UNIVERSITY OF NAIROBI

COLLEGE OF ARCHITECTURE AND

ENGINEERING

SCHOOL OF THE BUILT ENVIRONMENT

DEPARTMENT OF REAL ESTATE AND

CONSTRUCTION MANAGEMENT

BACHELOR OF QUANTITY SURVEYING

COURSE CONVENOR- MR.NGOLUA

GROUP 11: MONEY SUPPLY

BQS307: CONSTRUCTION ECONOMIS I

DATE DUE: 14TH OCTOBER, 2019
GROUP 11.GROUP MEMBERS
NUMBER NAME REG.NUMBER
1. WEPUKHULU BACKSTON OCHIENG B66/81087/2017
2. NURA QABALE B66/81069/2017
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3. ODHIAMBO GABRIEL ODIWUOR B66/81086/2017
4. EDITH KANANA B66/81073/2017
5. GIDEON SAMWEL NACHAMI B66/81077/2017
6. MAINA DORAS WANJIKU B66/85346/2017
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Contents
GROUP 11: MONEY SUPPLY.........................................................................................................................4
Introduction............................................................................................................................................4
Definition of money;..............................................................................................................................4
THE VALUE OF MONEY................................................................................................................................6
Factors that determine value of money.............................................................................................6
CREDIT CREATION........................................................................................................................................8
Basic Concepts of Credit Creation.....................................................................................................9
THE NEED FOR MONETARY CONTROL.......................................................................................................12
Objectives of the monetary policy;....................................................................................................14
INSTRUMENTS OF MONETARY CONTROL..................................................................................................17
EFFECTS OF MONETARY POLICY IN THE CONSTRUCTION SECTOR.............................................................19
CASE STUDY...............................................................................................................................................21
Money supply and real estate pricing in Kenya..............................................................................21
REFERENCES..............................................................................................................................................23

GROUP 11: MONEY SUPPLY

Introduction
Money supply implies to the amount of money in circulation in the economy which
influences either directly or indirectly the construction sector hence its relevance .

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Definition of money;
Money is a liquid asset whose liquidity characteristic enables it to be converted to other
assetswithout delay or loss of value.

It is the most liquid form of an asset and represents an individual’s purchasing power.

Purchasing power represents the person’s entitlement to make a claim for a share of
the goods and services available in the economy.

Money is mostly defined in terms of what it can buy which includes the following ;

1. Acts as a medium of exchange –enables individuals to conduct their affairs by

offering goods, services and labor in return of money .
2. It is used as a unit of account –used to compare the relative costs and prices
of components, service, goods and wealth.
3. May be accumulated by saving to form a store wealth provided inflation does
not reduce its purchasing power over time.
4. Used as a standard of deferred payment in which one can make payments in
later dates.

Characteristics of money

1. Must be acceptable
2. Must be recognizable
3. Should be divisible to enable sellers in turn to distribute their income into
smaller transactions.
4. Should have a stable value to reassure those people who accept payment
that they will be able to purchase the same amount of goods and services
the sold.
5. Portability for convenience
6. Durability to enable individuals to save or delay purchases.

For the building and property sector, durability and stability are of more essence since
they enable money to be used to finance construction and housing and then spread the
repayments over several years.

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Types of money

1. Fiat money –money established by government decree and normally has

no intrinsic value
2. Commodity money –commodity with some intrinsic money i.e. gold

Forms of money based on the liquidity

Money takes the following forms based on the liquidity:

On the monetary aggregates, there is narrow money and broad money

M1 –Currency plus demand deposits, traveler’scheques, and other checkable deposits

(narrow money)

This is the cash at hand or in demand deposits which can easily be used in transaction.

M2- M1 plus retail money market mutual fund balances saving deposits (including
money market deposit accounts
0and small deposits

This is the money which cannot be used in transaction as quickly as M1 ,it takes some
time before someone uses it .

M3, Extended Broad Money, comprises M2 and foreign currency holdings by

residents,market funds which take more than 24 hour to mature .

Economic survey of 2016 page 61 extract

The annual growth rates of money supply and private sector credit were consistent with
the developments in the financial sector, especially following the enforcement of the
Banking (Amendment) Act 2016. Money supply (M1) expanded by 6.7 per cent in
December 2017. The extended broad money supply (M3) grew by 8.9 per cent to KSh.
3,010.9 billion in December 2017. Credit to the private sector expanded by 2.4 per cent

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in 2017, compared to 4.1 per cent in 2016. Total domestic credit grew by 7.9 per cent to
3,252.2 billion in 2017.

THE VALUE OF MONEY.

1. The value of money is the quantity of goods in general that will be exchanged for
one unit of money.
2. The value of money is its purchasing power, that is, quantity of goods and
services it can purchase.
3. It is the utility derived from every purchase or every sum of money spent.
4. Value for money is based not only on the minimum purchase price (economy) but
also on the maximum efficiency and effectiveness of the purchase.

Factors that determine value of money.

The following are some of the factors that determine value of money.

1. Price levels.

What money can buy depends on the level of prices.

Money depreciates when the price level rises; meaning a unit of money can purchase
less goods than before.

Money appreciates when the price level falls; meaning a unit of money can purchase
more goods than before.

Therefore, when prices rise the value of money falls and when prices fall the value of
money rises.

Value of money and the general price level are inversely proportion.

Value of money = amount of money / price level.

A relationship of general money supply and price level equation is ;

Value of Rs 1 = 1/p.

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A graph illustrating the relationship of the money supply and the general price
levels

Source;Macroeconomic by Gregory Mankiw

Explanation

In the above figure, the convex curve shows the relationship between value of money
and general price level. It is downwardly sloped which shows that value of Rs1
decreases with every increase in price level.

The value of Rs 1(value of money) is the inverse of general price level.

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 2. Basic rule of supply and demand.

The more demand for a given currency or item, the more the worth especially when
demand exceeds supply. Therefore, the more the demand the more the value of the
money.

An increase in money supply results in decrease in the value of money. This is because
money is like any other commodity: increase in its supply decrease marginal value (the
buying capacity of one unit of currency). So, an increase in money supply causes prices
to rise as they compensate for decrease in money marginal value and rise in price
lowers the value of money.

3. Exchange rates.

This is the value of one currency for the purpose of exchange.

For instance, when a foreign currency is used to determine to be worth a specific

amount of Kenyan shillings, to use for example, 1 Kenyan shilling equals 35.7 Ugandan
shilling.

The value of Kenyan money, then, is much greater than that of the Ugandan currency.

Examples of other exchange rates:

1 Ethiopian Birr = 3.51 Kenyan shilling.

1 Kenyan shilling = 22.16 Tanzanian shilling.

1 Kenyan shilling = 8.92 Rwanda Francs.

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CREDIT CREATION
The central bank is the main source of money supply in an economy. It ensures
issuance of currency so as to facilitate economic activities such as production and
distribution. However to do this the central bank also depends on the reserves of
commercial banks which are the secondary source of money supply.

Money supplied by this commercial banks is the credit money which is created by
advancing loans and purchasing securities.

Basic Concepts of Credit Creation

I. Bank deposits
There are two types of bank deposits which form the basis of credit creation.
They include;

a) Primary deposits
This is where the bank accepts cash from a customer and opens a deposit
account in his or her name. The deposits form the basis of credit creation

b) Secondary deposits/ Derivative deposits

This refers to were a bank grants loans and advances to a borrower and
instead of giving cash to the borrower the bank opens a deposit account in
his or her name. This creation of secondary deposit means creation of
credit.

II. Cash reserve ratio

Banks know that depositors will not withdraw all their deposits at the same time
therefore they keep a fraction of the total deposits to meet the cash demand for
depositors and lend the remaining excess deposits.

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 Therefore Cash reserve ratio is the percentage of the total deposits which the
banks must hold in cash reserves to meet depositors demand for cash.

Aspects of Credit Creation

There are two main aspects of credit creation;

i. Liquidity
Liquidity is one of the important financial stability indicators as it depicts
ability of the bank to meet obligations when they fall due.
The bank should be able to pay cash to its depositors when they exercise
the right to demand cash against their deposits.

ii. Profitability
Banks are profit driven enterprises therefore a bank must grant loans in a
manner in which earns higher interest rate than the interest rate that the
bank gives to depositors for the money they have deposited in their
accounts.

A decrease in interest rate on loans decreases the bank’s profitability as

was the case in Kenya where the banking sector registered a decrease in
profitability in December 2017 by 9.6% to 133.2 billion from 147.4 billion in
December 2016. The decrease in profitability was attributed to a decline in
interest on advances.

Methods of credit creation

There are two main ways of credit creation;

i. Advancing loans
Since bankers know that not all the depositors will withdraw all their
deposits at the same time they advance some of the deposits to a
borrower of a loan.

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 The bank opens an account for him and credits the account of the
borrower. The borrower then draws cheques on the bank while making
purchases. Those who receive the cheques deposit them with the bank
in their account, creating deposits which are then used for credit
creation.

ii. Purchasing securities

The bank can also create deposits by purchasing securities. The bank
buys securities by buying real assets and by doing so the bank does not
pay the sellers in cash rather it credits the amount of the price of those
securities to the accounts of the sellers therefore creating deposit with it.
This deposits form the basis of credit creation

Factors Affecting Credit Creation

i. Availability of cash

Capacity to create credit depend on availability of cash deposits with the banks.
When customer make more deposits, the excess deposits are used in credit
creation by giving loans to borrowers however the amount held by this
commercial banks is controlled by the central bank.

ii. Cash reserve ratio

This is the percentage of total deposits which the bank must hold in cash
reserves (in their accounts with central bank) to meet the depositors demand for
cash. When the ratio falls the credit creation would be more and vice versa.

iii. Excess reserves

This takes place when the economy is moving towards a recession. In such
case the banks may decide to maintain their reserves instead of utilizing
funds for lending. Therefore in such situations credit created by commercial
banks would be small as a large amount of cash is reserved.

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 Availability of borrowers. Credit is created by advancing loans to a
borrower. There will be no credit created if there are no borrowers.

iv. Availability of securities.

For a bank to grant loans availability of securities is important. Credit
creation will not occur if there are no securities.

v. Economy
Credit creation is influenced by nature of the economy. When the
economy is in the phase of depression there is less borrowing of money
as businessmen do not prefer to invest in new projects hence reducing
credit creation as there is less borrowing.

THE NEED FOR MONETARY CONTROL

The quantity of money available in an economy is called the money supply. In a system
of commodity money, the money supply is simply the quantity of that commodity. In an
economy that uses fiat money (currency without intrinsic value that has been
established as money, often by government regulation), such as most economies today,
the government controls the supply of money.
“Monetary policy involves the influence on the level and composition of aggregate
demand by the manipulation of interest rates and the availability of credit”-D.C. Aston.

Monetary policy implies those measures designed to ensure an efficient operation of the
economic system or set of specific objectives through its influence on the supply, cost
and availability of money.

The concept of monetary policy has been defined in a different manner according to
different economists;

1. R.P. Kent has defined the monetary policy as “The management of the expansion
and contraction of the volume of money in circulation for the explicit purpose of attaining
a specific objective such as full employment.”

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2. Dr.D.C. Rowan remarked, “The monetary policy is defined as discretionary action
undertaken by the authorities designed to influence:

(a) The supply of money,

(b) Cost of Money or rate of interest and

(c) The availability of money.”

3. According to Prof. Crothers, “Monetary Policy consists of the steps taken or efforts
made to reduce to a minimum the disadvantages that flow from the existence and
operation of the monetary system. It is a policy to regulate the flow of monetary
resources in the economy to attain certain specific objectives.”x

4. D.C. Aston has defined: “Monetary policy involves the influence on the level and
composition of aggregate demand by the manipulation of interest rates and the
availability of credit.”

5. According to G.K. Shaw; “By monetary policy we mean any conscious action
undertaken by the monetary authorities to change the quantity, availability or cost (rate
of interest) of money. A broader definition might also take into account action
designated to influence the composition and the age profile of the national debt, as for
example, open market operations geared to purchase the short term securities and seal
of long term bonds.”

Objectives of the monetary policy;

The monetary policy in developed economies has to serve the function of stabilization
and maintaining proper equilibrium in the economic system. But in case of
underdeveloped countries e.g. Burundi, the monetary policy has to be more dynamic so
as to meet the requirements of an expanding economy by creating suitable conditions
for economic progress.

As the objective of monetary policy varies from country to country and from time
to time, a brief description of the same has been as following:

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(I) Neutrality of money

(ii) Stability of exchange rates

(iii) Price stability

(iv)Full Employment

(v) Economic Growth

(vi)Equilibrium in the Balance of Payments.

1. Neutrality of Money:
Neutral monetary policy also called “natural” or “equilibrium” rate is the federal funds
rate that neither stimulates nor restrains economic growth.
Any monetary change is the root cause of all economic fluctuations. According to
neutralists, the monetary change causes distortion and disturbances in the proper
operation of the economic system of the country.
They are of the confirmed view that if somehow neutral monetary policy is followed,
there will be no cyclical fluctuations, no trade cycle, no inflation and no deflation in the
economy. Under this system, money is kept stable by the monetary authority. Thus the
main aim of the monetary authority is not to deviate from the neutrality of money. It
means that quantity of money should be perfectly stable. It is not expected to influence
or discourage consumption and production in the economy.

2. Price Stability:
The objective of price stability has been highlighted during the twenties and thirties of
the present centuries. In fact, economists like Crustar Cassels and Keynes suggested
price stabilization as a main objective of monetary policy.

It promotes business activity and ensures equitable distribution of income and wealth.
As a consequence, there is general wave of prosperity and welfare in the community.
Price stability also impedes economic progress as there is no incentive left with the
business community to increase production of qualitative goods.
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It discourages exports and encourages imports. But it is admitted that price stability
does not mean ‘price rigidity’ or price stagnation’. A mild increase in the price level
provides a tonic for economic growth. It keeps all virtues of a stable price.

3. Full Employment:

Keynes equation of income, Y = C + I throws light as to how full employment can be

secured with monetary policy. He argues that to increase income, output and
employment, it is necessary to increase consumption expenditure and investment
expenditure simultaneously. This indirectly solves the problem of unemployment in the
economy. Since the consumption function is more or less stable in the short period, the
monetary policy should aim at raising investment expenditure.

As monetary policy is the government policy regarding currency and credit, in this way,
government measures of currency and credit can easily overcome the problem of trade
fluctuations in the economy. On the other side, when the economy is facing the problem
of depression and unemployment, private investment can be stimulated by adopting
‘cheap money policy’ by the monetary authority.

Therefore, this policy will serve as an effective and ideal stimulant to private investment
as there is pessimism all rounds in the economy. Further, the objective of full-
employment must be integrated with other objectives, like price and exchange
stabilization.

The advanced countries like U.S.A. and U.K. are normally working at full employment
level as their main concern is how to maintain full employment and avoid fluctuations in
the level of employment and production. While, on the contrary, the main problem in
underdeveloped country is as to how to achieve full employment.

Therefore, in such economies, monetary policy can be designed to meet with the
problem of under employment and disguised unemployment and by further creating new
opportunities for employment. The most suitable and favorable monetary policy should

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be followed to promote full-employment through increased investment, which in turn
having multiplier and acceleration effects.

After achieving the objective of full-employment, monetary policy should aim at

exchange and price stability. In short, the policy of full employment has the far-reaching
beneficial effects.

4. Economic Growth:
Prof. Meier defined “Economic growth as the process whereby the real per capita
income of a country increases over a long period of time.” It implies an increase in the
total physical or real output, production of goods for the satisfaction of human wants.
In other words, it means utilization of all the productive natural, human and capital
resources in such a manner as to ensure a sustained increase in national and per
capita income over time.

Therefore, monetary policy promotes sustained and continuous economic growth by

maintaining equilibrium between the total demand for money and total production
capacity and further creating favorable conditions for saving and investment. For
bringing equality between demand and supply, flexible monetary policy is the best
course.

5. Equilibrium in the Balance of Payments:

Equilibrium in the balance of payments is another objective of monetary policy. A fiscal
policy of restraint will generally cause both the government and consumers to slow its
spending. A general decrease in overall spending can cause the cash flow leaving the
country to decrease as consumers and the government both purchase less and vice
versa

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INSTRUMENTS OF MONETARY CONTROL
These instruments are applied by the Central Bank in order to control the quantity of
money in circulation in the economy.

There are three main instruments used:

a) Open Market Operations.

b) Discount Rate.
c) Reserve Requirement.

These instruments help to sustain a healthy economic growth in a country.

a) Open Market Operations.

Here the Central Bank either buys or sells government securities like treasury bills
and bonds to the public.

Expansionary monetary policy- the Central Bank buys the securities from the public
thus supplying money to the economy hence this move increases the quantity of
money in circulation in the economy.

Contractionary monetary policy- the Central Bank sells the securities to the public
thus reducing the quantity of money in circulation in the economy

b) Discount Rate.

Discount rate refers to the interest rate at which the Central Bank charges when it
gives loans to the commercial banks.

Commercial banks borrow from the Central Bank when they find themselves with too
few reserves to meet the reserve requirement.

Expansionary monetary policy- when the Central Bank imposes a lower discount
rate, the reserves shall be cheaper to borrow thus more banks shall borrow from the

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 Central Bank’s discount window hence more money shall be in circulation in the
economy.

Contractionary monetary policy- when the Central Bank imposes a higher discount
rate, the reserves shall be expensive to borrow thus less banks shall borrow hence
reducing he quantity of money in circulation in the economy.

c) Reserve Requirement.

This is where the Central Bank regulates the commercial banks’ minimum reserve-
deposit ratio requirement.

Expansionary monetary policy- the Central Bank allows a low reserve requirement
thus allowing banks to lend more of their deposits hence increasing the quantity of
money in circulation in the economy.

Contractionary monetary policy- the Central Bank allows a high reserve requirement
thus the commercial banks have less money to lend to their customers hence
reducing the quantity of money in circulation in the economy.

MONETARY POLICY AND CONSTRUCTION INDUSTRY

The central bank functions to regulate the flow of money within the country with an aim
of maintaining price stability which would result to low and stable inflation hence a
stable economy. In order to achieve this, the central bank applies tools such as the
Open Market operations (OMO) which involves purchase and sale of eligible securities
such us bonds and treasury bills from the public and to the public respectively.
Moreover, it makes use of the Central Bank Rate that requires commercial banks to
keep a specified proportion of their total deposits at the Central bank cash reserve
ration of the total banks domestic and foreign deposit liabilities. A reduction in CBR
signals an easing of monetary policy and a desire for market interest rates to move
downwards.

Furthermore, the central bank controls the interest rates at which commercial banks
borrow money. Lower interest rates increase the amount of money at the commercial

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banks disposal that encourages them to lower the interest rate on loans to the public.
This encourages borrowing hence increase in money supply.

The above tools either result to an increase or decrease in money supply in the
economy which affects the construction industry investments.

EFFECTS OF MONETARY POLICY IN THE CONSTRUCTION

SECTOR
1. Changes on real estate market liquidity

Liquidity describes the degree to which an asset can be quickly bought or sold in the
market at a price reflecting its intrinsic value. This describes its ease of being
converted to cash. Market liquidity, therefore, is the extent to which a market e.g. a
town’s real estate market allows assets to be bought and sold at stable and
transparent prices.

An increase in money supply in an economy, increases money at the consumers or

real estate disposal. This increases the demand for houses making the consumers
more willing and able to lease or buy houses. On the other hand, the investors in the
real estate will make more sales easily hence increase in liquidity of their assets.

An action by the central bank to reduce money supply in the economy decreases the
amount available for people to consume. This would mean less demand for houses.
Investors would therefore have to wait longer to make sales. This makes their assets
more illiquid hence less profits.

2. Low construction business activities.

The central bank may increase CBR or raise the interest rates for the commercial
banks. The banks will then be forced to increase interest on loans. Investors will
find it expensive to borrow loans from banks and this would mean little or no

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 capital availability for investments. Investment on real estate therefore goes
down lowering the business.
Moreover, the little available houses become less affordable to consumers who
then seek alternatives like settling in slums where housing is affordable.

3. Affects availability and cost of financing projects

One of the roles of monetary policy is to regulate inflation which is the gradual
rise in general price levels. Most financiers would desire a positive return on
investment. A decrease in money supply means less sales hence decrease in
returns on investment. This discourages investors from investing in that particular
country.
Increase in money supply causes a rise in general prices of commodities
including materials used in construction. This would result to a higher cost of
financing the project. Financiers would therefore be reluctant to put their money
to investment.
4. Real estate financial viability
Financial viability is the ability to generate sufficient income to meet operating
payments, debt commitments and, where applicable, to allow growth while
maintaining service levels.
For a building to run satisfactorily, the building services must be maintained to
standards and checked regularly for failure. Decrease in money supply makes
maintenance and service provisions expensive due to decrease in income.

5. Escalating rates of interest rates are injurious top projects of real estate capacity
of repayment in the future for leases, mortgages and loans. Escalating interest
rates will reduce the amount of money available to the borrowers making it
difficult for them to settle the loans

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CASE STUDY
Money supply and real estate pricing in Kenya
In the post-independence era provision of housing to the public within the emerging
towns was the responsibility of the government (Murugi, 2005). Currently, both
government and private sectors have developed partnership to ensure affordable
dwellings to urban dwellers. The ever increasing need for land in the peril- urban areas
has contributed to the rise in prices. Moreover, as the rural to urban migration increases
so is the value of land and real estate rents. The market for real estate then contributes
to rise in money supply in the economy.

Nairobi, for instance, has a residential sector performance that is heavily dependent on
household disposable income and availability of credit which all depends on the money
supply in the economy owing to CBR, Open Market Operations and interest rate by the
CBK. All this with an effort to maintain a stable economy. Increase in money supply has
caused Kenya’s household disposable income to rise hence able to spend more on
shelter and other basic needs.

The concept of real estate in Kenya consist of various categories of property ranging
from shopping malls, rentals, wholesale outlets, warehousing, residential homes etc.
(Masika 2010). A report by the National Housing Corporation indicates that the country
has acquired 50000 units out of 200000 units envisioned in 2030 (2013 report). In 2017,
the construction sector registered a growth of 8.6% and the value of new private
buildings increased by 10.2% due to increase in money supply by the CBK over the
years.

Rise in money supply increases consumer’s disposable income who then seeks better
housing. Investors will tend to raise the rents to increase their returns. The graph below
shows rise in rents in different residential areas in Nairobi.

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 180

160

140

120

100

80 160 160
150 150 150 150
60 120 120 120
110 110
90
40
65 60 60
50 50 50 55
20 45

0
2016 2017 2018 2019

lavington parklands ruaka westlands ngong

A GRAPH SHOWING THE MONEY SUPPLY BY CBK FROM JULY 2018 TO JUNE
2019 (billions)

The above graph illustrates the accumulation of money supply by the central bank of
Kenya from 2018 to 2019 for selected years.

The years vary with the money supply depending on the CBK’s intention.

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REFERENCES

Construction economics, Stephen L. Gruneberg, 1997

Construction Economics Danny Myers –– new approach
Economy survey 2018
Economic Survey Bank supervision annual report 2017 by central Bank of
Kenya, 2018
MACROECONOMICS N. Gregory Mankiw, Harvard University, 2009.

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