Money and banking — common mistakes

In exams, do not just list the four functions of money. You must be able to explain how each function overcomes a specific problem associated with a barter economy. For example, the medium of exchange function solves the problem of the double coincidence of wants.

When explaining credit creation, be clear that it is bank deposits (a component of the broad money supply) that are being created, not physical cash. Also, remember that the money multiplier represents the maximum possible expansion; in reality, the effect is smaller as some cash may not be re-deposited and banks may not lend out all excess reserves.

No, they cannot. Credit creation is limited by several factors. The most important is the liquidity ratio (or reserve requirement), which forces banks to hold a certain percentage of deposits as liquid assets. Other limitations include the demand for loans from creditworthy borrowers, the willingness of banks to lend, and the central bank's monetary policy actions, such as changing the policy interest rate to influence the cost of borrowing.

Strictly speaking, a credit card is not money. It is a tool for accessing a pre-approved, short-term loan from the bank that issued the card. The actual 'money' is the bank deposit that is electronically transferred to the seller's account to settle the transaction. Therefore, a credit card is a means of payment that relies on deferring the use of actual money (bank deposits), which functions as the medium of exchange.

No, the central bank acts as the government's banker but does not control it. In most developed economies, the central bank has operational independence from the government, particularly in setting monetary policy. This independence is designed to prevent short-term political pressures from influencing decisions about interest rates, thereby helping to maintain long-term price stability. The central bank advises the government, but fiscal policy (taxation and government spending) remains under the government's control.