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.

       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.

    Apart from monetary systems based on money, there do also exist systems based on "favors". One example of this is the LETS system. LETS, or Local Exchange Trading Systems, are local community trading groups where members exchange their goods and services with each other.

    Another definition of monetary system it is the set of mechanisms by which a government provides money (cash) in a country's economy. It usually consists of a mint, central bank, and commercial banks.

    The first modern international monetary system was the gold standard. Operating during the late 19th and early 20th cent., the gold standard provided for the free circulation between nations of gold coins of standard specification. Under the system, gold was the only standard of value.

    The advantages of the system lay in its stabilizing influence. A nation that exported more than it imported would receive gold in payment of the balance; such an influx of gold raised prices, and thus lowered the value of the domestic currency. Higher prices resulted in decreasing the demand for exports, an outflow of gold to pay for the now relatively cheap imports, and a return to the original price level.

    A major defect in such a system was its inherent lack of liquidity; the world's supply of money would necessarily be limited by the world's supply of gold. Moreover, any unusual increase in the supply of gold, such as the discovery of a rich lode, would cause prices to rise abruptly. For these reasons and others, the international gold standard broke down in 1914.

    During the 1920s the gold standard was replaced by the gold bullion standard, under which nations no longer minted gold coins but backed their currencies with gold bullion and agreed to buy and sell the bullion at a fixed price. This system, too, was abandoned in the 1930s.

    In the decades following World War II, international trade was conducted according to the gold-exchange standard. Under such a system, nations fix the value of their currencies not with respect to gold, but to some foreign currency, which is in turn fixed to and redeemable in gold. Most nations fixed their currencies to the U.S. dollar and retained dollar reserves in the United States, which was known as the "key currency" country. At the Bretton Woods international conference in 1944, a system of fixed exchange rates was adopted, and the International Monetary Fund (IMF) was created with the task of maintaining stable exchange rates on a global level.

    During the 1960s, as U.S. commitments abroad drew gold reserves from the nation, confidence in the dollar weakened, leading some dollar-holding countries and speculators to seek exchange of their dollars for gold. A severe drain on U.S. gold reserves developed and, in order to correct the situation, the so-called two-tier system was created in 1968. In the official tier, consisting of central bank gold traders, the value of gold was set at $35 an ounce, and gold payments to noncentral bankers were prohibited. In the free-market tier, consisting of all nongovernmental gold traders, gold was completely demonetized, with its price set by supply and demand. Gold and the U.S. dollar remained the major reserve assets for the world's central banks, although Special Drawing Rights were created in the late 1960s as a new reserve currency. Despite such measures, the drain on U.S. gold reserves continued into the 1970s, and in 1971 the United States was forced to abandon gold convertibility, leaving the world without a single, unified international monetary system.

    Widespread inflation after the United States abandoned gold convertibility forced the IMF to agree (1976) on a system of floating exchange rates, by which the gold standard became obsolete and the values of various currencies were to be determined by the market. In the late 20th cent., the Japanese yen and the German Deutschmark strengthened and became increasingly important in international financial markets, while the U.S. dollar—although still the most important national currency—weakened with respect to them and diminished in importance. The euro was introduced in financial markets in 1999 as replacement for the currencies (including the Deutschmark) of 11 countries belonging to the European Union (EU); it began circulating in 2002 in 12 EU nations (see European Monetary System ). The euro replaced the European Currency Unit, which had become the second most commonly used currency after the dollar in the primary international bond market. Many large companies use the euro rather than the dollar in bond trading, with the goal of receiving a better exchange rate.

    Lets now consider modern global monetary system. The global financial system (GFS) is a financial system consisting of institutions and regulators that act on the international level, as opposed to those that act on a national or regional level. The main players are the global institutions, such as International Monetary Fund and Bank for International Settlements, national agencies and government departments, e.g., central banks and finance ministries, and private institutions acting on the global scale, e.g., banks and hedge funds. Deficiencies and reform of the GFS have been hotly discussed in recent years.

    The history of financial institutions must be differentiated from economic history and history of money. In Europe, it may have started with the first commodity exchange, the Bruges Bourse in 1309 and the first financiers and banks in the 1400–1600s in central and western Europe. The first global financiers - the Fuggers (1487) in Germany; the first stock company in England (Russia Company 1553); the first foreign exchange market (The Royal Exchange 1566, England); the first stock exchange (the Amsterdam Stock Exchange 1602).

    Milestones in the history of financial institutions are the Gold Standard (1871–1932), the founding of International Monetary Fund (IMF), World Bank at Bretton Woods, and the abolishment of fixed exchange rates in 1973.

    The most prominent international institutions are the IMF and the World Bank:

• The International Monetary Fund keeps account of international balance of payments accounts of member states. The IMF acts as a lender of last resort for members in financial distress, e.g., currency crisis, problems meeting balance of payment when in deficit and debt default. Membership is based on quotas, or the amount of money a country provides to the fund relative to the size of its role in the international trading system.
• The World Bank aims to provide funding, take up credit risk or offer favorable terms to development projects mostly in developing countries that couldn't be obtained by the private sector. The other multilateral development banks and other international financial institutions also play specific regional or functional roles.

3. .          Monetary policy and Central banks

    Monetary policy is the process by which the government, central bank, or monetary authority of a country controls the supply of money, availability of money, and cost of money or rate of interest, in order to attain a set of objectives oriented towards the growth and stability of the economy. Monetary theory provides insight into how to craft optimal monetary policy.

    Monetary policy is primarily associated with interest rate and credit. For many centuries there were only two forms of monetary policy: Decisions about coinage; Decisions to print paper money to create credit. Interest rates, while now thought of as part of monetary authority, were not generally coordinated with the other forms of monetary policy during this time. Monetary policy was seen as an executive decision, and was generally in the hands of the authority with seignior age, or the power to coin. With the advent of larger trading networks came the ability to set the price between gold and silver, and the price of the local currency to foreign currencies. This official price could be enforced by law, even if it varied from the market price.

    Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at which money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment. Where currency is under a monopoly of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and thus influence the interest rate (in order to achieve policy goals). The beginning of monetary policy as such comes from the late 19th century, where it was used to maintain the gold standard. A policy is referred to as contractionary if it reduces the size of the money supply or raises the interest rate. An expansionary policy increases the size of the money supply, or decreases the interest rate. Furthermore, monetary policies are described as follows: accommodative, if the interest rate set by the central monetary authority is intended to create economic growth; neutral, if it is intended neither to create growth nor combat inflation; or tight if intended to reduce inflation.

    A policy is referred to as contraction if it reduces the size of the money supply or raises the interest rate. An expansionary policy increases the size of the money supply, or decreases the interest rate. Furthermore, monetary policies are described as follows: accommodative, if the interest rate set by the central monetary authority is intended to create economic growth; neutral, if it is intended neither to create growth nor combat inflation; or tight if intended to reduce inflation.

    There are several monetary policy tools available to achieve these ends: increasing interest rates by fiat; reducing the monetary base; and increasing reserve requirements. All have the effect of contracting the money supply; and, if reversed, expand the money supply. Since the 1970s, monetary policy has generally been formed separately from fiscal policy. Even prior to the 1970s, the Bretton Woods system still ensured that most nations would form the two policies separately.

    The primary tool of monetary policy is open market operations. This entails managing the quantity of money in circulation through the buying and selling of various credit instruments, foreign currencies or commodities. All of these purchases or sales result in more or less base currency entering or leaving market circulation.

    Constant market transactions by the monetary authority modify the supply of currency and this impacts other market variables such as short term interest rates and the exchange rate.

    The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century. The Bretton Woods system was the first example of a fully negotiated monetary order intended to govern monetary relations among independent nation-states.

    Preparing to rebuild the international economic system as World War II was still raging, 730 delegates from all 44 Allied nations gathered at the Mount Washington Hotel in Bretton Woods, New Hampshire, United States, for the United Nations Monetary and Financial Conference. The delegates deliberated upon and signed the Bretton Woods Agreements during the first three weeks of July 1944.

    The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value—plus or minus one percent—in terms of gold and the ability of the IMF to bridge temporary imbalances of payments. In the face of increasing financial strain, the system collapsed in 1971, after the United States unilaterally terminated convertibility of the dollars to gold. This action caused considerable financial stress in the world economy and created the unique situation whereby the United States dollar became the "reserve currency" for the states which had signed the agreement. 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

      CHAPTER II. MONETARY SYSTEM OF UKRAINE AND OTHER COUNTRIES 

1. History of Ukrainian monetary system and its nature

      Formation of the strong state in Rus has begun since X century, but origin of coins has occurred much earlier.

      At a certain stage of economic development the role of money performed cattle. In other time the role of money was carried out by the fur of a marten also repeatedly mentioned in “Russian Truth”.

      Coin stamping in the Kiev Rus has begun earlier, than in many European states. There are incontestable proofs of stamping of a coin in X-XI centuries in Russia - Vladimir Monomah's (1078-1125) silver coins, the Kiev grivna (it is powerful 140-160), etc. Coins in Ancient Rus were much larger, than in the Western Europe those times. The integrated coin in weight to 3 grammes above was minted for hundreds years earlier, than in Europe. The coin of the Kiev period, especially gold, is is technically better executed, rather than the West European medieval coin. And, it is necessary to notice, that gold stamping has begun even earlier, than in France. However the coin was minted in the limited quantity and a share гривен and an overseas coin in circulation was more. Own mass coin in Russia has appeared later.

      In the middle of XVII century the financial condition of Russia under the influence of numerous wars was very heavy. Foreign trade was the major source of reception of profit. Obtained during it on thalers - foreign silver coins - Russian overprint became. Thalers were different tests and weight. It very much complicated calculations, especially with foreign dealers.

      In the conditions of war with Poland the government issues copper money with a compulsory course which have very quickly superseded silver from the reference. But copper money was easily forged, and, having depreciated, they have caused Copper revolt of 1662 after which copper money has been redeemed under the price "for rouble of copper money two silver money".

         The early Marxists expected that money would die away under socialism, made unnecessary by the abolition of markets, the use of central planning based on non-monetary units, the replacement of scarcity by abundance, and the worldwide acceptance of socialism. Since none of this came to pass, a monetary system remained, but it was a very peculiar monetary system. In contrast to a market economy, where money-based exchange is fundamental and money plays an active role, under central management money adapts itself to planned production flows and is basically passive.

      In a market economy, money has three functions (means of exchange, a measure of value, and a store of value). A whole set of institutions supports these functions. In the Soviet economy, the ruble fulfilled these functions only in a limited way. The set of monetary institutions was similarly restricted.

      Money circulation was strictly divided into two spheres. In the state sector, enterprises could legally use only noncash money, in practice transfers through a state-owned banking system. Only transfers sanctioned by a corresponding plan assignment could be legally made, and it was generally impossible to use the banking system for nonsanctioned transactions. The banking system was thus an important control mechanism. Households, on the other hand, lived in a cash economy facing mostly fixed-price markets for labor and consumer goods. There were also legal, more or less free-priced markets such as the kolkhoz markets for foodstuffs as well as illegal, often cash-based markets. To control the economy, Soviet planners put great emphasis on maintaining this duality. By and large, they succeeded. Under perestroika, enterprises found ways to convert noncash to cash money. This contributed to the collapse of the Soviet system.