Money and Banking

Money and Banking

🟢 Lite — Quick Review

Rapid summary for last-minute revision.

Money is any generally accepted medium of exchange used to settle debts. It performs four roles: medium of exchange, unit of account, store of value, and standard of deferred payments. Good money must be durable, portable, divisible, homogeneous, scarce, and acceptable. The Ghana cedi (GH¢) is Ghana’s legal tender, issued by the Bank of Ghana (BoG). The quantity theory is captured by Fisher’s equation MV = PT, where M = money supply, V = velocity, P = price level, T = transactions; a rise in M with V and T constant raises P (inflation). Commercial banks create deposits through the deposit multiplier = 1 / cash reserve ratio. Monetary policy by the BoG targets inflation through the policy rate, cash reserve ratio (CRR), and open market operations (OMO). WASSCE loves (i) functions/qualities of money, (ii) Fisher vs Cambridge, (iii) credit creation arithmetic, (iv) BoG instruments.

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🟡 Standard — Regular Study

Standard content for students with a few days to months.

Definition and Qualities of Money

Money is any commodity or token generally accepted in payment for goods, services, and the settlement of debts. In Ghana, the Bank of Ghana Act 2002 (Act 612) vests the power to issue the cedi and pesewa coins in the Bank of Ghana (BoG). Qualities of good money include: durability (resists wear), portability (easy to carry), divisibility (subdivided without losing value), homogeneity (identical units), stability of value (low inflation erosion), acceptability (legal-tender status), and scarcity (controls its purchasing power).

Functions of Money

1. Medium of exchange — replaces barter, eliminating the double coincidence of wants.
2. Unit of account — prices are quoted in cedi; e.g. GH¢50 per bag of rice.
3. Store of value — wealth is held in money for future use (weakened by inflation).
4. Standard of deferred payment — debts and loans (e.g. mortgages) are denominated in money.

Demand for and Supply of Money

Money is demanded for transactions (daily purchases), precaution (emergencies), and speculation (asset purchases). Supply is measured in tiers: M1 = currency outside banks + demand (cheque) deposits; M2 = M1 + savings and time deposits; M3 = M2 + near-money assets. The monetary base (high-powered money) = currency in circulation + commercial bank reserves at BoG.

The Quantity Theory of Money

Fisher’s transaction equation: MV = PT → P = MV / T. Assuming V and T are constant in the short run, changes in M cause proportional changes in P. The Cambridge equation M = kPY restates the same relationship: k is the fraction of nominal income (PY) held as money. A rise in M without a corresponding rise in Y causes inflation, reducing the purchasing power of money = 1 / P.

Commercial Banks and Credit Creation

Commercial banks accept deposits and grant loans. Required reserves are held at the BoG; the deposit multiplier = 1 / required reserve ratio. Maximum new deposits created from an initial deposit D equal D × (1 / r). Example: with r = 10 % and an initial deposit of GH¢1,000, total deposits expand to GH¢10,000, with GH¢9,000 being new credit.

The Central Bank (Bank of Ghana)

The BoG controls the money supply through monetary policy tools:

Instrument	How it works
Policy (Bank) rate	Benchmark rate; raising it cools lending
Cash Reserve Ratio (CRR)	% of deposits kept at BoG; raising it shrinks loanable funds
Open Market Operations (OMO)	BoG sells securities → mops up cedi; buys → injects cedi
Discount window / moral suasion	Direct influence on universal banks

Since 2007, BoG has operated an inflation-targeting framework aiming at 8 ± 2 % CPI inflation.

WASSCE Question Patterns

Expect: (a) distinguishing M1, M2, M3; (b) solving MV = PT for any one variable given the other three; (c) calculating deposit expansion from a given CRR; (d) explaining two BoG instruments and their effects on inflation and the cedi exchange rate.

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🔴 Extended — Deep Study

Comprehensive coverage for students on a longer study timeline.

Extended Credit-Creation Mechanism

Total deposits generated = Initial deposit / r. The multiplier assumes (i) no currency leakage from banks, (ii) banks lend out all excess reserves, and (iii) borrowers redeposit funds. The realistic money multiplier is (1 + c) / (r + e + c), where c = currency–deposit ratio, e = excess-reserve ratio, r = required reserve ratio. If c = 0.2, e = 0.05, r = 0.10, then m = 1.2 / 0.35 ≈ 3.43, so GH¢100m new base money creates about GH¢343m in broad money — explaining why BoG watches reserve behaviour closely.

Inflation Targeting and the Cedi

Under inflation targeting, BoG raises the policy rate when forecast inflation exceeds the 8 % target, raising commercial-bank lending rates, cooling aggregate demand, and stabilising the cedi. The real interest rate ≈ nominal rate − inflation; the BoG must keep this positive to protect savers. Persistent cedi depreciation against the US dollar feeds imported inflation, especially for fuel and rice.

Banking Structure in Ghana

Universal banks (e.g. GCB, Ecobank, CalBank) operate nationwide; Rural and Community Banks (RCBs) (~140) serve rural deposits under the ARB Apex Bank; microfinance institutions serve micro-depositors and small borrowers; mobile-money operators (MTN MoMo, Vodafone Cash, AirtelTigo Money) hold e-money float regulated under BoG Electronic Money Issuers Guidelines (2015). RCBs and MFIs must hold a minimum capital adequacy ratio of 10 % under BoG’s risk-weighted framework.

Adjacent Topics and Pitfalls

This topic links directly to inflation, balance of payments, exchange rates, and fiscal policy. Common WASSCE traps: confusing money with wealth or income; treating near money (treasury bills, savings bonds) as M1; stating that BoG lends directly to the public — it lends only to banks at the discount window. Students also misread MV = PT as a definition rather than a causal identity; under the classical view, M drives P.

Worked Mini-Example

Suppose M = GH¢200bn, V = 4, T = 800bn transactions. Then P = (200 × 4) / 800 = GH¢1 per transaction unit. If BoG raises M to GH¢250bn, new P = 1.25 → inflation = 25 % and purchasing power of money falls from 1.00 to 0.80 (a 20 % drop).

Practice Prompts

1. If required reserves are 12.5 % and GH¢8,000 is deposited with a commercial bank, calculate the maximum total deposits that can be created and the amount of new credit.
2. With reference to Ghana, explain how a rise in the Bank of Ghana policy rate will affect (a) commercial-bank lending, (b) inflation, and (c) the cedi–dollar exchange rate.

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