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Money, Banking and Financial Markets
                                                   Money


                                               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




Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   2 / 25
Outline


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




Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   3 / 25
Definition of Money


Money is what is being accepted in payment for goods and services and in
payment 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 be
        used for payment too.
        Money versus wealth: Wealth all the collection of pieces of property
        that serve to store value. Wealth includes many assets that cannot be
        used 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 or
        a stock the amount of which needs to be measured at a point in time.




Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   4 / 25
Outline


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




Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   5 / 25
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” of
               transaction 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 labor
               is not well advanced which means that resources are not allocated
               efficiently and economic growth is low.
        Using money as a medium of exchange:
               separates the transaction of good A for good B into 2 independent
               transactions good A for money and money for good B.
               The need of the double coincidence of wants is eliminated
               Transaction costs decrease.



Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   6 / 25
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.




Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   7 / 25
Unit of account

        Money is the num´raire in which all prices in the economy are
                        e
        expressed.
        Using a single num´raire enhances transparency and reduces
                           e
        information costs. In the absence of a single num´raire each good
                                                         e
        would have many prices denominated in different units of accounts.
        Example: Assume an economy with 4 goods, A, B, C, and D, but no
        money. What is the price of each individual good?
               Good A does not have 1 price but 3 relative prices expressed in units of
               good 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 in
               units of B.
               Good C has 1 “new” price in units of good D. The other prices are
               inverse relative prices of A and B.
               Good D has no “new” price. All prices of good D can be determined as
               inverse relative prices of A, B, or C.

Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   8 / 25
Unit of account




        This economy with 4 goods has 6 prices. The same economy using
        money would need only 4 prices expressed in money.
        More generally a barter economy with N goods needs N(N − 1)/2
        relative prices whereas an economy with N goods using money as a
        units of account needs only N prices




Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   9 / 25
Store of value


        Money is a repository of purchasing power over time. Most people do
        not wish to spend all their income at the same point in time when
        they earn it.
        Money competes with other assets to store value. These other assets
        include deposits, financial securities, real estate etc.
        Compared to money those assets usually pay the owner a positive
        interest 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 goods
        and services and pay debt.
        Liquidity is highly desirable. Illiquid assets involve transaction costs
        when they are converted into money.


Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   10 / 25
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 currency
        ceases to fulfil the functions of money.




Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   11 / 25
Outline


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




Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   12 / 25
Evolution of the Payment Systems
The payments system is the method of conducting transactions in the
economy.
    At the early stage of evolution commodity money (gold, silver) was
    used for transactions. Problems: High transaction (transport) costs;
    growth rate of money supply limited by the pace of extraction of
    those precious metals.
    At the next stage of evolution was fiat money (in latin “let it be
    done”, 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 still
    high.
    A further development involves the use of checks (instruction for a
    bank transfer). Larger amounts can be transferred by means of a
    check bringing down transport costs. Loss from theft is reduced.
    Problems: Time to bring a check from 1 place to another and to
    process a check
Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   13 / 25
Evolution of the Payment Systems




        Electronic payment is the next step in the evolution of the payment
        system. This saves transaction cost significantly; many payments
        become real-time transactions. Problem: Sensitive to attacks to
        computer systems.
        As a further step the development of e-money (money that exists only
        in electronic form), smart cards (cards with a restorable payment
        chip) or electronic cash (used on the internet to make transactions)
        can be seen.




Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   14 / 25
Outline


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




Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   15 / 25
How to Measure Monetary Aggregates?


        Measuring money is a problem because what is money is defined by
        peoples behavior.
        What is being accepted for payments may change over time; the
        proper measure of money would need to reflect this.
        Money is measured in monetary aggregates that include different
        types of assets characterized by a particularly high level of liquidity.
        The central bank of a country defines the monetary aggregates. The
        definition varies between countries as people’s behavior differs.
        It is important to measure money because money supply is
        systematically related to the inflation rate which is an important
        target variable of central bank policy.



Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   16 / 25
How to Measure Monetary Aggregates? The Egyptian
Case

        Reserve Money (MO): Composed of money in circulation outside the
        CBE and local currency deposits of banks with the CBE. It is
        considered the basis of money in its broader definitions and is also
        known as the monetary base or high-powered money.
        Money Supply (M1): Composed of money in circulation outside the
        banking system, i.e. with the public, and non-government demand
        deposits in local currency minus the balances of cheques and drafts
        under collection, with all the banking system units
        Domestic Liquidity (M2): Composed of money supply (M1) or what
        is known as the current means of payment, and quasi-money
        (comprising time and savings deposits in local currency and foreign
        currency deposits of residents other than government).


Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   17 / 25
Outline


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




Chahir Zaki (FEPS, Cairo University)   Money, Banking and Financial Markets   Second Semester, 2012   18 / 25
The Case of EgyptReserve Money and Counterpart Assets*
               1-
                                                                                                            ( LE mn )

                                                                        2006      2007          2008     2009       2010      2010
                                              End of
                                                                         June     June          June      June      June      Sept.          Oct.

                    Reserve Money (M0)                                  116050   134126    169911        175104    203071    216655         210432


                    Currency in circulation outside the CBE             78604    92174      111412       126268    144253    153079         153037

                    Banks' deposits in local currency with the CBE      37446    41952          58499    48836      58818    63576           57395



                    Counterpart Assets of Reserve Money                 116050   134126    169911        175104    203071    216655         210432


                                                                                           xx
                    Net Foreign Assets**                                61302    95372      180333 171732          190234    191648         193724


                    Net Domestic Assets                                 54748    38754      -10422       3372      12837     25007          16708
                                               ++
                    Net claims on government (A+B-C)                    114055   117254         81872    68613      80611    109835         107088
                                                                                           XX
                      A - Securities                                    164761   166724         123123   121709    121533    130597         130597

                      B - Credit facilities                              7047    25468          36574    25190      28754    51931           50877
                                     +++
                      C - Deposits                                      57753    74938          77825    78286      69676    72693           74386

                    Net claims on banks                                  1018    59512          77581     334       29010    56622           55317

                    Net balancing items                                 -60325   -138012   -169875       -65575    -96784    -141450        -145697
                                                                    X                       xx
                        Unclassified assets and liabilities (net)       34623    31902          12979    17296      4725      -6824          -8421

                        Open market operations                          -94948   -169914   -182854       -82871    -101509   -134626        -137276
                *     Derived from the CBE's balance sheet.
                +    Provisional.
Chahir Zaki (FEPS, Cairopublic economic authorities and theBanking and Financial Markets
              ++ Including University)           Money, National Investment Bank.                                 Second Semester, 2012   19 / 25
The Case of Egypt                                         *         ‫א‬          ‫א‬            ‫א‬       −١
                                                 (            )

2010                          2010                                          2011
                                                                    ‫א‬                       +       ‫א‬
 Sept.               Oct.     Nov.      Dec.          Jan.         Feb.            Mar.    April+

216655             210432 221924 218393              230862       246961       234900      240849                                          (M0)                                    ‫א‬

153079             153037    155660    153209        154156       177017       175647      175752                                          ‫א‬               ‫א‬               ‫א א‬           ‫א‬
63576               57395    66264     65184         76706        69944            59253   65097                      ‫א‬       ‫א‬                        ‫א‬                           ‫א א‬


216655             210432 221924 218393              230862       246961       234900      240849                                              ‫א‬                           ‫א‬             ‫א‬

                                                                                                                                      **
191648             193724 194312 198207              193507       184740       167446      154804                                                                  ‫א‬           ‫א‬


25007               16708    27612     20186         37355        62221        67454       86045                                                                   ‫א‬           ‫א‬
109835             107088    101920    100252        104468       106555       108831      108404                    ( − + ) ++                        ‫א‬                       ‫א‬
130597             130597    130597    130597        130597       130597       130597      130597                                                                          ‫− א‬
51931               50877    47529     45862         53070        57386            58985   61209                                                               ‫א‬                   −
                                                                                                                                                                   +++
72693               74386    76206     76207         79199        81428            80751   83402                                                                           ‫− א‬
56622               55317    50739     39848         17936         2169            -1287    -856                                                       ‫א‬                       ‫א‬
141450             -145697   -125047   -119914       -85049       -46503       -40090      -21503                                                                  ‫א א‬         ‫א‬
                                                                                                             x
-6824               -8421     -5492     -5011        -1920        -7101        -13542      -14601                         ‫א‬           ‫א‬            ‫א‬                   ‫א‬
134626             -137276   -119555   -114903       -83129       -39402       -26548      -6902                                                   ‫א‬               ‫א‬
                                                                                                                                  .            ‫א‬               ‫א‬       ‫א‬           ‫א‬         *
                                                                                                                                                       +                   .
     Chahir Zaki (FEPS, Cairo University)               Money, Banking and Financial Markets‫א‬
                                                                                        .                        ‫א‬                Second ‫ א‬Semester, +2012
                                                                                                                                     ‫א‬        ‫א‬        +                                         20 / 25
The Case of 2EgyptSurvey* : Domestic Liquidity and Counterpart Assets
             - Banking
                                                                                                                     ( LE mn )

                                                                                  2006       2007        2008     2009      2010      2010                       2010
                                                End of
                                                                                  June       June        June     June      June      Sept.         Oct.         Nov.
                          Domestic Liquidity (1+2) (M2)                          560356    662688    766664      831211    917459    948172        961244       96325


                          Money Supply (1) (M1)                                  109274    131290    170579      182991    214040    220472        222674       22489
                           Currency in circulation outside the banking system     74239     86860    104656      118146    135209    143799        142783       14505
                           Demand deposits in local currency**                    35035     44430        65923   64845     78831     76673         79891        79837


                          Quasi-Money (2)                                        451082    531398    596085      648220    703419    727700        738570       73836
                          Local currency time & saving deposits **               314188     377424   436268      481054    545303    569542        576948       58135
                          Foreign currency demand deposits **                     18534     26917        26581   32050     33901     34013         36321        33542
                          Foreign currency time & saving deposits **             118360     127057   133236      135116    124215    124145        125301       12347


                          Counterpart Assets                                     560356    662688    766664      831211    917459    948172        961244       96325
                                                                                                     x
                          Net Foreign AssetsXXX                                  133385    218629    303680 254134         282408    312144        315293       30494

                                                                                                     x
                          Net Domestic Assets                                    426971    444059    462984 577077         635051    636028        645951       65831
                          Domestic credit                                        509532     531314   570953      695326    775268    792347        803678       81390
                          Net balancing items                                    -82561     -87255   -107969     -118249   -140217   -156319       -157727      -15559


                          Indicators
                                                                                                                                     xx            xx           xx
                           M2 / GDP (%)                                           90.72      88.98       85.52    79.76     76.04         68.81         69.76        69.90
                           Foreign currency deposits/ Total deposits (%)          28.16      26.74       24.14    23.44     20.21     19.66         19.75        19.19
                                                                                                                                     xx            xx           xx
                           Income velocity of money (GDP / M2)                     1.10      1.12        1.17     1.25      1.32          1.45          1.43         1.43
                           Money multiplier (M2 / M0)                              4.83      4.94        4.51     4.75      4.52      4.38          4.57         4.34
                      *    Extracted from the consolidated balance sheet of the banking system.
                      +    Provisional

Chahir Zaki   (FEPS, Cairo University) of the business sector ( public and private ) and the household sector,
                   ** Representing deposits    Money, Banking and Financial Markets                                        Second Semester, 2012         21 / 25
s
          The Case of Egypt                                                               ‫א‬        ‫א‬           ‫א‬                    ‫*: א‬       ‫א‬       ‫٢−א‬
                                                               (                )

     2010                             2010                                                    2011
                                                                                         ‫א‬                         +        ‫א‬
     Sept.               Oct.         Nov.         Dec.             Jan.            Feb.             Mar.          April+
    948172              961244       963255       973962           969712       982547            988076       986760                                                                 ( M2 )                (٢+١)                             ‫א‬                   ‫א‬

    220472              222674       224890       223456           229528       239401            240814       241863                                                                           (M1)                (١)                   ‫א‬                       ‫א‬
    143799              142783       145053       143633           145857        161818           163489       165003                                                                               ‫א‬           ‫א‬                     ‫א א‬                 ‫א‬
    76673               79891        79837        79823            83671            77583         77325            76860
                                                                                                                                                                                      **
                                                                                                                                                                                                            ‫א‬                             ‫א א א‬

    727700              738570       738365       750506           740184       743146            747262       744897                                                                                                   (٢)                       ‫א‬
    569542              576948       581350       592451           579119        568572           567394       566259
                                                                                                                                                                              **
                                                                                                                                                                                                    ‫א‬                         ‫א‬             ‫א א‬
    34013               36321        33542        34072            38134            45829         46257            44613
                                                                                                                                                                                  **
                                                                                                                                                                                                        ‫א‬                                 ‫א א א‬
    124145              125301       123473       123983           122931        128745           133611       134025
                                                                                                                                                                         **
                                                                                                                                                                                           ‫א‬                                  ‫א‬             ‫א א‬

    948172              961244       963255       973962           969712       982547            988076       986760                                                                                   ‫א‬                                 ‫א‬                   ‫א‬
    312144              315293       304944       305252           286196       274549            266036       256212
                                                                                                                                                                                                    XXX
                                                                                                                                                                                                                          ‫א‬                       ‫א‬

    636028              645951       658311       668710           683516       707998            722040       730548                                                                                                     ‫א‬                       ‫א‬
    792347              803678       813903       805057           814739        851595           870469       879024                                                                                                                 ‫א‬                   ‫א‬
    -156319             -157727      -155592      -136347          -131223      -143597           -148429      -148476                                                                                                  ‫א א‬                   ‫א‬

                                                                                                                                                                                                                                                      ‫א‬
    xx
         68.81          xx
                             69.76   xx
                                          69.90   xx
                                                       70.68       xx
                                                                        70.37    xx
                                                                                      71.30       xx
                                                                                                       71.70   xx
                                                                                                                    71.61                                             (٪)   ‫א‬     ‫/א א‬                                                ‫א‬       ‫א‬
     19.66               19.75        19.19        19.04            19.55           21.27          21.81           21.74                                            (٪) ‫א א‬     /   ‫א‬                                                       ‫א א‬
    xx
         1.45           xx
                             1.43    xx
                                          1.43    xx
                                                       1.41        xx
                                                                        1.42        xx
                                                                                         1.40     xx
                                                                                                       1.39        xx
                                                                                                                        1.40                       (    ‫א‬        ‫/א‬       ‫א‬   ‫)א א‬                                                        ‫א‬   ‫א‬
     4.38                4.57         4.34         4.46             4.20             3.98            4.21           4.10                                                                            (M2 / M0)                         ‫א‬
                                                                                                                                                                     .            ‫א‬                                 ‫א‬     ‫א א א‬                                   *
                                                                                                                                                                                                                             .                                +
                                                                                              .   ‫א א‬                   ‫א‬       ‫א‬    ‫א א‬   ‫א‬                 ‫א‬     ‫( א‬        ‫א‬                ‫)א‬
                                                                                                                                                                                               **               ‫א‬                 ‫א‬
          Chahir Zaki (FEPS, Cairo University)                                  Money, Banking and Financial Markets                                                          Second Semester, 2012                                                                   22 / 25
The Case of Egypt
                                                       Main Macroeconomic Indicators
                                                                                                        %
                                                                               2006    2007    2008    2009    2010                 2010
                                 End of *
                                                                               June    June    June    June    June      Sept.              Oct.
     Financial & Monetary Sector
       Growth rate of reserve money (M0)                                       14.8    15.6    26.7     3.1    16.0      13.1           12.2
       Growth rate of money supply (M1)                                        21.8    20.1    29.9     7.3    17.0      14.4           15.6
       Domestic liquidity growth rate (M2)                                     13.5    18.3    15.7     8.4    10.4      11.8           13.4
       Money multiplier (M2 / M0)                                              4.83    4.94    4.51    4.75    4.52      4.38           4.57
       Currency in circulation / money supply                                  67.9    66.2    61.4    64.6    63.2      65.2           64.1
                                                                                                                       ***            ***
       M2/GDP                                                                  90.72   88.98   85.52   79.76   76.04         68.81          69.76
                                                                                                                        ***            ***
       Income velocity of money (GDP/M2)                                       1.10    1.12    1.17    1.25    1.32          1.45           1.43
       Growth rate of domestic liquidity in local currency                     13.6    20.1    19.3     9.4    14.4      15.1           15.9
                                                                                                                       ***            ***
       M2 in local currency /GDP                                               68.55   68.30   67.69   63.72   62.9          57.33          58.03
       Total deposits growth rate                                              12.8    18.5    15.00   7.71    9.70     11.67          13.40
       Household deposits/ total deposits                                      78.2    73.0    67.6    72.1    73.5      73.5           73.1
       Growth rate of local currency deposits                                  12.8    20.8    19.0     8.7    14.3          15.6          16.5
       Household local currency deposits/ total local currency deposits        82.5    76.3    70.5    75.8    76.6          76.6           76.3
       Foreign currency deposits /total deposits                               28.16   26.74   24.14   23.44   20.21     19.66         19.75
       Foreign currency deposits growth rate                                   13.0    12.5     3.8     4.6    -5.4          -2.0           2.3
       Household foreign currency deposits / total foreign currency deposits   67.3    63.9    58.6    59.9    61.3          60.8           59.9
       Private business sector credit / total credit                           47.0    50.6    51.1    43.8    42.1          41.2           40.9
       Net claims on the government / total credit                             36.1    33.6    30.5    39.3    42.1      43.1           43.3
       Banking density (population in thousand for each banking unit)          24.5    24.2    22.9    22.3    22.3      22.3
                                                                                                                       ***            ***
       Note issue /GDP                                                         12.79   12.52   12.54   12.25   12.09         11.26          11.25
       Equity /assets**                                                         5.3     4.9     4.9     5.8     6.2          5.9            5.9
       Provisions /assets**
Chahir Zaki (FEPS, Cairo University)                   Money, Banking and Financial Markets 5.8
                                                                             7.2     5.7                6.4
                                                                                                         Second5.8    5.7
                                                                                                                Semester,           20125.6         23 / 25
The Case of Egypt
                                                                                                      ‫א‬          ‫א א‬   ‫א‬
                                                                  %
0                                   2010                                        2011
                                                                            ‫א‬                         +                                      *
     Oct.                    Nov.           Dec.      Jan.             Feb.        March          April+
                                                                                                                                                                                                                                       ‫א‬                ‫א‬             ‫א‬
 12.2                    16.3           13.1          20.1             32.0         19.8          20.5                                                                     (M0)                                                    ‫א‬
 15.6                    13.4           13.4          16.4             19.9         19.3          17.7                                                                 ( M1)                                           ‫א‬                    ‫א‬
 13.4                    12.8           12.4          11.8             12.2         11.2          10.8                                                                 ( M2)                                               ‫א‬                ‫א‬
 4.57                    4.34           4.46          4.20             3.98         4.21          4.10                                                                                 (M2 / M0)                                                ‫א‬
 64.1                    64.5           64.3          63.5             67.6         67.9          68.2                                                                                             ‫א‬                               ‫א א /א‬                         ‫א‬
**
     69.76             ***
                             69.90    ***
                                            70.68   ***
                                                          70.37   ***
                                                                        71.30     ***
                                                                                        71.70   ***
                                                                                                      71.61                                                                ‫א‬                       ‫א‬                   ‫/א‬                       ‫א‬                 ‫א‬
***
     1.43               ***
                             1.43      ***
                                            1.41     ***
                                                          1.42        ***
                                                                        1.40       ***
                                                                                        1.39     ***
                                                                                                          1.40             (       ‫א‬         ‫/ א‬           ‫א‬                       ‫א‬               ‫)א‬                                               ‫א‬             ‫א‬
 15.9                    15.5           14.7          13.9             12.7         10.6          10.0                                                                 ‫א‬                                                   ‫א‬                ‫א‬
**
     58.03
                       ***
                             58.51
                                      ***
                                            59.21
                                                    ***
                                                          58.68
                                                                  ***
                                                                        58.63
                                                                                  ***
                                                                                        58.65
                                                                                                ***
                                                                                                      58.64                                        ‫א‬       ‫א‬               ‫/א‬                          ‫א‬                                        ‫א‬                 ‫א‬
13.40                   13.17          12.25         11.12             9.78         8.54          8.11                                                                                             ‫א א‬                                                  ‫א‬
 73.1                    73.4           73.5          74.2             74.2         74.5          75.4                                                                 ‫א א‬                                     /                       ‫א‬                ‫א א‬
    16.5                 16.6              15.0       13.5              9.7             7.0           6.4                                                                              ‫א‬                                   ‫א א‬                          ‫א‬
     76.3                    76.4           76.4          77.6         78.5         78.9          79.8                         ‫א‬             ‫א א‬                   /                       ‫א‬                                           ‫א‬                ‫א א‬
19.75                   19.19          19.04         19.55            21.27        21.81         21.74                                                 ‫א א‬                                     /                           ‫א‬                                    ‫א א‬
     2.3                     0.8            2.1           2.2          10.2         14.2          14.9                                                                         ‫א‬                                           ‫א א‬                          ‫א‬
     59.9                    60.6           60.8          60.1         58.5         58.9          59.7                     ‫א‬               ‫א א‬         /                           ‫א‬                                                   ‫א‬                ‫א א‬
     40.9                    40.6           38.8      38.9             37.7         36.9          36.6                                                 ‫א‬                           /                       ‫א‬                       ‫א‬                              ‫א‬
 43.3                    43.7           45.3          45.3             47.2         48.1          48.6                                                         ‫א‬                           /                       ‫א‬                                    ‫א‬
                                        22.3                                        22.3                                               (                                                                   ‫א‬                   )                    ‫א‬             ‫א‬
**
     11.25             ***
                             11.49    ***
                                            11.29   ***
                                                          11.33   ***
                                                                        12.92     ***
                                                                                        12.87   ***
                                                                                                      12.84                                                                                ‫א‬                   ‫א‬                       ‫/א‬                   ‫א‬     ‫א‬
     5.9                     5.9            6.2           6.4           6.2             6.6           6.4                                                                                          **                              ‫/א‬                   ‫א‬
     5.6Chahir   Zaki (FEPS, Cairo University) 4.2
                        5.5    4.2     4.3                                         4.3     4.4
                                                                                 Money, Banking and Financial Markets                                                           **  ‫/א‬      ‫א‬
                                                                                                                                                                           Second Semester, 2012                                                                          24 / 25
References




        Mishkin, chapter 2.
        The lectures of Prof. Heiko Fritz.
        Akerlof (1970).
        The CBE, Monthly Report, June 2011.




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

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2 money

  • 1. Money, Banking and Financial Markets Money Chahir Zaki FEPS, Cairo University Second Semester, 2012 Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 1 / 25
  • 2. 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 Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 2 / 25
  • 3. Outline 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 Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 3 / 25
  • 4. Definition of Money Money is what is being accepted in payment for goods and services and in payment 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 be used for payment too. Money versus wealth: Wealth all the collection of pieces of property that serve to store value. Wealth includes many assets that cannot be used 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 or a stock the amount of which needs to be measured at a point in time. Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 4 / 25
  • 5. Outline 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 Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 5 / 25
  • 6. 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” of transaction 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 labor is not well advanced which means that resources are not allocated efficiently and economic growth is low. Using money as a medium of exchange: separates the transaction of good A for good B into 2 independent transactions good A for money and money for good B. The need of the double coincidence of wants is eliminated Transaction costs decrease. Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 6 / 25
  • 7. 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. Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 7 / 25
  • 8. Unit of account Money is the num´raire in which all prices in the economy are e expressed. Using a single num´raire enhances transparency and reduces e information costs. In the absence of a single num´raire each good e would have many prices denominated in different units of accounts. Example: Assume an economy with 4 goods, A, B, C, and D, but no money. What is the price of each individual good? Good A does not have 1 price but 3 relative prices expressed in units of good 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 in units of B. Good C has 1 “new” price in units of good D. The other prices are inverse relative prices of A and B. Good D has no “new” price. All prices of good D can be determined as inverse relative prices of A, B, or C. Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 8 / 25
  • 9. Unit of account This economy with 4 goods has 6 prices. The same economy using money would need only 4 prices expressed in money. More generally a barter economy with N goods needs N(N − 1)/2 relative prices whereas an economy with N goods using money as a units of account needs only N prices Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 9 / 25
  • 10. Store of value Money is a repository of purchasing power over time. Most people do not wish to spend all their income at the same point in time when they earn it. Money competes with other assets to store value. These other assets include deposits, financial securities, real estate etc. Compared to money those assets usually pay the owner a positive interest 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 goods and services and pay debt. Liquidity is highly desirable. Illiquid assets involve transaction costs when they are converted into money. Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 10 / 25
  • 11. 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 currency ceases to fulfil the functions of money. Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 11 / 25
  • 12. Outline 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 Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 12 / 25
  • 13. Evolution of the Payment Systems The payments system is the method of conducting transactions in the economy. At the early stage of evolution commodity money (gold, silver) was used for transactions. Problems: High transaction (transport) costs; growth rate of money supply limited by the pace of extraction of those precious metals. At the next stage of evolution was fiat money (in latin “let it be done”, 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 still high. A further development involves the use of checks (instruction for a bank transfer). Larger amounts can be transferred by means of a check bringing down transport costs. Loss from theft is reduced. Problems: Time to bring a check from 1 place to another and to process a check Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 13 / 25
  • 14. Evolution of the Payment Systems Electronic payment is the next step in the evolution of the payment system. This saves transaction cost significantly; many payments become real-time transactions. Problem: Sensitive to attacks to computer systems. As a further step the development of e-money (money that exists only in electronic form), smart cards (cards with a restorable payment chip) or electronic cash (used on the internet to make transactions) can be seen. Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 14 / 25
  • 15. Outline 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 Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 15 / 25
  • 16. How to Measure Monetary Aggregates? Measuring money is a problem because what is money is defined by peoples behavior. What is being accepted for payments may change over time; the proper measure of money would need to reflect this. Money is measured in monetary aggregates that include different types of assets characterized by a particularly high level of liquidity. The central bank of a country defines the monetary aggregates. The definition varies between countries as people’s behavior differs. It is important to measure money because money supply is systematically related to the inflation rate which is an important target variable of central bank policy. Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 16 / 25
  • 17. How to Measure Monetary Aggregates? The Egyptian Case Reserve Money (MO): Composed of money in circulation outside the CBE and local currency deposits of banks with the CBE. It is considered the basis of money in its broader definitions and is also known as the monetary base or high-powered money. Money Supply (M1): Composed of money in circulation outside the banking system, i.e. with the public, and non-government demand deposits in local currency minus the balances of cheques and drafts under collection, with all the banking system units Domestic Liquidity (M2): Composed of money supply (M1) or what is known as the current means of payment, and quasi-money (comprising time and savings deposits in local currency and foreign currency deposits of residents other than government). Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 17 / 25
  • 18. Outline 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 Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 18 / 25
  • 19. The Case of EgyptReserve Money and Counterpart Assets* 1- ( LE mn ) 2006 2007 2008 2009 2010 2010 End of June June June June June Sept. Oct. Reserve Money (M0) 116050 134126 169911 175104 203071 216655 210432 Currency in circulation outside the CBE 78604 92174 111412 126268 144253 153079 153037 Banks' deposits in local currency with the CBE 37446 41952 58499 48836 58818 63576 57395 Counterpart Assets of Reserve Money 116050 134126 169911 175104 203071 216655 210432 xx Net Foreign Assets** 61302 95372 180333 171732 190234 191648 193724 Net Domestic Assets 54748 38754 -10422 3372 12837 25007 16708 ++ Net claims on government (A+B-C) 114055 117254 81872 68613 80611 109835 107088 XX A - Securities 164761 166724 123123 121709 121533 130597 130597 B - Credit facilities 7047 25468 36574 25190 28754 51931 50877 +++ C - Deposits 57753 74938 77825 78286 69676 72693 74386 Net claims on banks 1018 59512 77581 334 29010 56622 55317 Net balancing items -60325 -138012 -169875 -65575 -96784 -141450 -145697 X xx Unclassified assets and liabilities (net) 34623 31902 12979 17296 4725 -6824 -8421 Open market operations -94948 -169914 -182854 -82871 -101509 -134626 -137276 * Derived from the CBE's balance sheet. + Provisional. Chahir Zaki (FEPS, Cairopublic economic authorities and theBanking and Financial Markets ++ Including University) Money, National Investment Bank. Second Semester, 2012 19 / 25
  • 20. The Case of Egypt * ‫א‬ ‫א‬ ‫א‬ −١ ( ) 2010 2010 2011 ‫א‬ + ‫א‬ Sept. Oct. Nov. Dec. Jan. Feb. Mar. April+ 216655 210432 221924 218393 230862 246961 234900 240849 (M0) ‫א‬ 153079 153037 155660 153209 154156 177017 175647 175752 ‫א‬ ‫א‬ ‫א א‬ ‫א‬ 63576 57395 66264 65184 76706 69944 59253 65097 ‫א‬ ‫א‬ ‫א‬ ‫א א‬ 216655 210432 221924 218393 230862 246961 234900 240849 ‫א‬ ‫א‬ ‫א‬ ** 191648 193724 194312 198207 193507 184740 167446 154804 ‫א‬ ‫א‬ 25007 16708 27612 20186 37355 62221 67454 86045 ‫א‬ ‫א‬ 109835 107088 101920 100252 104468 106555 108831 108404 ( − + ) ++ ‫א‬ ‫א‬ 130597 130597 130597 130597 130597 130597 130597 130597 ‫− א‬ 51931 50877 47529 45862 53070 57386 58985 61209 ‫א‬ − +++ 72693 74386 76206 76207 79199 81428 80751 83402 ‫− א‬ 56622 55317 50739 39848 17936 2169 -1287 -856 ‫א‬ ‫א‬ 141450 -145697 -125047 -119914 -85049 -46503 -40090 -21503 ‫א א‬ ‫א‬ x -6824 -8421 -5492 -5011 -1920 -7101 -13542 -14601 ‫א‬ ‫א‬ ‫א‬ ‫א‬ 134626 -137276 -119555 -114903 -83129 -39402 -26548 -6902 ‫א‬ ‫א‬ . ‫א‬ ‫א‬ ‫א‬ ‫א‬ * + . Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets‫א‬ . ‫א‬ Second ‫ א‬Semester, +2012 ‫א‬ ‫א‬ + 20 / 25
  • 21. The Case of 2EgyptSurvey* : Domestic Liquidity and Counterpart Assets - Banking ( LE mn ) 2006 2007 2008 2009 2010 2010 2010 End of June June June June June Sept. Oct. Nov. Domestic Liquidity (1+2) (M2) 560356 662688 766664 831211 917459 948172 961244 96325 Money Supply (1) (M1) 109274 131290 170579 182991 214040 220472 222674 22489 Currency in circulation outside the banking system 74239 86860 104656 118146 135209 143799 142783 14505 Demand deposits in local currency** 35035 44430 65923 64845 78831 76673 79891 79837 Quasi-Money (2) 451082 531398 596085 648220 703419 727700 738570 73836 Local currency time & saving deposits ** 314188 377424 436268 481054 545303 569542 576948 58135 Foreign currency demand deposits ** 18534 26917 26581 32050 33901 34013 36321 33542 Foreign currency time & saving deposits ** 118360 127057 133236 135116 124215 124145 125301 12347 Counterpart Assets 560356 662688 766664 831211 917459 948172 961244 96325 x Net Foreign AssetsXXX 133385 218629 303680 254134 282408 312144 315293 30494 x Net Domestic Assets 426971 444059 462984 577077 635051 636028 645951 65831 Domestic credit 509532 531314 570953 695326 775268 792347 803678 81390 Net balancing items -82561 -87255 -107969 -118249 -140217 -156319 -157727 -15559 Indicators xx xx xx M2 / GDP (%) 90.72 88.98 85.52 79.76 76.04 68.81 69.76 69.90 Foreign currency deposits/ Total deposits (%) 28.16 26.74 24.14 23.44 20.21 19.66 19.75 19.19 xx xx xx Income velocity of money (GDP / M2) 1.10 1.12 1.17 1.25 1.32 1.45 1.43 1.43 Money multiplier (M2 / M0) 4.83 4.94 4.51 4.75 4.52 4.38 4.57 4.34 * Extracted from the consolidated balance sheet of the banking system. + Provisional Chahir Zaki (FEPS, Cairo University) of the business sector ( public and private ) and the household sector, ** Representing deposits Money, Banking and Financial Markets Second Semester, 2012 21 / 25
  • 22. s The Case of Egypt ‫א‬ ‫א‬ ‫א‬ ‫*: א‬ ‫א‬ ‫٢−א‬ ( ) 2010 2010 2011 ‫א‬ + ‫א‬ Sept. Oct. Nov. Dec. Jan. Feb. Mar. April+ 948172 961244 963255 973962 969712 982547 988076 986760 ( M2 ) (٢+١) ‫א‬ ‫א‬ 220472 222674 224890 223456 229528 239401 240814 241863 (M1) (١) ‫א‬ ‫א‬ 143799 142783 145053 143633 145857 161818 163489 165003 ‫א‬ ‫א‬ ‫א א‬ ‫א‬ 76673 79891 79837 79823 83671 77583 77325 76860 ** ‫א‬ ‫א א א‬ 727700 738570 738365 750506 740184 743146 747262 744897 (٢) ‫א‬ 569542 576948 581350 592451 579119 568572 567394 566259 ** ‫א‬ ‫א‬ ‫א א‬ 34013 36321 33542 34072 38134 45829 46257 44613 ** ‫א‬ ‫א א א‬ 124145 125301 123473 123983 122931 128745 133611 134025 ** ‫א‬ ‫א‬ ‫א א‬ 948172 961244 963255 973962 969712 982547 988076 986760 ‫א‬ ‫א‬ ‫א‬ 312144 315293 304944 305252 286196 274549 266036 256212 XXX ‫א‬ ‫א‬ 636028 645951 658311 668710 683516 707998 722040 730548 ‫א‬ ‫א‬ 792347 803678 813903 805057 814739 851595 870469 879024 ‫א‬ ‫א‬ -156319 -157727 -155592 -136347 -131223 -143597 -148429 -148476 ‫א א‬ ‫א‬ ‫א‬ xx 68.81 xx 69.76 xx 69.90 xx 70.68 xx 70.37 xx 71.30 xx 71.70 xx 71.61 (٪) ‫א‬ ‫/א א‬ ‫א‬ ‫א‬ 19.66 19.75 19.19 19.04 19.55 21.27 21.81 21.74 (٪) ‫א א‬ / ‫א‬ ‫א א‬ xx 1.45 xx 1.43 xx 1.43 xx 1.41 xx 1.42 xx 1.40 xx 1.39 xx 1.40 ( ‫א‬ ‫/א‬ ‫א‬ ‫)א א‬ ‫א‬ ‫א‬ 4.38 4.57 4.34 4.46 4.20 3.98 4.21 4.10 (M2 / M0) ‫א‬ . ‫א‬ ‫א‬ ‫א א א‬ * . + . ‫א א‬ ‫א‬ ‫א‬ ‫א א‬ ‫א‬ ‫א‬ ‫( א‬ ‫א‬ ‫)א‬ ** ‫א‬ ‫א‬ Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 22 / 25
  • 23. The Case of Egypt Main Macroeconomic Indicators % 2006 2007 2008 2009 2010 2010 End of * June June June June June Sept. Oct. Financial & Monetary Sector Growth rate of reserve money (M0) 14.8 15.6 26.7 3.1 16.0 13.1 12.2 Growth rate of money supply (M1) 21.8 20.1 29.9 7.3 17.0 14.4 15.6 Domestic liquidity growth rate (M2) 13.5 18.3 15.7 8.4 10.4 11.8 13.4 Money multiplier (M2 / M0) 4.83 4.94 4.51 4.75 4.52 4.38 4.57 Currency in circulation / money supply 67.9 66.2 61.4 64.6 63.2 65.2 64.1 *** *** M2/GDP 90.72 88.98 85.52 79.76 76.04 68.81 69.76 *** *** Income velocity of money (GDP/M2) 1.10 1.12 1.17 1.25 1.32 1.45 1.43 Growth rate of domestic liquidity in local currency 13.6 20.1 19.3 9.4 14.4 15.1 15.9 *** *** M2 in local currency /GDP 68.55 68.30 67.69 63.72 62.9 57.33 58.03 Total deposits growth rate 12.8 18.5 15.00 7.71 9.70 11.67 13.40 Household deposits/ total deposits 78.2 73.0 67.6 72.1 73.5 73.5 73.1 Growth rate of local currency deposits 12.8 20.8 19.0 8.7 14.3 15.6 16.5 Household local currency deposits/ total local currency deposits 82.5 76.3 70.5 75.8 76.6 76.6 76.3 Foreign currency deposits /total deposits 28.16 26.74 24.14 23.44 20.21 19.66 19.75 Foreign currency deposits growth rate 13.0 12.5 3.8 4.6 -5.4 -2.0 2.3 Household foreign currency deposits / total foreign currency deposits 67.3 63.9 58.6 59.9 61.3 60.8 59.9 Private business sector credit / total credit 47.0 50.6 51.1 43.8 42.1 41.2 40.9 Net claims on the government / total credit 36.1 33.6 30.5 39.3 42.1 43.1 43.3 Banking density (population in thousand for each banking unit) 24.5 24.2 22.9 22.3 22.3 22.3 *** *** Note issue /GDP 12.79 12.52 12.54 12.25 12.09 11.26 11.25 Equity /assets** 5.3 4.9 4.9 5.8 6.2 5.9 5.9 Provisions /assets** Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets 5.8 7.2 5.7 6.4 Second5.8 5.7 Semester, 20125.6 23 / 25
  • 24. The Case of Egypt ‫א‬ ‫א א‬ ‫א‬ % 0 2010 2011 ‫א‬ + * Oct. Nov. Dec. Jan. Feb. March April+ ‫א‬ ‫א‬ ‫א‬ 12.2 16.3 13.1 20.1 32.0 19.8 20.5 (M0) ‫א‬ 15.6 13.4 13.4 16.4 19.9 19.3 17.7 ( M1) ‫א‬ ‫א‬ 13.4 12.8 12.4 11.8 12.2 11.2 10.8 ( M2) ‫א‬ ‫א‬ 4.57 4.34 4.46 4.20 3.98 4.21 4.10 (M2 / M0) ‫א‬ 64.1 64.5 64.3 63.5 67.6 67.9 68.2 ‫א‬ ‫א א /א‬ ‫א‬ ** 69.76 *** 69.90 *** 70.68 *** 70.37 *** 71.30 *** 71.70 *** 71.61 ‫א‬ ‫א‬ ‫/א‬ ‫א‬ ‫א‬ *** 1.43 *** 1.43 *** 1.41 *** 1.42 *** 1.40 *** 1.39 *** 1.40 ( ‫א‬ ‫/ א‬ ‫א‬ ‫א‬ ‫)א‬ ‫א‬ ‫א‬ 15.9 15.5 14.7 13.9 12.7 10.6 10.0 ‫א‬ ‫א‬ ‫א‬ ** 58.03 *** 58.51 *** 59.21 *** 58.68 *** 58.63 *** 58.65 *** 58.64 ‫א‬ ‫א‬ ‫/א‬ ‫א‬ ‫א‬ ‫א‬ 13.40 13.17 12.25 11.12 9.78 8.54 8.11 ‫א א‬ ‫א‬ 73.1 73.4 73.5 74.2 74.2 74.5 75.4 ‫א א‬ / ‫א‬ ‫א א‬ 16.5 16.6 15.0 13.5 9.7 7.0 6.4 ‫א‬ ‫א א‬ ‫א‬ 76.3 76.4 76.4 77.6 78.5 78.9 79.8 ‫א‬ ‫א א‬ / ‫א‬ ‫א‬ ‫א א‬ 19.75 19.19 19.04 19.55 21.27 21.81 21.74 ‫א א‬ / ‫א‬ ‫א א‬ 2.3 0.8 2.1 2.2 10.2 14.2 14.9 ‫א‬ ‫א א‬ ‫א‬ 59.9 60.6 60.8 60.1 58.5 58.9 59.7 ‫א‬ ‫א א‬ / ‫א‬ ‫א‬ ‫א א‬ 40.9 40.6 38.8 38.9 37.7 36.9 36.6 ‫א‬ / ‫א‬ ‫א‬ ‫א‬ 43.3 43.7 45.3 45.3 47.2 48.1 48.6 ‫א‬ / ‫א‬ ‫א‬ 22.3 22.3 ( ‫א‬ ) ‫א‬ ‫א‬ ** 11.25 *** 11.49 *** 11.29 *** 11.33 *** 12.92 *** 12.87 *** 12.84 ‫א‬ ‫א‬ ‫/א‬ ‫א‬ ‫א‬ 5.9 5.9 6.2 6.4 6.2 6.6 6.4 ** ‫/א‬ ‫א‬ 5.6Chahir Zaki (FEPS, Cairo University) 4.2 5.5 4.2 4.3 4.3 4.4 Money, Banking and Financial Markets ** ‫/א‬ ‫א‬ Second Semester, 2012 24 / 25
  • 25. References Mishkin, chapter 2. The lectures of Prof. Heiko Fritz. Akerlof (1970). The CBE, Monthly Report, June 2011. Chahir Zaki (FEPS, Cairo University) Money, Banking and Financial Markets Second Semester, 2012 25 / 25