intrinsic value, such as that of the precious metal that was used to make a coin.  (^) Means of exchange- it must be impossible to exchange money freely and widely for goods and it’s value should be as stable as possible.  (^) Unit of account- money can be used to record wealth possessed, traded or spent personally and nationally  (^) Standard of Deferred Payment- money can facilitate exchange at given point by providing a medium of exchange and unit of account.

Artifacts of

Money

S I N C E T H E E A R LY AT T E M P T S AT S E T T I N G VA L U E S F O R B A RT E R E D G O O D S “ M O N E Y ” H A S C O M E I N M A N Y F O R M S , F R O M I O U S TO TO K E N S. C O W S , S H E L L S , O R N A M E N T S , B E A D S A N D P R E C I O U S M E TA L S H AV E A L L B E E N U S E D.

Lydian gold coins (600BCE)

• In Lydia, a mixture of gold and silver was formed into disks, or coins, stamped with inscriptions. Athenian drachma (600BCE)
• The Athenians used silver from Laurion to mint a currency used right across the Greek world. Han dynasty coin (200BCE) *Often made of bronze or copper, early Chinese coins had holes punched in their center. Barter (5,000 BCE) *Early trade involved directly exchanged items - often perishable ones such as a COW. **Sumerian cuneiform tablets (4,000 BCE) *** Scribes recorded transactions on clay tablets, which could also act as receipts. Cowrie shells (1,000BCE) *Used as currency across India and the South Pacific, they appeared in many colors and sizes.

Roman coin (27 BCE) *Bearing the head of the emperor, these coins circulated throughout the Roman Empire. Byzantine coin (700CE) *Early Byzantine coins were pure gold; later ones also contained metals such as copper Anglo-Saxon coin (900CE) *This 10th century silver penny has an inscription stating that Offa is King ("rex") of Mercia. Arabic dirham (900CE) *Many silver coins from the Islamic empire were carried to Scandinavia by Vikings.

Gold Standard (From 1844)

• (^) The British pound was tied to a defined equivalent amount of gold. Other countries adopted a similar Gold Standard. Credit Cards (1970s)
• (^) The creation of credit cards enabled consumers to access short-term credit to make smaller purchases. This resulted in the growth of personal debt. Digital Money (1990s)
• (^) The easy transfer of funds and convenience of electronic payments became increasingly popular as internet use increased. Euro (1999)
• (^) Twelve EU countries joined together and replaced their national currencies with the Euro. Bank notes and coins were issued three years later. Bitcoin (2008) Bitcoin - a form of electronic money that exists solely as encrypted data on servers - is announced. The first transaction took place in January 2009. HIGHLIGHTS IN THE HISTORY OF MONEY IN THE PHILIPPINES Pre-Spanish Regime Prior to the coming of the Spanish in 1521, the Philippine was already trading with neighboring countries such as China, Java and Macau. Through the prevailing medium of exchange was barter, some coins were circulating in the Philippines as early as the 8th century.

Spanish Regime. The Spanish introduced coins in the Philippines when they colonized the country in 1521. Silver coins minted in Mexico were predominantly used in 1861, the first mint was established in order to standardize coinage. American Regime After gaining independence in 1898 when Spain ceded the Philippines to the United States. The country's first local currency, the Philippine Peso, was introduced replacing the Spanish-Filipino Peso. Japanese Regime When the Philippines was occupied by Japan during World War II, the Japanese issued the Japanese War Notes. There bills had no reserves nor backed up by any government asset and were called "mickey Post-War Period In 1944, when the American forces defeated the Japanese Imperial army, the Philippine Commonwealth was established under President Sergio Osmeña. All Japanese currencies circulating in the Philippines were declared illegal, all banks were closed and all Philippine National Bank notes were withdrawn from circulation.

The Money Supply The Key Measures for the Money Supply are:

• (^) M1. The narrowest measure of the money supply, refers primarily to money used as a medium of exchange. (e.g. currency in circulation held by the nonbank public, demand deposit, traveler’s check and etc.) -M2. This includes money held in savings, money market deposit accounts and etc. This refers to money used as a store value. (e.g. overnight Eurodollars)
  • (^) M3. Includes the financial institutions, refers primarily to money used as a unit of account. (e.g. Large-denomination time deposits and term Eurodollars)
  • (^) L. This measure includes liquid and near-liquid assets. (e.g. short term treasury notes, high-grade commercial paper and bank acceptance notes)

The Demand for Money The Sources of the Demand for Money are :

• (^) Transaction Demand. Money demanded for day- to-day payments through balances held by household and firms (instead of bonds, stocks or other assets). This kind of demand varies with GDP; it does not depend on the rate of interest.
• (^) Precautionary Demand. Money demanded as a result of unanticipated payments. This kind of demand varies with GDP.
• (^) Speculative Demand. Money demanded because of expectations about interest rates in the rates in the future.

OBJECTIVE 8: THE IMPACT OF

MONEY

THE IMPACT OF MONEY

In the macroeconomics short-run, some prices (e.g. wage rates affected by the labor contracts) will be inflexible. This causes economic fluctuations, with real GDP either below potential GDP (recessionary gap) or above potential GDP (inflationary gap)

THE TIME

VALUE OF

MONEY

What is an Interest? In general business terms , interest is defined as the cost of using money over time. In economics , interest represents the time value of money Present Value -also known as present discounted value -it is based on the commonsense notion that a peso of cash flow paid to you one year from now is less valuable to than the peso paid to you today

From the lenders viewpoint, it is a reward for waiting a payment for supplying others with current purchasing power. The interest rates allow the lender to calculate the future benefit (future payments earned) of extending a loan or saving funds today. INTEREST RATES The interest rates link the future to the present. It allows individuals to evaluate the present value (the value today) of future income and costs. In essence, it is the market price of earlier availability. From the viewpoint of a potential borrower , the interest rate is the premium that must be paid in order to acquire goods sooner and pay for them later.

HOW INTEREST RATES ARE

DETERMINED

The demand of investors for loanable funds stems from the productivity of capital. Investors are willing to borrow in order to finance the use of capital in production because they expect that expanding future output will provide them with more than enough resources to repay the amount borrowed (the principal) and the interest on the loan.

In essence, the interest rate provides lenders with the incentive to reduce their current consumption so that, borrowers can either invest or consume beyond their present income. Higher interest rates give people willing to save (willing to supply loanable funds) the ability to purchase more goods in the future in exchange for sacrificing current consumption. Even though people have a positive rate of time preference, they will give up current consumption to supply funds to the loanable funds market if the price is right. Higher interest rates will induce people to save more. Therefore, as the interest rate rises, the quantity of funds supplied to the loanable funds market will increase. As Figure 2-1 illustrates, the interest rate will bring the quantity of funds demanded into balance with the quantity supplied. At the equilibrium interest rate, the quantity of funds borrowers demand for investment and consumption now (rather than later) will just equal the quantity of funds lenders save. So, the interest rate brings the choices of borrowers and lenders into harmony. The rate of interest functions as the price in the money market. Money has a time value, and its use is bought and sold in the money market in return for the payment of interest.

Although, intermediaries can achieve equality between the rates of interest in two markets, the potential lack of balance between the investment and money markets was essential to Keynesians, who claimed that it caused unemployment in the short-run. THE NOMINAL OR MONEY RATE VERSUS THE REAL RATE OF INTEREST We have emphasized that the interest rate is a premium paid by borrowers for earlier availability and a reward received by lenders for delaying consumption. However, during a period of inflation, the nominal interest rate or money rate of interest is misleading indicator of how much borrowers are paying and lenders are receiving. Inflation reduces the purchasing power of a loan’s principal. When inflation is common, lenders will recognize they are being repaid with pesos of less purchasing power. Unless they are compensated for the anticipated inflation by an upward adjustment in the interest rate, they will supply fewer funds to the loanable funds market. At the same time, when borrowers anticipate inflation, they will want to purchase goods and services now before they become even more expensive in the future. Thus, they are willing to pay an inflationary premium, an additional amount of interest that reflects the expected rate of future price increases. Unlike when the general price level is stable, the supply of loanable funds will decline (the supply curve will shift to the left) and the demand will increase (the demand curve will shift to the right) once decision makers anticipate future inflation. The money interest rate thus, rises overstating the cost of borrowing and the yield from lending. This true cost is the real rate interest, which is equal to the money rate of interest minus the inflationary premium. It reflects the real burden to borrowers and payoff to lenders in terms of their being able to buy goods and services.

INTEREST

RATES AND

RISK