The Introduction of Monetary Economics..

This presentation provides an overview of monetary economics, exploring its fundamental concepts, key theories, and the role of monetary policy in influencing economic activity. It covers the functions of money, the relationship between interest rates and inflation, and the impact of central banks on the economy. Ideal for students and professionals alike, this introduction aims to enhance understanding of how monetary systems operate and their significance in shaping economic outcomes. Perfect for anyone looking to grasp the essentials of monetary economics and its real-world applications.

1. Chapter 1
Introduction of Monetary Economics

2. Monetary Economics
Monetary economics is a branch of economics
that provides framework for analyzing money in
its functions as a medium of exchange, store of
value, and unit of account.
It considers how money can gain acceptance
purely because of its convenience as a public
good.
It examines the effects of monetary systems,
including regulation of money and associated
financial institutions and international aspects.

3. Why Study?
•To examine:
how financial markets work (bond,
stock and foreign exchange markets)
how financial institutionswork (banks
and insurance companies
the role of money in the economy

4. Financial Markets
•What is a financial market?
These are markets in which funds are
transferred from people who have an
excess of available funds to people who
have a shortage of funds

5. Circular Flow Diagram
Document

6. Function of Financial Markets
•Channel funds from economic agents that
have saved surplus funds to those that have a
shortage of funds
•Promote economic efficiency by producing
an efficient allocation of capital
•Directly improve the well-being of consumers
by allowing them to time purchases better
(e.g., spend now against future income)

8. Function of Financial Intermediaries:
Indirect Finance
•Lower transaction costs
Economies of scale
Liquidity services
•Reduce Risk
Risk Sharing (Asset Transformation)
Diversification
•Address Asymmetric Information problems
Adverse Selection (before the transaction)—more likely to
select risky borrower
Moral Hazard (after the transaction)—less likely borrower will
repay loan

10. Debt and Equity
•Debt refers to the money owed by one party
(debtor) to the second party (creditor). Initiated
with a contract regarding amount and timing of
repayment of principal and interest.
•Equity refers to the value of an ownership in
property or business (asset). Owner of equity is
liable to receive share of earning of the
business

11. Money and Capital Market
•Money markets deal in short-term debt
instruments
•Capital markets deal in longer-term debt and
equity instruments

12. Bonds and Securities
•Securities or Financial Instruments: A security
(financial instrument) is a claim on the issuer’s
future income or assets
•A bond is a debt security that promises to
make payments periodically for a specified
period of time
•An interest rate is the cost of borrowing or the
price paid for the rental of funds

13. Stock Market / Stock Exchange
•It is a market for sale and purchase of stocks
(securities), which represent ownership claims
on business and share on its earnings
(dividends).
•Stock market index will show the average
price of shares of all the companies which are
listed in stock market

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15. Internationalization
of Financial Markets
•Foreign Bonds—sold in a foreign country and
denominated in that country’s currency
•Eurobond—bond denominated in a currency other
than that of the country in which it is sold
•Eurocurrencies—foreign currencies deposited in
banks outside the home country
Eurodollars—U.S. dollars deposited in foreign banks outside
the U.S. or in foreign branches of U.S. banks
•Sukuk Bonds
•World Stock Markets

16. The Foreign Exchange Market
•The foreign exchange market is where funds
are converted from one currency into another
•The foreign exchange rate is the
price of one currency in terms of
another currency (Rs. / $)
•The foreign exchange market determines the
foreign exchange rate

17. -.04
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volatility
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Exchange rate
0 1000 2000 3000
Days since 1-Jun-07
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Daily Exchange Rate

18. Types of Financial Institutions
•Financial Intermediaries—institutions that borrow funds
from people who have saved and make loans to other
people
•Banks—institutions that accept deposits and make
loans
Commercial banks
Specialized banks
•Other Financial Institutions—insurance companies,
finance companies, pension funds, mutual funds and
investment banks
•Financial Innovation—in particular, the advent of the
information age and e-finance

19. Money and Business Cycles
•Evidence suggests that money
plays an important role in generating
business cycles
•Recessions (unemployment) and booms
(inflation) affect all of us
•Monetary Theory ties changes in the money
supply to changes in aggregate economic
activity and the price level

21. Money and Inflation
•The aggregate price level is the
average price of goods and services in an
economy
•A continual rise in the price level (inflation)
affects all economic agents
•Data shows a connection between the money
supply and the price level

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24. Money and Interest Rates
•Interest rates are the price of money
•Prior to 1980, the rate of money growth and
the interest rate on long-term Treasure bonds
were closely tied
•Since then, the relationship is less clear but
still an important determinant of interest rates

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26. "Workmenaregiventheirpaytwiceadaynow--inthemorningandinthe
afternoon,witharecessofahalf-houreachtimesothattheycanrushoutand
buythings--foriftheywaitedafewhoursthevalueoftheirmoneywoulddrop
sofarthattheirchildrenwouldnotgethalfenoughfoodtofeelsatisfied."
(Erich Maria Remarque, Three Comrades)

27. Monetary and Fiscal Policy
•Monetary policy is the management of the money
supply and interest rates
Conducted in the Pakistan by SBP
•Fiscal policy is government spending
and taxation
Budget deficit is the excess of expenditures over revenues for
a particular year
Budget surplus is the excess of revenues over expenditures
for a particular year
Any deficit must be financed by borrowing

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29. School of Thoughts
•Classical School
It considers money as a nominal variable which cannot
effect real variable
•Keynesian School
It considers money as a nominal variable which can only
effect real variable in short run
•Monetarists School (Former Chicago School)
Money can effect real variable in short run and in long
run.
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