Monetary Theory and Practices
EMBU UNIVERSITY COLLEGE
(A Constituent College of the University of Nairobi)
Bachelor of Commerce Year 3.1
DFI 301 – Monetary Theory and Practices
COURSE OUTLINE
Course Duration: 3 HRS PER WEEK
Purpose: To introduce the students to modern theories of money and banking.
Course objectives: By the end to the unit, the students should be able to;
1. Appreciate the importance of money and banking in an economy
2. Understand the quality theory of money and related controversies
3. Identify the theoretical and empirical definition of money
5 Appreciate the role of monetary authorities in control of money
6. Identify the role of banking in society
7. Appreciate the role of other financial institutions in Kenya
8. Identify various banker-customer relationships
Course Contents.
1) Introduction to Monetary Theory and Practice
Definition of money
The functions of money in the economy
The characteristics of money
2) Demand for Money
Motives of holding money
Factors influencing demand for money
3) Money Supply
Determinants of money supply
The role of the central monetary authority in controlling money supply
4) Banking System
Introduction to banking
The role of banking in the society
Banking as a business
1
, Monetary Theory and Practices
5) Interest Rate Structure
Introduction
Determinants of interest rate
The theories of interest rates determination
6) The Management, Structure and Regulation of the Banking System
Objectives of the banking system
The structure of the banking system
The central bank of Kenya as a regulator of banking sector.
Other regulators of financial institutions
7) Deposit and Non Deposit Taking Financial Institutions
Financial markets
Roles of financial markets
Types of financial markets in Kenya
Financial institutions in the banking sector
8) Innovations in the Banking Sector
Meaning of financial innovation
Mobile banking
Agency banking
Islamic banking
Insurance banking
E-commerce
9) Law of Banking
Introduction to law of banking
Evolution of banking and banking law
10) Other Financial Institutions in Kenya
Definition of financial institutions
Factors responsible for rapid growth of financial institutions in Kenya
Possible consequences of rapid increase of other financial institutions
Differences between commercial banks and other financial institutions
11) Banker – Customer Relationship
Introduction of terms
Banker customer relationships
Legal rights and duties under the Banker/Customer Relationship
Termination of Banker/Customer Relationship
Evaluation
CATs and Assignments = 30 Marks
Final Exam = 70 Marks
Total 100 Marks
2
, Monetary Theory and Practices
INTRODUCTION TO MONETARY THEORY AND PRACTICES
1.1 Definition of money
A) Money is a medium that can be exchanged for goods and services and is used as a measure of
their values in the market, including among its forms a commodity such as gold, an officially
issued coin or note, or a deposit in a checking account or other readily liquefiable account.
b) Money is the official currency, coins, and negotiable paper notes issued by a government.
c) Money is anything that is generally accepted as a medium of exchange for goods and services.
In theory, money is easy to define. It is the stock of assets that can readily be used to settle debts
or to buy goods and services. This property, of being easily and quickly exchanged for
something else, is known as liquidity, and provides a reason for people to hold money, either to
enable them to buy and sell goods when they want to, or as a form of insurance against
unforeseen events.
The nature and function of money
The development of money was necessitated by specialization and exchange. Money was
needed to overcome the shortcomings and frustrations of the barter system which is system
where goods and services are exchanged for other goods and services.
Disadvantages of Barter Trade
It is impossible to barter unless A has what B wants, and A wants what B has. This is
called double coincidence of wants and is difficult to fulfill in practice.
Even when each party wants what the other has, it does not follow they can agree on a
fair exchange. A good deal of time can be wasted sorting out equations of value.
(Lacked measure of value)
The indivisibility of large items is another problem. For instance if a cow is worth two
sacks of wheat, what is one sack of wheat worth? Once again we may need to carry over
part of the transaction to a later period of time.
It is possible to confuse the use value and exchange value of goods and services in a
barter economy. Such confusion precludes a rational allocation of resources and
promotion of economic efficiency.
When exchange takes place over time in an economy, it is necessary to store goods for
future exchange. If such goods are perishable by nature, then the system will break
down. (Lacked store of value)
The development of industrial economies usually depends on a division of labour,
specialization and allocation of resources on the basis of choices and preferences.
3
, Monetary Theory and Practices
Economic efficiency is achieved by economizing on the use of the most scarce resources.
Without a common medium of exchange and a common unit of account which is
acceptable to both consumers and producers, it is very difficult to achieve an efficient
allocation of resources to satisfy consumer preferences.
Some goods are heavy and bulky hence not portable.
Some goods e.g. land and buildings lacks geographical mobility
For these reasons the barter system was discarded by societies which develop beyond autarky to
more specialized methods of production. For such peoples a money system is essential.
Functions of money
Medium of exchange: Money facilitates the exchange of goods and services in the
economy. Workers accept money for their wages because they know that money can be
exchanged for all the different things they will need. Use of money as an intermediary in
transactions therefore, removes the requirement for double coincidence of wants between
transactions. Without money, the world‘s complicated economic systems which are
based on specialization and the division of labour, would be impossible. The use of
money enables a person who receives payment for services in money to obtain an
exchange for it, the assortment of goods and services from the particular amount of
expenditure which will give maximum satisfaction.
Unit of account: Money is a means by which the prices of goods and services are
quoted and accounts kept. The use of money for accounting purposes makes possible the
operation of the price system and automatically provides the basis for keeping accounts,
calculating profit and loss, costing etc. It facilitates the evaluation of performance and
forward planning. It also allows for the comparison of the relative values of goods and
services even without an intention of actually spending (money) on them e.g. ―window
shopping‖.
Store of Wealth/value: The use of money makes it possible to separate the act of sale
from the act of purchase. Money is the most convenient way of keeping any form of
property which is surplus to immediate use; thus in particular, money is a store of value
of which all assets/property can be converted. By refraining from spending a portion of
one‘s current income for some time, it becomes possible to set up a large sum of money
to spend later (of course subject to the time value of money). Less durable or otherwise
perishable goods tend to depreciate considerably over time, and owners of such goods
avoid loss by converting them into money.
Standard of deferred payment: Many transactions involve future payment, e.g. hire
purchase, mortgages, long term construction works and bank credit facilities. Money
thus provides the unit in which, given the stability in its value, loans are advanced/made
and future contracts fixed. Borrowers never want money for its own sake, but only for
the command it gives over real resources. The use of money again allows a firm to
borrow for the payment of wages, purchase of raw materials or generally to offset
4
EMBU UNIVERSITY COLLEGE
(A Constituent College of the University of Nairobi)
Bachelor of Commerce Year 3.1
DFI 301 – Monetary Theory and Practices
COURSE OUTLINE
Course Duration: 3 HRS PER WEEK
Purpose: To introduce the students to modern theories of money and banking.
Course objectives: By the end to the unit, the students should be able to;
1. Appreciate the importance of money and banking in an economy
2. Understand the quality theory of money and related controversies
3. Identify the theoretical and empirical definition of money
5 Appreciate the role of monetary authorities in control of money
6. Identify the role of banking in society
7. Appreciate the role of other financial institutions in Kenya
8. Identify various banker-customer relationships
Course Contents.
1) Introduction to Monetary Theory and Practice
Definition of money
The functions of money in the economy
The characteristics of money
2) Demand for Money
Motives of holding money
Factors influencing demand for money
3) Money Supply
Determinants of money supply
The role of the central monetary authority in controlling money supply
4) Banking System
Introduction to banking
The role of banking in the society
Banking as a business
1
, Monetary Theory and Practices
5) Interest Rate Structure
Introduction
Determinants of interest rate
The theories of interest rates determination
6) The Management, Structure and Regulation of the Banking System
Objectives of the banking system
The structure of the banking system
The central bank of Kenya as a regulator of banking sector.
Other regulators of financial institutions
7) Deposit and Non Deposit Taking Financial Institutions
Financial markets
Roles of financial markets
Types of financial markets in Kenya
Financial institutions in the banking sector
8) Innovations in the Banking Sector
Meaning of financial innovation
Mobile banking
Agency banking
Islamic banking
Insurance banking
E-commerce
9) Law of Banking
Introduction to law of banking
Evolution of banking and banking law
10) Other Financial Institutions in Kenya
Definition of financial institutions
Factors responsible for rapid growth of financial institutions in Kenya
Possible consequences of rapid increase of other financial institutions
Differences between commercial banks and other financial institutions
11) Banker – Customer Relationship
Introduction of terms
Banker customer relationships
Legal rights and duties under the Banker/Customer Relationship
Termination of Banker/Customer Relationship
Evaluation
CATs and Assignments = 30 Marks
Final Exam = 70 Marks
Total 100 Marks
2
, Monetary Theory and Practices
INTRODUCTION TO MONETARY THEORY AND PRACTICES
1.1 Definition of money
A) Money is a medium that can be exchanged for goods and services and is used as a measure of
their values in the market, including among its forms a commodity such as gold, an officially
issued coin or note, or a deposit in a checking account or other readily liquefiable account.
b) Money is the official currency, coins, and negotiable paper notes issued by a government.
c) Money is anything that is generally accepted as a medium of exchange for goods and services.
In theory, money is easy to define. It is the stock of assets that can readily be used to settle debts
or to buy goods and services. This property, of being easily and quickly exchanged for
something else, is known as liquidity, and provides a reason for people to hold money, either to
enable them to buy and sell goods when they want to, or as a form of insurance against
unforeseen events.
The nature and function of money
The development of money was necessitated by specialization and exchange. Money was
needed to overcome the shortcomings and frustrations of the barter system which is system
where goods and services are exchanged for other goods and services.
Disadvantages of Barter Trade
It is impossible to barter unless A has what B wants, and A wants what B has. This is
called double coincidence of wants and is difficult to fulfill in practice.
Even when each party wants what the other has, it does not follow they can agree on a
fair exchange. A good deal of time can be wasted sorting out equations of value.
(Lacked measure of value)
The indivisibility of large items is another problem. For instance if a cow is worth two
sacks of wheat, what is one sack of wheat worth? Once again we may need to carry over
part of the transaction to a later period of time.
It is possible to confuse the use value and exchange value of goods and services in a
barter economy. Such confusion precludes a rational allocation of resources and
promotion of economic efficiency.
When exchange takes place over time in an economy, it is necessary to store goods for
future exchange. If such goods are perishable by nature, then the system will break
down. (Lacked store of value)
The development of industrial economies usually depends on a division of labour,
specialization and allocation of resources on the basis of choices and preferences.
3
, Monetary Theory and Practices
Economic efficiency is achieved by economizing on the use of the most scarce resources.
Without a common medium of exchange and a common unit of account which is
acceptable to both consumers and producers, it is very difficult to achieve an efficient
allocation of resources to satisfy consumer preferences.
Some goods are heavy and bulky hence not portable.
Some goods e.g. land and buildings lacks geographical mobility
For these reasons the barter system was discarded by societies which develop beyond autarky to
more specialized methods of production. For such peoples a money system is essential.
Functions of money
Medium of exchange: Money facilitates the exchange of goods and services in the
economy. Workers accept money for their wages because they know that money can be
exchanged for all the different things they will need. Use of money as an intermediary in
transactions therefore, removes the requirement for double coincidence of wants between
transactions. Without money, the world‘s complicated economic systems which are
based on specialization and the division of labour, would be impossible. The use of
money enables a person who receives payment for services in money to obtain an
exchange for it, the assortment of goods and services from the particular amount of
expenditure which will give maximum satisfaction.
Unit of account: Money is a means by which the prices of goods and services are
quoted and accounts kept. The use of money for accounting purposes makes possible the
operation of the price system and automatically provides the basis for keeping accounts,
calculating profit and loss, costing etc. It facilitates the evaluation of performance and
forward planning. It also allows for the comparison of the relative values of goods and
services even without an intention of actually spending (money) on them e.g. ―window
shopping‖.
Store of Wealth/value: The use of money makes it possible to separate the act of sale
from the act of purchase. Money is the most convenient way of keeping any form of
property which is surplus to immediate use; thus in particular, money is a store of value
of which all assets/property can be converted. By refraining from spending a portion of
one‘s current income for some time, it becomes possible to set up a large sum of money
to spend later (of course subject to the time value of money). Less durable or otherwise
perishable goods tend to depreciate considerably over time, and owners of such goods
avoid loss by converting them into money.
Standard of deferred payment: Many transactions involve future payment, e.g. hire
purchase, mortgages, long term construction works and bank credit facilities. Money
thus provides the unit in which, given the stability in its value, loans are advanced/made
and future contracts fixed. Borrowers never want money for its own sake, but only for
the command it gives over real resources. The use of money again allows a firm to
borrow for the payment of wages, purchase of raw materials or generally to offset
4
