Monetary system of Ukraine

UKOOPSPILKA

POLTAVA UNIVERSITY OF CONSUMER COOPERATIVES IN UKRAINE

Chair of Management of Organizations and Foreign Economic Activity 
 
 
 
 
 

Research project

From microeconomics

On theme

“Monetary System of Ukraine” 
 
 
 
 
 

      Written by

Second year student

Of group IE-21e

Polina Sviatenko 
 
 
 
 
 
 

Poltava 2009

Table of Content

Chapter I

The essence of monetary system

1. The notion of money, its types, categories and functions………………..…...4
2. Main features of monetary system……………………………………...........11
3. Monetary policy and Central banks………………………………………….15

Chapter II

    Monetary system of Ukraine and other countries

    2.1. History of Ukrainian monetary system and its nature…………………….….18

    2.2. The USA monetary system…………………………………………….……..25

    2.3. Monetary system of European Union……………………………………...…29

Chapter III

    Modern tendencies in monetary system of Ukraine

    3.1. Current situation in monetary system of Ukraine………………….…………34

    3.2. Problems in monetary system of Ukraine and ways of their solving…….…..43

   Literature…………………………………………………………………….…………50

      
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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Introduction

      The formation of the stable relations concerning the purchase and sale of foreign currency and their legal consolidation historically led to the formation of the first national and then the international monetary systems. Although monetary relations brought to life primarily by the development of the international trade (through the movement of goods and services overseas), as well as the international capital movements, they have relative independence, which in the global economy has a tendency to increase. Currency relations’ impact on the production becomes more perceptible. To a large extent, this is the result of the further economic life internationalization, the deepening of integration trends in different regions of the world, significantly increasing role of external factors in the national reproductive process of industrial production, a huge increase in world currency trading, and the emergence and rapid spread of new financial instruments.

    So, nowadays, in the era of the globalization and growing interdepence of nations it is very important to know not only how monetary system of every single country is carried out, but also how the international monetary system works.

    The research project on a theme “The international monetary system and its evolution” is devoted to the problems of the international monetary system and its particular elements functioning showed through its gradual development.

    The object of research of the work is the international monetary system. The subject of the research project is functioning of the international monetary system and its evolution stages. The purpose of this research project is the analysis of its object.

    For achieving the purpose of the project it is necessary to fulfill such tasks, as:

• The analysis of the theoretical bases of the international monetary system functioning;
• The analysis of the stages of development of the international monetary system, as well as the leading organization of the modern international monetary system – International Monetary Fund (IMF).
• The research of functioning of the international monetary system's key elements;
• An overview of the international monetary system problems and prospect.

    Methods for achieving the tasks of the research project are as follows: analytical, comparative, observant, statistical and research.

    As a result of this research project modern consisting and functioning of the international monetary system and its elements through the process of its evolution must be clear. 
 
 
 
 

CHAPTER I. THE ESSENCE OF MONEY AND MONETARY SYSTEM 

1. The notion of money, its types, categories and functions

      Money is a token that is widely accepted as a medium of exchange.  The token can be tangible like a coin or note, or intangible like a bank deposit. If the token is convertible on demand into a valuable commodity like gold, the token is known as commodity money.  The exchange value of commodity money varies, but is normally greater than its value as a commodity. A precious metal coin is simply a token potentially convertible into the bullion that comprises it.

    If the tokens are intrinsically worthless and inconvertible, the government must endow them with a special status to make them viable as money.  Such tokens are known as fiat money.  Except for collector’s items, all government-issued tokens today are fiat money. 

    Fiat money is money declared by a government to be legal tender. The term derives from the Latin fiat, meaning "let it be done". Fiat money achieves value because a government demands it in payment of taxes and says it should be used within the country as a tender (offering) to pay all debts. In effect, this validates it to be used to buy and sell goods and services and mandates it to pay tax. Where fiat money is used as currency, the term fiat currency is used. Today, most national currencies, including the major reserve currencies, i.e. US dollar, euro, and pound sterling, are fiat currencies.  Fiat money is not linked to physical a reserve, which is why it risks becoming worthless due to hyperinflation. If people lose faith in a nation's paper currency, the money will no longer hold any value.

    Fiat money held by the private sector is known as the monetary base, which we will refer to as base money.  The Central bank issues base money when it buys securities from the public for its own portfolio, mainly Treasury debt.  It pays by simply creating a deposit at the Federal Reserve Bank for the seller’s own bank.  This is known as monetizing the debt.

    Banks create deposits, known as bank money, when they issue loans by simply crediting the borrower’s account with a new deposit.  The total amount of bank money increases when a bank issues a loan.  When a loan is paid off, that amount of bank money vanishes. 

    The value of bank money is based on the promise that it can be converted on demand into base money at par.  Current rules require a bank to hold reserves of base money equal to at least 10% of its transaction deposits.  Reserves can be held in any combination of vault cash and deposit at the Fed.  There is no required reserve for other bank liabilities, such as savings accounts or certificates of deposit.

    In the past, money was generally considered to have the following four main functions: a medium of exchange, a unit of account, a standard of deferred payment, and a store of value. However, most modern textbooks now list only three functions, that of medium of exchange, unit of account, and store of value, not considering a standard of deferred payment as a distinguished function, but rather subsuming it in the others. Let’s now give closer consideration to the functions of money.

    When money is used to intermediate the exchange of goods and services, it is performing a function as a medium of exchange. It thereby avoids the inefficiencies of a barter system, such as the 'double coincidence of wants' problem.

    A unit of account is a standard numerical unit of measurement of the market value of goods, services, and other transactions. Also known as a "measure" or "standard" of relative worth and deferred payment, a unit of account is a necessary prerequisite for the formulation of commercial agreements that involve debt.

    To act as a store of value, a commodity, a form of money, or financial capital must be able to be reliably saved, stored, and retrieved — and be predictably useful when it is so retrieved. Fiat currency like paper or electronic money no longer backed by gold in most countries is not considered by some economists to be a store of value.

    While standard of deferred payment is distinguished by some texts, particularly older ones, other texts subsume this under other functions. A "standard of deferred payment" is an accepted way to settle a debt – a unit in which debts are denominated, and the status of money as legal tender, in those jurisdictions which have this concept, states that it may function for the discharge of debts. When debts are denominated in money, the real value of debts may change due to inflation and deflation, and for sovereign and international debts via debasement and devaluation.

    The different types of money are typically classified as Ms. The number of Ms usually range from M0 (narrowest) to M3 (broadest) but which Ms are actually used depends on the system. The typical layout for each of the Ms is as follows:

• M0: Notes and coins (currency) in circulation and in bank vaults. In some countries, such as the United Kingdom, M0 includes bank reserves, so M0 is referred to as the monetary base, or narrow money.
• MB: Equals M0 + reserves which commercial banks hold in their accounts with the central bank (minimum reserves and excess reserves). MB is referred to as the monetary base or total currency. This is the base from which other forms of money (like checking deposits, listed below) are created and is traditionally the most liquid measure of the money supply.
• M1: M1 includes funds that are readily accessible for spending. M1 consists of currency outside Federal Reserve Banks, and the vaults of depository institutions; traveler's checks of nonbank issuers; demand deposits; and other checkable deposits (OCDs), which consist primarily of negotiable order of withdrawal (NOW) accounts at depository institutions and credit union share draft accounts. Bank reserves are not included in M1.
• M2: Equals M1 + savings deposits, time deposits less than $100,000 and money market deposit accounts for individuals. M2 represents money and "close substitutes" for money. M2 is a broader classification of money than M1. Economists use M2 when looking to quantify the amount of money in circulation and trying to explain different economic monetary conditions. M2 is a key economic indicator used to forecast inflation.
• M3: Equals M2 + large time deposits, institutional money-market funds, short-term repurchase agreements, along with other larger liquid assets. M3 is no longer published or revealed to the public by the US central bank. However, it is estimated by the web site Shadow Government Statistics.

          Fig. 1.1.  Components of US money supply (currency, M1, M2, and M3) since 1959 - 2009 

       The Federal Reserve previously published data on three monetary aggregates, but on 10 November 2005 announced that as of 23 March 2006, it would cease publication of M3. Since the Spring of 2006, the Federal Reserve only publishes data on two of these aggregates. The first, M1, is made up of types of money commonly used for payment, basically currency (M0) and checking deposits. The second, M2, includes M1 plus balances that generally are similar to transaction accounts and that, for the most part, can be converted fairly readily to M1 with little or no loss of principal. The M2 measure is thought to be held primarily by households. The third aggregate, M3 is no longer published. Prior to this discontinuation, M3 had included M2 plus certain accounts that are held by entities other than individuals and are issued by banks and thrift institutions to augment M2-type balances in meeting credit demands; it had also included balances in money market mutual funds held by institutional investors. The aggregates have had different roles in monetary policy as their reliability as guides has changed. The following details their principal components:

• M0: The total of all physical currency, plus accounts at the central bank that can be exchanged for physical currency.
• M1: The total of all physical currency part of bank reserves + the amount in demand accounts ("checking" or "current" accounts).
• M2: M1 + most savings accounts, money market accounts, retail money market mutual funds, and small denomination time deposits (certificates of deposit of under $100,000).
• M3: M2 + all other CDs (large time deposits, institutional money market mutual fund balances), deposits of Eurodollars and repurchase agreements.

      When the Federal Reserve announced in 2005 that they would cease publishing M3 statistics in March 2006, they explained that M3 did not convey any additional information about economic activity compared to M2, and thus, "has not played a role in the monetary policy process for many years." Therefore, the costs to collect M3 data outweighed the benefits the data provided. Some politicians have spoken out against the Federal Reserve's decision to cease publishing M3 statistics and have urged the U.S. Congress to take steps requiring the Federal Reserve to do so. Congressman Ron Paul claimed that "M3 is the best description of how quickly the Fed is creating new money and credit. Common sense tells us that a government central bank creating new money out of thin air depreciates the value of each dollar in circulation." Some of the data used to calculate M3 are still collected and published on a regular basis. Current alternate sources of M3 data are available from the private sector.

      As of 4 November 2009 the federal reserve reported that the U.S. dollar monetary base is $1,999,897,000,000. This is an increase of 142% in 2 years. The monetary base is only one component of money supply, however. M2, the broadest measure of money supply, has increased from approximately $7.41 trillion to $8.36 trillion from November 2007 to October 2008, the latest month-data available. This is a 2-year increase in U.S. M2 of approximately 12.9%.

    

    Fig. 1.2. The Euro money supply from 1998-2007. 

      The European Central Bank's definition of euro area monetary aggregates:

• M1: Currency in circulation + overnight deposits;
• M2: M1 + Deposits with an agreed maturity up to 2 years + Deposits redeemable at a period of notice up to 3 months;
• M3: M2 + Repurchase agreements + Money market fund (MMF) shares/units + Debt securities up to 2 years.

 

    

Fig. 1.3. Money supply of Australia 1984-2007

       The Reserve Bank of Australia defines the monetary aggregates as:

• M1: currency bank + current deposits of the private non-bank sector;
• M3: M1 + all other bank deposits of the private non-bank sector;
• Broad Money: M3 + borrowings from the private sector by NBFIs, less the latter's holdings of currency and bank deposits;
• Money Base: holdings of notes and coins by the private sector plus deposits of banks with the Reserve Bank of Australia (RBA) and other RBA liabilities to the private non-bank sector.

 
 
 
 
 
 
 
 
 
 
 
 
 

 

1.2.           Monetary system and its main features

      A monetary system is anything that is accepted as a standard of value and measure of wealth in a particular region.

      The current trend, however, is to use international trade and investment to alter the policy and legislation of individual governments. The best recent example of this policy is the European Union's creation of the euro as a common currency for many of its individual states. Modern currencies are not linked to physical commodities (silver or gold) and are not a contract to deliver a good or service. As such the value of a currency fluctuates based on politics, perception and emotion in addition to monetary policy.