Chapter 11 - Money and banking

Question 1

What is money?

Answer 1

Anything that is generally accepted as payment for goods, services, or repayment of debt.

Question 2

What is the difference between money and wealth?

Answer 2

Wealth is the total collection of property/assets that serve to store value.

Question 3

What is the difference between money and income?

Answer 3

Income is the flow of earnings per a unit of time.

Question 4

How do we define money? (3 concepts)

Answer 4

1- Medium of exchange: It eliminates the need of finding a double coincidence of needs (barter system).
2- Unit of account: used as a common basis to measure value in the economy.
3- Store of value: used to save purchasing power over time. Other assets may serve the same function but money is the most liquid.

Question 5

What is Gresham’s Law?

Answer 5

“Bad money drives out good”, meaning that legally overvalued currency will tend to drive legally undervalued currency out of circulation. For example if we have 2 coins in circulation that have the same value but one is made of a more expensive metal. People will hoard the more expensive coin and drive it out of circulation, leaving the bad money in circulation.

Question 6

What are the three different payment systems? Give an example for each.

Answer 6

1-Commodity money: Money whose value comes from a commodity from which it was made. Example: money backed by gold or silver.
2- Token money: Convertible claims on commodity money.
Example: Gold deposit Receipt.
3- Fiat money: Authorized by central bank to be legal tender and doesnt need to be backed by gold.
Example: 20$ bill.

Question 7

What does legal tender mean?

Answer 7

Money that by law must be accepted anywhere as means of payment.

Question 8

How do we calculate Money supply?

Answer 8

MS = Coins & Notes in circulation + Bank deposits

Question 9

How do we calculate Monetary Base?

Answer 9

MB = Coins & Notes in circulation + cash held by banks,

Question 10

What is the most liquid measure of money?

Answer 10

M0

Question 11

What is the least liquid measure of money?

Answer 11

M3

Question 12

What are the different measures of money? (explain M0-M3)

Answer 12

M0 = coins, notes, and assets that can easily be converted to cash.
M1 = M0 + Check deposits
M2 = M1 + short term time deposits in banks
M2+ = M2 + Deposits at any other financial institution (Credit unions, mutual funds, etc)
M3 = M2 + long term time deposits in banks (bonds).

Question 13

Who interacts with the Central Bank of Canada?

Answer 13

Only commercial banks and the federal govt can have accounts and deposits at the Central Bank.

Question 14

What is the Central Bank’s role?

Answer 14

Bank of Canada sets up monetary policy to achieve a rate of monetary expansion consistent with maintaining a low and stable rate of inflation.

Question 15

How does the Central Bank of Canada ‘manipulate’ the economy? (3 tools)

Answer 15

1- Overnight rate: Interest rate for commercial banks to borrow from the Central Bank. (changes ~8 times a year)
2- Reserve requirements: Almost never used. Requirement for bank to hold a certain % of deposits as reserve.
3- Open Market Operations: Buy or sell govt bonds to/from banks. When it buys bonds, monetary base expands.

Question 16

What is the best description for “near money”?

Answer 16

Assets that are readily/easily converted to a medium of exchange (cash) but are not themselves a medium of exchange. They fulfill the store-of-value function. For example a treasury bill.

Question 17

What is the best description for “money substitute”?

Answer 17

Assets that serve as a medium of exchange but are not themselves a store of value. For example credit cards.

Question 18

The practice of debasement by authorities results in …. ?

Answer 18

Inflation

Question 19

Suppose Nina withdraws $1000 from her money-market mutual fund and deposits this money into her brother’s chequing account. Then

Answer 19

A. M2 will increase by $1000, and M2+ will stay the same (correct)
B. M2 will decrease by $1000 and M2+ will increase by $1000
C. Both remain unchanged.
D. Both increase by $1000.
E. Both decrease by $1000.

explanation:
M2 includes currency + short-term deposits.
M2+ includes M2 + other deposits at other financial institutions.
Therefore, withdrawing from mutual funds affects M2+, and depositing at chequing account affects M2.
Since M2 is part of M2+, the value of M2+ will not change (1000$ is subtracted from M2+ and added to M2, but since M2 is included in M2+, then the 1000$ is added to M2+ too).