2 money

Money, Banking and Financial MarketsMoney

Chahir Zaki

FEPS, Cairo University

Second Semester, 2012

Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 1 / 25

1 Definition of Money

2 Functions of Money

3 Evolution of the Payment Systems

4 How to Measure Monetary Aggregates?

5 The Case of Egypt


Outline





5 The Case of Egypt


Definition of Money

Money is what is being accepted in payment for goods and services and inpayment for debt.

Money vs. currency: Currency is only cash issued by the central bank.Currency is too narrow a concept for money as other assets can beused for payment too.

Money versus wealth: Wealth all the collection of pieces of propertythat serve to store value. Wealth includes many assets that cannot beused to make payments and is thus too broad a concept for money.

Money vs. income: Income is a flow of earnings per unit of time, e.g.salary per month or interest per year. Money, however, is an asset ora stock the amount of which needs to be measured at a point in time.


Outline





5 The Case of Egypt


Means of transaction/ medium of exchange

In a barter economy goods are exchanged without using money:

The precondition for this is the “double coincidence of wants” oftransaction partners.Looking for a suitable transaction partner is time consuming;The transaction costs are high;The number of transactions low.In an economy with a low number of transactions the division of laboris not well advanced which means that resources are not allocatedefficiently and economic growth is low.

Using money as a medium of exchange:

separates the transaction of good A for good B into 2 independenttransactions good A for money and money for good B.The need of the double coincidence of wants is eliminatedTransaction costs decrease.


Means of transaction/ medium of exchange

Characteristics of a commodity to serve as a medium of exchange:

It must be standardized;

It must be widely accepted;

It must be divisible;

It must be easy to carry;

It must not deteriorate quickly.


Unit of account

Money is the numeraire in which all prices in the economy areexpressed.

Using a single numeraire enhances transparency and reducesinformation costs. In the absence of a single numeraire each goodwould have many prices denominated in different units of accounts.

Example: Assume an economy with 4 goods, A, B, C, and D, but nomoney. What is the price of each individual good?

Good A does not have 1 price but 3 relative prices expressed in units ofgood B, units of good C or units of good D.Good B has 2 “new” prices in units of good C or in units of good D.The third price is just the inverse of the relative price of A measured inunits of B.Good C has 1 “new” price in units of good D. The other prices areinverse relative prices of A and B.Good D has no “new” price. All prices of good D can be determined asinverse relative prices of A, B, or C.


Unit of account

This economy with 4 goods has 6 prices. The same economy usingmoney would need only 4 prices expressed in money.

More generally a barter economy with N goods needs N(N − 1)/2relative prices whereas an economy with N goods using money as aunits of account needs only N prices


Store of value

Money is a repository of purchasing power over time. Most people donot wish to spend all their income at the same point in time whenthey earn it.

Money competes with other assets to store value. These other assetsinclude deposits, financial securities, real estate etc.

Compared to money those assets usually pay the owner a positiveinterest rate whereas the interest rate of money is 0.

Why then do people wish to store value in the form of money?Money is the most liquid asset that can be used for purchasing goodsand services and pay debt.

Liquidity is highly desirable. Illiquid assets involve transaction costswhen they are converted into money.


Store of value

How well money stores value depends on the rate of inflation.

When there is hyperinflation (more than 50% inflation per month)money does not store value at all.

People do not accept money for transactions anymore and currencyceases to fulfil the functions of money.


Outline





5 The Case of Egypt


Evolution of the Payment Systems

The payments system is the method of conducting transactions in theeconomy.

At the early stage of evolution commodity money (gold, silver) wasused for transactions. Problems: High transaction (transport) costs;growth rate of money supply limited by the pace of extraction ofthose precious metals.

At the next stage of evolution was fiat money (in latin “let it bedone”, as such money is established by government as legal tender).Fiat money is accepted only if there is trust in the issuing authority.Problems: Fiat money can be easily stolen; transport cost are stillhigh.

A further development involves the use of checks (instruction for abank transfer). Larger amounts can be transferred by means of acheck bringing down transport costs. Loss from theft is reduced.Problems: Time to bring a check from 1 place to another and toprocess a check


Evolution of the Payment Systems

Electronic payment is the next step in the evolution of the paymentsystem. This saves transaction cost significantly; many paymentsbecome real-time transactions. Problem: Sensitive to attacks tocomputer systems.

As a further step the development of e-money (money that exists onlyin electronic form), smart cards (cards with a restorable paymentchip) or electronic cash (used on the internet to make transactions)can be seen.


Outline





5 The Case of Egypt


How to Measure Monetary Aggregates?

Measuring money is a problem because what is money is defined bypeoples behavior.

What is being accepted for payments may change over time; theproper measure of money would need to reflect this.

Money is measured in monetary aggregates that include differenttypes of assets characterized by a particularly high level of liquidity.

The central bank of a country defines the monetary aggregates. Thedefinition varies between countries as people’s behavior differs.

It is important to measure money because money supply issystematically related to the inflation rate which is an importanttarget variable of central bank policy.


How to Measure Monetary Aggregates? The EgyptianCase

Reserve Money (MO): Composed of money in circulation outside theCBE and local currency deposits of banks with the CBE. It isconsidered the basis of money in its broader definitions and is alsoknown as the monetary base or high-powered money.

Money Supply (M1): Composed of money in circulation outside thebanking system, i.e. with the public, and non-government demanddeposits in local currency minus the balances of cheques and draftsunder collection, with all the banking system units

Domestic Liquidity (M2): Composed of money supply (M1) or whatis known as the current means of payment, and quasi-money(comprising time and savings deposits in local currency and foreigncurrency deposits of residents other than government).


Outline





5 The Case of Egypt


The Case of Egypt

2006 2007 2008 2009 2010 2010

End of א + אJune June June June June Sept. Oct. Nov. Dec. Jan. Feb. Mar. April+

Reserve Money (M0) 116050 134126 169911 175104 203071 216655 210432 221924 218393 230862 246961 234900 240849 (M0) א

Currency in circulation outside the CBE 78604 92174 111412 126268 144253 153079 153037 155660 153209 154156 177017 175647 175752 א א א א אBanks' deposits in local currency with the CBE 37446 41952 58499 48836 58818 63576 57395 66264 65184 76706 69944 59253 65097 א א א א א

Counterpart Assets of Reserve Money 116050 134126 169911 175104 203071 216655 210432 221924 218393 230862 246961 234900 240849 א א א

Net Foreign Assets** 61302 95372 xx180333 171732 190234 191648 193724 194312 198207 193507 184740 167446 154804 ** א א

Net Domestic Assets 54748 38754 -10422 3372 12837 25007 16708 27612 20186 37355 62221 67454 86045 א א Net claims on government++(A+B-C) 114055 117254 81872 68613 80611 109835 107088 101920 100252 104468 106555 108831 108404 ( − + ) ++ א א A - Securities 164761 166724 XX123123 121709 121533 130597 130597 130597 130597 130597 130597 130597 130597 א − B - Credit facilities 7047 25468 36574 25190 28754 51931 50877 47529 45862 53070 57386 58985 61209 א −

C - Deposits+++ 57753 74938 77825 78286 69676 72693 74386 76206 76207 79199 81428 80751 83402 +++ א −Net claims on banks 1018 59512 77581 334 29010 56622 55317 50739 39848 17936 2169 -1287 -856 א א

Net balancing items -60325 -138012 -169875 -65575 -96784 -141450 -145697 -125047 -119914 -85049 -46503 -40090 -21503 א א א

Unclassified assets and liabilities (net)X 34623 31902 xx12979 17296 4725 -6824 -8421 -5492 -5011 -1920 -7101 -13542 -14601 x א א א א Open market operations -94948 -169914 -182854 -82871 -101509 -134626 -137276 -119555 -114903 -83129 -39402 -26548 -6902 א א* Derived from the CBE's balance sheet.

+ Provisional. . +++ Including public economic authorities and the National Investment Bank. . א א א א א + ++++ All government deposit accounts (including public economic and service authorities) were transferred, as of

December 2006, to the Treasury Single Account (TSA) at the Central Bank, pursuant to Law No. 139 for 2006.

x Including capital accounts. . א x

xx The settlement of rescheduled debts - under Paris Club agreements - resulted in the decline of the CBE’s

foreign liabilities, claims on the government (securities) and the unclassified assets (net).

** According to the updated statistical treatment adopted by the IMF, SDR allocations were classified as

foreign liabilities rather than capital accounts, as of August 2009. . א א א א

- 23 - - 22 -

+++ تم تحويل حسابات الودائع الحكومية ( شاملة الهيئات العامة االقتصادية والخدمية ) من البنوك الى حساب الخزانة الموحد بالبنك المرآزي

. א א ، א א א אxx تم تسوية الديون المعاد جدولتها في اطار إتفاقيات نادي باريس، وآان من نتيجة ذلك انخفاض االلتزامات األجنبية للبنك المرآزي، وأيضا المطلوبات

،٢٠٠٩ א א א א א א א א **

.٢٠٠٦ ١٣٩ ،٢٠٠٦ א

. א א א א *

1 - Reserve Money and Counterpart Assets* * א א א − ١( LE mn ) ( )

20112010


The Case of Egypt

2006 2007 2008 2009 2010 2010


Reserve Money (M0) 116050 134126 169911 175104 203071 216655 210432 221924 218393 230862 246961 234900 240849 (M0) א

Currency in circulation outside the CBE 78604 92174 111412 126268 144253 153079 153037 155660 153209 154156 177017 175647 175752 א א א א אBanks' deposits in local currency with the CBE 37446 41952 58499 48836 58818 63576 57395 66264 65184 76706 69944 59253 65097 א א א א א

Counterpart Assets of Reserve Money 116050 134126 169911 175104 203071 216655 210432 221924 218393 230862 246961 234900 240849 א א א

Net Foreign Assets** 61302 95372 xx180333 171732 190234 191648 193724 194312 198207 193507 184740 167446 154804 ** א א

Net Domestic Assets 54748 38754 -10422 3372 12837 25007 16708 27612 20186 37355 62221 67454 86045 א א Net claims on government++(A+B-C) 114055 117254 81872 68613 80611 109835 107088 101920 100252 104468 106555 108831 108404 ( − + ) ++ א א A - Securities 164761 166724 XX123123 121709 121533 130597 130597 130597 130597 130597 130597 130597 130597 א − B - Credit facilities 7047 25468 36574 25190 28754 51931 50877 47529 45862 53070 57386 58985 61209 א −

C - Deposits+++ 57753 74938 77825 78286 69676 72693 74386 76206 76207 79199 81428 80751 83402 +++ א −Net claims on banks 1018 59512 77581 334 29010 56622 55317 50739 39848 17936 2169 -1287 -856 א א

Net balancing items -60325 -138012 -169875 -65575 -96784 -141450 -145697 -125047 -119914 -85049 -46503 -40090 -21503 א א א

Unclassified assets and liabilities (net)X 34623 31902 xx12979 17296 4725 -6824 -8421 -5492 -5011 -1920 -7101 -13542 -14601 x א א א א Open market operations -94948 -169914 -182854 -82871 -101509 -134626 -137276 -119555 -114903 -83129 -39402 -26548 -6902 א א* Derived from the CBE's balance sheet.

+ Provisional. . +++ Including public economic authorities and the National Investment Bank. . א א א א א + ++++ All government deposit accounts (including public economic and service authorities) were transferred, as of

December 2006, to the Treasury Single Account (TSA) at the Central Bank, pursuant to Law No. 139 for 2006.

x Including capital accounts. . א x

xx The settlement of rescheduled debts - under Paris Club agreements - resulted in the decline of the CBE’s


** According to the updated statistical treatment adopted by the IMF, SDR allocations were classified as

foreign liabilities rather than capital accounts, as of August 2009. . א א א א

- 23 - - 22 -

+++ تم تحويل حسابات الودائع الحكومية ( شاملة الهيئات العامة االقتصادية والخدمية ) من البنوك الى حساب الخزانة الموحد بالبنك المرآزي

. א א ، א א א אxx تم تسوية الديون المعاد جدولتها في اطار إتفاقيات نادي باريس، وآان من نتيجة ذلك انخفاض االلتزامات األجنبية للبنك المرآزي، وأيضا المطلوبات

،٢٠٠٩ א א א א א א א א **

.٢٠٠٦ ١٣٩ ،٢٠٠٦ א

. א א א א *

1 - Reserve Money and Counterpart Assets* * א א א − ١( LE mn ) ( )

20112010


The Case of Egypt

2006 2007 2008 2009 2010 2010


Domestic Liquidity (1+2) (M2) 560356 662688 766664 831211 917459 948172 961244 963255 973962 969712 982547 988076 986760 ( M2 ) (١+٢) א א

Money Supply (1) (M1) 109274 131290 170579 182991 214040 220472 222674 224890 223456 229528 239401 240814 241863 (M1) (١) א אCurrency in circulation outside the banking system 74239 86860 104656 118146 135209 143799 142783 145053 143633 145857 161818 163489 165003 א א א א אDemand deposits in local currency** 35035 44430 65923 64845 78831 76673 79891 79837 79823 83671 77583 77325 76860 ** א א א א

Quasi-Money (2) 451082 531398 596085 648220 703419 727700 738570 738365 750506 740184 743146 747262 744897 (٢) א Local currency time & saving deposits ** 314188 377424 436268 481054 545303 569542 576948 581350 592451 579119 568572 567394 566259 ** א א א א Foreign currency demand deposits ** 18534 26917 26581 32050 33901 34013 36321 33542 34072 38134 45829 46257 44613 ** א א א א Foreign currency time & saving deposits ** 118360 127057 133236 135116 124215 124145 125301 123473 123983 122931 128745 133611 134025 ** א א א א

Counterpart Assets 560356 662688 766664 831211 917459 948172 961244 963255 973962 969712 982547 988076 986760 א א א Net Foreign AssetsXXX 133385 218629 x303680 254134 282408 312144 315293 304944 305252 286196 274549 266036 256212 XXX א א

Net Domestic Assets 426971 444059 x462984 577077 635051 636028 645951 658311 668710 683516 707998 722040 730548 א א Domestic credit 509532 531314 570953 695326 775268 792347 803678 813903 805057 814739 851595 870469 879024 א א Net balancing items -82561 -87255 -107969 -118249 -140217 -156319 -157727 -155592 -136347 -131223 -143597 -148429 -148476 א א א

Indicators אM2 / GDP (%) 90.72 88.98 85.52 79.76 76.04 xx68.81 xx69.76 xx69.90 xx70.68 xx70.37 xx71.30 xx71.70 xx71.61 (٪) א א א / א אForeign currency deposits/ Total deposits (%) 28.16 26.74 24.14 23.44 20.21 19.66 19.75 19.19 19.04 19.55 21.27 21.81 21.74 (٪) א א / א א א

Income velocity of money (GDP / M2) 1.10 1.12 1.17 1.25 1.32 xx1.45 xx1.43 xx1.43 xx1.41 xx1.42 xx1.40 xx1.39 xx1.40 ( א א / א א א ) א אMoney multiplier (M2 / M0) 4.83 4.94 4.51 4.75 4.52 4.38 4.57 4.34 4.46 4.20 3.98 4.21 4.10 (M2 / M0) א

* Extracted from the consolidated balance sheet of the banking system. . א א א א א *+ Provisional . +** Representing deposits of the business sector ( public and private ) and the household sector, . א א א א א א א א א ( א (א א א **

x The settlement of the rescheduled debts - under Paris Club agreements - resulted in the decline of the CBE’s . א א ، א א א


- 25 - - 24 -

. ٠ א א א א א א ٢٠١١/ ٢٠١٠ א א א א xx

XXX According to the new classification of SDR allocations referred to in Table (1).

.(١) א א א א א xxxXX According to the Ministry of Planning and International Cooperation GDP (provisional) for FY 2010/2011.

א א ، א א א א א ، א א א א x

2 - Banking Survey* : Domestic Liquidity and Counterpart Assets א א א א : * א א − ٢( )( LE mn )

minus purchased cheques & drafts as regards demand deposits.

2010 2011


The Case of Egypt

2006 2007 2008 2009 2010א +

June June June June June Sept. Oct. Nov. Dec. Jan. Feb. March April+

Financial & Monetary Sector א א אGrowth rate of reserve money (M0) 14.8 15.6 26.7 3.1 16.0 13.1 12.2 16.3 13.1 20.1 32.0 19.8 20.5 (M0) אGrowth rate of money supply (M1) 21.8 20.1 29.9 7.3 17.0 14.4 15.6 13.4 13.4 16.4 19.9 19.3 17.7 ( M1) א אDomestic liquidity growth rate (M2) 13.5 18.3 15.7 8.4 10.4 11.8 13.4 12.8 12.4 11.8 12.2 11.2 10.8 ( M2) א אMoney multiplier (M2 / M0) 4.83 4.94 4.51 4.75 4.52 4.38 4.57 4.34 4.46 4.20 3.98 4.21 4.10 (M2 /M0) אCurrency in circulation / money supply 67.9 66.2 61.4 64.6 63.2 65.2 64.1 64.5 64.3 63.5 67.6 67.9 68.2 א א / א א אM2/GDP 90.72 88.98 85.52 79.76 76.04 ***68.81 ***69.76 ***69.90 ***70.68 ***70.37 ***71.30 ***71.70 ***71.61 א א א / א אIncome velocity of money (GDP/M2) 1.10 1.12 1.17 1.25 1.32 ***1.45 ***1.43 ***1.43 ***1.41 ***1.42 ***1.40 ***1.39 ***1.40 ( א א / א א א ) א אGrowth rate of domestic liquidity in local currency 13.6 20.1 19.3 9.4 14.4 15.1 15.9 15.5 14.7 13.9 12.7 10.6 10.0 א א אM2 in local currency /GDP 68.55 68.30 67.69 63.72 62.9

***57.33 ***58.03 ***58.51 ***59.21 ***58.68 ***58.63 ***58.65 ***58.64 א א /א א א אTotal deposits growth rate 12.8 18.5 15.00 7.71 9.70 11.67 13.40 13.17 12.25 11.12 9.78 8.54 8.11 א א אHousehold deposits/ total deposits 78.2 73.0 67.6 72.1 73.5 73.5 73.1 73.4 73.5 74.2 74.2 74.5 75.4 א א / א א אGrowth rate of local currency deposits 12.8 20.8 19.0 8.7 14.3 15.6 16.5 16.6 15.0 13.5 9.7 7.0 6.4 א א א אHousehold local currency deposits/ total local currency deposits 82.5 76.3 70.5 75.8 76.6 76.6 76.3 76.4 76.4 77.6 78.5 78.9 79.8 א א א / א א א אForeign currency deposits /total deposits 28.16 26.74 24.14 23.44 20.21 19.66 19.75 19.19 19.04 19.55 21.27 21.81 21.74 א א / א א אForeign currency deposits growth rate 13.0 12.5 3.8 4.6 -5.4 -2.0 2.3 0.8 2.1 2.2 10.2 14.2 14.9 א א א אHousehold foreign currency deposits / total foreign currency deposits 67.3 63.9 58.6 59.9 61.3 60.8 59.9 60.6 60.8 60.1 58.5 58.9 59.7 א א א / א א א אPrivate business sector credit / total credit 47.0 50.6 51.1 43.8 42.1 41.2 40.9 40.6 38.8 38.9 37.7 36.9 36.6 א / א א אNet claims on the government / total credit 36.1 33.6 30.5 39.3 42.1 43.1 43.3 43.7 45.3 45.3 47.2 48.1 48.6 א / א א

Banking density (population in thousand for each banking unit) 24.5 24.2 22.9 22.3 22.3 22.3 22.3 22.3 ( א ) א אNote issue /GDP 12.79 12.52 12.54 12.25 12.09 ***11.26 ***11.25 ***11.49 ***11.29 ***11.33 ***12.92 ***12.87 ***12.84 א א א / א אEquity /assets** 5.3 4.9 4.9 5.8 6.2 5.9 5.9 5.9 6.2 6.4 6.2 6.6 6.4 ** א / אProvisions /assets** 7.2 5.7 5.8 6.4 5.8 5.7 5.6 5.5 4.2 4.3 4.2 4.3 4.4 ** א / אLoans and discount balances /assets** 42.5 37.7 37.1 39.4 38.2 36.1 35.9 35.8 35.7 37.0 36.3 36.9 37.2 ** א / א א אLoans and discount balances / deposits with banks ** 57.0 54.4 53.7 53.1 52.2 51.0 50.7 51.1 48.5 49.7 50.2 50.0 50.4 ** א א א / א א אDeposits /assets** 74.7 69.3 69.0 74.1 73.1 70.7 70.8 70.2 73.6 74.6 72.4 73.9 73.8 ** א / א אSecurities ( including TBs) /assets** 25.5 18.8 18.6 30.5 33.3 32.7 32.9 33.3 34.4 32.9 33.5 35.4 35.9 ** א / ( א א א ) א א אSecurities ( including TBs) / deposits ** 34.1 27.1 27.0 41.1 45.5 46.2 46.5 47.4 46.7 44.1 46.2 48.0 48.7 ** א א / ( א א א ) א א אLoans to private sector /total loans** 82.7 84.6 83.7 82.1 81.6 81.2 81.1 81.1 80.2 80.3 80.3 80.6 80.2 ** א / א א אForeign currency assets / foreign currency liabilities** 112.9 109.4 109.3 114.6 113.5 111.8 111.5 112.1 112.0 113.6 113.7 114.9 114.5 ** א א / א א

2006 2007 2008 2009 2010 2010 End of א

June June June June June Oct. Nov. Dec. Jan. Feb. March April May Net International Reserves (US$ mn) 22931 28559 34572 31310 35221 35545 35571 36005 35007x 33321 30106 28024 27228 ( ) א א

Gross official reserves (US$ mn) 22952 28589 34603 31347 35248 35574 35604 36038 35023 33337 30123 28040 27243 ( ) א אNIR in months of merchandise imports 9.0 8.9 7.9 7.5 8.6 8.6 8.6 8.7 8.4 8.0 7.3 ++6.8 ++6.6 א א א א א א א

+ Provisional + مبدئى .

* Growth rates are calculated on an annual basis. . א *

** With banks operating in Egypt, except the CBE. . א א א א א א ***** According to the Ministry of Planning and International Cooperation GDP (provisional) for FY 2010/2011.

++ Estimated on the basis of merchandise imports during July/March of FY 2010/2011.

Egyptian sovereign eurobonds and Egyptian notes.

. ٢٠١١/٢٠١٠ א א / א א א א א ++

- 13 -

x Compared with December 2010, the NIR declined by about US$ 999 million in January 2011 due to the following :a- Repayment of US$ 2.1 billion to local banks in redemption of Egyptian treasury bonds denominated in US$.

b- Repayment of about US$ 665 million of Egypt's external debt to Paris Club member countries as well as coupons on

*

2010

2010 20112010

2011

End of *

א א א Main Macroeconomic Indicators א%%

- 12 -

. א א א א א א ٢٠١١/٢٠١٠ א א א א ***

: א ٢٠١٠ ، ٢٠١١ ٩٩٩ א א א א x

. א א א א א א א ٢,١ א − . א א ، א א א א . א א א ٦٦٥ א −


References

Mishkin, chapter 2.

The lectures of Prof. Heiko Fritz.

Akerlof (1970).

The CBE, Monthly Report, June 2011.


2 money

Economy & Finance

cairo university money

rate of money

form of money

transaction of good

money stores value

prices of good d

units of good c

units of good b