Most nations have their own system of money and print their own currency. Fiat money (notes and coins) represent a specific monetary value (K20, K100) decreed by the government and accepted by the people.

What are the Characteristics of Money:

• Scarcity – money is scarce or in limited supply
• Recognition – it can be easily identified
• Portability – easy (convenient) to carry around
• Divisibility – can be broken down into smaller units
• Acceptability – generally accepted in payments for goods/services
• Uniformity – standard units are the same; a K10 note does not change
• Durability – long lasting

What are the Functions of Money:

• Medium of exchange – offeed as payment for goods/services
• Measure of value – used to measure value in a standardized way
• Storer of value – enables people to store wealth for future use
• Standard of deferred payment – necessitates payments (contracts, loans)

What are the problems in the Traditional Economy?

Double coincidence of wants

Limited specialisation

Low productivity

Problem of divisibility

Problem of portability

Problem of storage

Problem in agreement on the value of goods

What are the Modern Types of Money?

• Metal coins
• Notes
• Commodity money (gold, silver)
• Token Money
• Currency
• Bank deposits

Papua New Guinea measures its money supply in three main ways:

What are the factors determining how resources are allocated in PNG?

• Narrow Money Supply (M1) – currency in circulation, includes cash (notes/coin), domestic deposits and foreign currency deposits ($US accounts)
• Broad Money Supply (M3) – quasi money, includes M1 ITEMS alongside savings and term deposits. Regarded as the best measure of money supply for PNG
• Total Money Supply (M3) – includes M1 and M3 alongside bank deposits of the stabilisation funds

What are the Factors affecting the size of the money supply?

• Balance of Payments
• Government Expenditure
• Market Operations by the Bank of PNG
• Lending by Commercial Banks

If the money supply grows (constricts) too fast this can result in excess (shortage of) demand and consequently high(er) inflation (lower economic growth). Increased (decreased) lending increases (decreases) the money supply.
Changes in government taxation, spending, and borrowing policies affect money supply. Increases in government expenditure (tax) increases (decreases) money supply. Borrowing increases money supply and debt repayments decreases it.
Selling government securities to the public (Government Inscribed Stock, Treasury Bills, Central Bank Bills) reduces money supply. Buying back government securities increases money supply
Government securities are monetary tools the government uses to borrow money from the domestic/international market.
It is a form of investment for those who lend the money because they will receive interest payments + principal upon maturity.

QTM: Governments can control inflation by controlling the amount of money (money supply) they spend/tax and that the value of money is determined by demand/supply.

Monetarists, led by Milton Friedman, argued that there should be less government intervention in the economy. Instead, market forces should be allowed to determine the value of money

Keynesians, led by John Maynard Keynes, believed the opposite and that the government should play a role in stabilising markets by ‘smoothing out the economic cycle’

How do we calculate money supply (M)? money can be used multiple times – velocity of circulation. Thus, M x V must equal the total amount spent (C).
Then, add the average price level (P) and the total amount spend on Goods/Services (T). P x T must equal the total goods/services purchased/sold in a year.
Thus, MV = PT. As a result, if V is a constant, an increase in M will lead to an increase in either or both P and T. Then, if the economy is at full employment T cannot increase so an increase in M will lead to an increase in P (increasing inflation).

Key Definitions:

• 1. Liquid Assets: assets that can be quickly and reliably changed into cash
• 2. Assets: things of value owned by an individual/organisation
• 3. Liabilities: things of value owed to another individual/organisation

Commercial Banks (BSP, KSL) are required by BPNG to keep a certain proportion of their assets as liquid assets – LGS ratio (liquid asset and government securities ratio).
Most of the money banks accept as deposits (Liabilities) is lent to borrowers (Assets). After the borrowed money has been invested, most of the money returns to the banks as additional deposits. This increases the bank’s ability to lend – credit creation.

• • Major Liabilities = Customer Deposits. This is because it is money the commercial banks owe to the person depositing it + interest payments
• • Major Assets = loans/advances to customers, reserve assets, land, buildings, and office equipment

Other key Definitions

• >> Reserve Assets: liquid assets and government securities (LGS) and Statutory Reserve Deposits (SRD). Reserve assets refer to any assets that banks are required to keep against their deposit liabilities
• >> Liquidity: a measure of how quickly an asset could be changed into cash – the most liquid asset
• >> Liquid Assets of Commercial Banks: cash in hand (or branches), money deposited with the central bank in the exchange settlement account, and government securities
• >> Liquid asset ratio: the ratio of LGS to the total deposits of trading (commercial) banks
• >> Reserve asset ratio: the ratio of LGS to SRD to Total Deposits. There is a need for liquid assets to meet customer demands for withdrawals and as instrument of monetary policy to control money supply

Credit creation and credit:

• Credit creation: process by which an initial increase in the value of bank deposits may lead to an even larger increase (multiplier effect) in the money supply
• Credit: money which is made available for spending through loans

The Multiplier: the process by which an initial change will later lead to an even larger (multiplier) change in others

Bank Credit Multiplier: the reciprocal of the LGS ratio. The Multiplier Effect = New Deposit x Credit Multiplier

Balance Sheet: shows the financial position of a business – assets, liabilities, and owner’s equity.

The Bank of Papua New Guinea (BPNG) aims to ensure that the nation’s monetary policies are carried out in the most efficient way and to promote monetary stability and a sound and efficient financial structure.

The functions of BPNG:

• 1. Issuer of currency
• 2. Banker to the government and commercial banks
• 3. Management of international (foreign) reserves
• 4. Control over foreign capital inflow/outflow
• 5. Provide forward exchange facilities to importers and exporters
• 6. Management of exchange rate
• 7. Supervision of financial system
• 8. Registration of savings and loans societies
• 9. Economic reporting
• 10. Implementation of monetary policies via control over commercial banks

• • Major Liabilities = Customer Deposits. This is because it is money the commercial banks owe to the person depositing it + interest payments
• • Major Assets = loans/advances to customers, reserve assets, land, buildings, and office equipment

Other key Definitions

• >> Accepting deposits
• >> Honouring cheques and affecting payments by other means
• >> Making loans and credit available
• >> Exchange of foreign currency to and from customers
• >> Giving advice, providing safe custody for valuables

• Money: a generally accepted form for exchanging goods/services and settling debt
• Characteristics of money: scarcity, recognisable, portable, divisible, acceptance, durable, and uniform
• Functions of money: medium of exchange, measure of value, standard of deferred payments, and store of value
• Money supply is the total amount of money circulating in the economy
• The three ways of measuring money supply in PNG are: Narrow, Broad, and Total money supply
• Factors affecting the size of the money supply are balance of payments, government expenditure (budget), open market operations, lending by commercial banks
• The Quantity Theory of Money explains the relationship between money supply and price level
• Multiplier effect calculator: Multiplier Effect = New Deposit x Credit Multiplier
• Credit creation: a process of providing multiple amounts of credits using the customers’ deposits received by the banking system
• Credit multiplier shows the number of times, total deposits can be turned into credits

The functions of the Central Bank (BPNG) are:

• o Issuer of currency
• o Banker to the government and commercial banks
• o Management of international (foreign) reserves
• o Control over foreign capital inflow/outflow
• o Provide forward exchange facilities to importers and exporters
• o Management of exchange rate
• o Supervision of financial system
• o Registration of savings and loans societies
• o Economic reporting
• o Implementation of monetary policies via control over commercial banks

The functions of the Commercial banks are:
• Accepting deposits
• Honouring cheques and effecting payments by other means
• Making loans available
• Exchange of foreign currency to and from customers
• Exchange of foreign currency to and from customers and giving financial advice
• Providing safe custody for valuables, acting as executors and trustees