The Role of Money and Monetary Policies in the Economy

The Role of Money and Monetary Policies in the Economy

The role of money and monetary policies has been one of the offer debuted issues in development economics for long. Despite schunpeter’s  dramatization of money and credit as phenomenon of development the nature of momentary policy   remained ill-defined until reticently, for two reasons, for one thing monetary policy was relieved in a narrow perspective as  influencing aggregate demand in the regulation of interest rate credit availability and credit allocation for another, views on the  rode of money and monetary policy  was dominated  by then prevailing perception of the growth process himself,  and modern growth theory had not yet assigned a meaning full function to money. But Dr Robert moxiu looks at the role of money   from the perspective that it services several purpose in the society.

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The believed that people convents assest into moneyto have an efficient medium of exchange. He agreed that berter is also used occasionally. Again money is used as a unit of account to determine the value of  goods and may be been at times as the safest way to hold ones assets. The money hoarder trusts it value more than the value of stock or this satiety of banks. But in sense, the person who keep cash on hand pays you the privilege, if the individual choose to do so. He or sure could earn interest by investing.

Investment can be interceded by measures. Credit creation which renders  money and credit a more caused factor. However with the prevailing conditions in less developed countries like ours such credit induced investment is a sure prescription for inflection.

The saving unit accumulate financial claims on this investing unit or on the financial intermediaries which their transmit the und so mobilized to the investing sector.  This flow of fund between various economic units creates assets and liabilities in this process, but the structure of these assets and liabilities is not the same in every phase of economic development.

The role of specialization in the development of any economy and an increase in national income should not be over emphasized,   and owns will not be an exception specialization  means  that each worker devotes himself to a sight occupation such as farming.


The total amount of money every one wishes to hole for all purposes is known as demand for money. This means the aggregated demand of money in an economy for this purpose of effective transaction, Households, individuals firms etc demand money for various reason which depends on the development of capital market of this economy.


There are thus major motives for demanding money:-

  1. Transaction
  2. Precautionary or liquidity
  3. Speculative motives

 TRANSACTION DEMAND FOR MONEY: Virtually all transaction in our economy requires money. Money is passed from household to firms to pay for the  goals and services produced by the firms and money is passed from firms to household.

PRECAUTIONARY DEMAND FOR MONEY:  The precautionary motive for demanding money has to do  with maintaining a cushion or butter to meet unexpected contingencies such contingencies include irregular and unplanned payments such as paying for unexpected bills making purchases at unexpectedly favourable prices and meeting sudden emergencies used perhaps by accident or ill health.

SPECULATIVE MOTIVES:  This relates to the holding of money in over to take advantage of expected changes in security price. When interest rate is expected to rise and security prices to fall, this motive suggests t hat product investors should hold money until the rise in interest rate ceases. While that is high level of literacy and  a sopliaticed capital market in the developed countries, the opposite is the case in Nigeria and other developing countries of the world.


Three hypothesis can be drawn about the motives for demanding money.

  1. The demand for money is positively related a national income valued at current prices. The higher the national income higher the amount of money needs for transaction and precautionary purposes.
  2. The demand for money is negatively related to the rate of interest. The higher the rate of interest the higher the opportunity cost of holding money and less money will be held for precautionary motives.
  3. The demand for money is positively related to wealth if firms and household wishes to hold some traction of their wealth in money because of uncertainty over bond prices, the demand for money to hold will rise as wealth rises.


Bank performs numerous functions but only those relevant to the research will be eminently extensively. They include.

  1. Mobilization of saving and other deposits
  2. Extension of credit facilities to the economy
  3. Creating money and
  4. Inculcating banking habit

MOBILIZATION OF SAVING AND OTHER DEPOSITS: This is one of the most important functions of bank is mobilization of savings and other deposit from savings sector of the economy and making the fund available to the investing sector of the economy. Banks pay interests on savings so mobilized which charging interest on loans and advances extended.


One of the primary functions of bank in Nigeria (In this content, commercial and merchant) is the extension of credit to worthy borrowers. In marking loans available to the economy, bank are rendering a great service, through their action production is increased capital investment are expanded and a higher standard of living is realized.

CREATING MONEY: This is another major function of commercial banks. If bank had not been able to create money, it would have been impossible to expand our productive capacities  which would have resulted in the slow down of economic activity generally, as business would have been force to want until sufficient profits are made before they could expand.

INCULCATING OF THE BANKING HABIT: One of the primary functions and purpose which banks are surpose to fulfill is that of indenting the banking habit. This role of bank is so basic as to be regarded as the condition precedent on which the ability of bank to successfully fulfill their function of financial intensification us predated.


To understand the importance of money creation to economic development, it is important to examine the process of money creation by banks. The principle process by which the banking system creates money is the granting of loan and overdrafts. Every loan and overdraft  approved by a bank creates  a new deposit. Upon the granting of loan the customer can draw a cheques to effect payment.


If deposit money can be created easily, what prevents banks from making too much, that is more than is needed handle the volume of transaction resulting from optimum use of the nations productive resources at stable prices various factors which limits the amount of deposit bank can create include:-

  1. RESPRSUS REQUIREMENT: The main factor which limits the ability of the banking system to increase demand deposits by expend loans and investments is the reserves that banks hold ageist deposit. Growth of deposit can continue only to the point where existing resaves are just sufficient to satisfy legal requirement.
  2. PROFITABILITY OF ASSET AS A LIMITING FACTOR: Olubumi argued that bank can increase their lending at existing rate only so long as there is an unsatisfied demand for loans of the type that they consider as safer the demand for loan is influenced by the level of economic activity and prices, and by the relationship between the interest charged and convenience of the bank loans on the one hand, and cost and convenience of alternative source of finance on the other hand, However, the demand for loan of the type that the bank consider suitable and safer also depends on the number of borrowers of satisfactory collateral security.

 RATIO OF IDLE MONEY IN THE ECONOMY: Another serious limiting factor to banks ability to create money in Nigeria is the ratio at which the public demand idle currency. Bank can not be able to create despite first mobilizing saving from the public. The currency change exercise OF April 1994 more then anything depicted our economy as a cash economy.


The supply of money at any moment is the sum of all this money holding of all the members of the society. This include M1 and M2 in Nigeria (ie notes and coins issued by the central bank of Nigeria plus bank deposit hold in current accounts of commercial banks plus saving deposit with banks and non-bank financial institution). The CBN defined money supply in Nigerian as currency outside bank plus domestic deposit with CBN minus deposit of federal government at commercial banks.


          The measurement of velocity in essence, in the ration between the stock of money and the value of monetary transactions in say, a year, divided by the stock of money. This velocity V, stands for the average  number of times a unit money turns over in the  transaction that creates  CAOP.


The stock of money is usually considerably in excess of the minimum  amount the society needed to finance transaction. This  excess can be regarded as idle in the sense the out put transaction can be conducted without inconvenience. This means that the stock of money held outside transaction purposes, in money held for precautionary  and speculative natives are idle, since this stock of money does not affect the financing of out put transaction.


          Of course, people do not really distinguish in any practiced way between the portion of money held affiancing output transaction and the potion which is excess or idle, However the concept of distinction is an extremely useful analytical device.


There are reasons that may influence a full in demand for idle money, and they include:-

  1. OPPORTUNITIES TO SPEND MAY ENERGY WHICH WERE PREVIOUSLY: Idle balance can be depleted if exceptionally attractive new products upper on the market commodity expectation can also course temporary reduction in the demand for idle money, since wider spreat expectations that commode prices  will rise in the new future is likely to tempt  some speculator to substitute stocks of commodities  for idle balances in anticipation of profit.


Hoarding which is the amount of money saved but not invested has devastating effects on the Nigerian economy. Fund that are hoarding (ie not save in bank or their financial institutions) are not released for the use of  other people their by retarding economic activity. Hoarding can also affect the monetary a hoardings ability to control the quality of money supply.

—-This article is not complete———–This article is not complete————

This article was extracted from a Project Research Work Topic:



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