The impact of monetary policy on consumer price index (CPI): 1985-2010

1.9 Definitions of key terms

This chapter refers to defining the key words used in the work in order to facilitate the interested reader to have the same understanding with the authors about such important concepts.

1.9.1 Money

Money is any asset that is acceptable as a medium of exchange in payment for goods and services. The functions of money are as follows:

· A medium of exchange used in payment for goods and services

· A unit of account used to relative measure prices and draw up accounts

· A standard of deferred payment : for example when using credit to purchase goods and services now but pay for them later

· A store of value: money holds its value unless there is a situation of accelerating inflation. As the general price level raises the internal value of a unit of currency decreases.

1.9.2 Interest Rates

An interest rate is the rate at which  interest is paid by a borrower (debtor) for the use of money that they borrow from a  lender (creditor). Specifically, the interest rate (I/m) is a  percentage of  principal (P) paid a certain number of times (m) per period (usually quoted per year). For example, a small company borrows capital from a bank to buy new assets for its business, and in return the lender receives interest at a predetermined interest rate for deferring the use of funds and instead lending it to the borrower.

Interest rates are normally expressed as a percentage of the principal for a period of one year. Interest-rate targets are a vital tool of  monetary policy and are taken into account when dealing with variables like  investment,  inflation, and unemployment. The  Central banks of countries generally tend to reduce interest rates when they wish to increase investment and consumption in the country's economy.

The interest rates are calculated using the  simple interest formula:

Simple Interest = P ( principal) x I (annual interest rate) x N (years) ( http://www.investopedia.com/terms/i/interestrate.asp visited on 28 August, 2014).

1.9.3 Money Supply

The  quantity  of liquid assets (usually  cash) in economy  can be exchanged for  goods and services.

Increase in  money supply (relative to the  output of goods and services)  leads to  inflation, higher  employment, and  high  utilization of the  manufacturing  capacity. Its decrease leads to  deflation,  unemployment, and idle manufacturing capacity. It can have different meanings depending on the  degree of  liquidity chosen to  define an  asset as money. 

Measures of money supply ( called  monetary aggregates) have different  criteria in different  countries, and are categorized from the narrowest to the broadest.

( http://www.businessdictionary.com/definition/money-supply visited on 30 August, 2014).

There are different measures of money:

1. The narrowest measure of money (M1) in Rwanda includes the currency in circulation out the banking sector (CC) and checking account deposit (CD) in other words, narrow money measures cover highly liquid forms of money (Money as means of exchange).

2. The broad monetary aggregate (M2) in Rwanda adds to M1 savings deposits in Rwf and in foreign currency. It includes the less liquid forms (Money as a store of value).