Chapter 15

Question 1

What is money

Answer 1

The set of all assets that are regularly used to directly purchase goods and services

Question 2

What is store of value

Answer 2

A certain amount of purchasing power that money retains over time

Question 3

What is medium of exchange

Answer 3

The ability to use money to purchase goods and services

Question 4

What is a barter

Answer 4

Directly offering a good or service in exchange for some good or service you want

Question 5

What is commodity- backed money

Answer 5

Any form of money that can be legally exchanged into a fixed amount of an underlying commodity

Question 6

What is fiat money

Answer 6

Money created by rule, without any commodity to back it

Question 7

What are demand deposits

Answer 7

Funds held in bank accounts that can be withdrawn by depositors at anytime without advance notice

Question 8

What are reserves

Answer 8

The money that a bank keeps on hand, either in cash or in deposits, at the bank of canada

Question 9

What are requires reserves

Answer 9

The minimum fraction of deposits that banks are legally required to keep on hand

Question 10

What are excess reserves

Answer 10

Any additional amount beyond the required reserves that a bank chooses to keep in reserve

Question 11

What are desired reserves

Answer 11

In the absence of requires reserves, the amount of reserves a bank wishes to hold

Question 12

What is the basic accounting equation

Answer 12

Assets = liabilities + owners equity

Question 13

How do you calculate change in money supply

Answer 13

Change in reserves x money multiplier

Question 14

What is fractional reserve banking

Answer 14

A system in which banks keep on reserve less than 100 percent of their deposits which allows the bank to lend out a portion of the money deposited in the bank

Question 15

What is the money multiplier

Answer 15

The ratio of money created by the lending activities of the banking system to the money created by the central bank

We calculate it as 1/R

Where R is the reserve ratio

Question 16

What is money supply and momentary base

Answer 16

The amount of money available in the economy

Contains: cash and bank reserves (can be used immediately) known as momentary base

Question 17

What is M1+

Answer 17

Includes currency held by the public plus chequing account balances at charted banks, trust and mortgage loan companies, credit unions and caisses populaires (demand deposits)

*if we want to look at spending use M1+

Question 18

What is M2

Answer 18

Includes everything M1+ has plus personal savings accounts and non-personal notice deposits where money is locked away for a specific period of time

• when looking at savings use M2
• it can give a sense of the money multiplier

Question 19

What is a central bank

Answer 19

The institution ultimately responsible for managing the nations money supply and coordinating the banking system to ensure a sound economy

Question 20

What are the four essential functions of a central bank (bank of canada)

Answer 20

1. Being the sole issuer of Canada’s bank notes
2. Conducting monetary policy via managing the money supply
3. Acting as the fiscal agent for the federal government
4. Acting as a lender of last resort

Question 21

What is the main difference between the department of finance and the bank of canada

Answer 21

The department of finance executes fiscal policy

The bank of canada conducts monetary policy

Question 22

What is monetary policy

Answer 22

It consists of actions by the central bank to manage the money supply, in pursuit of certain macroeconomic goals

Question 23

What is lender of last resort

Answer 23

Central banks can act as a lender of last resort which means that when nobody else is willing to lend to banks facing a bank run, the bank of canada can step in and do it

Question 24

What is the primary objective of the bank of canada

Answer 24

To enhance the wellbeing of Canadians by contributing to sustained economic growth, rising levels of employment, and improved living standards

Question 25

What tools does the bank of canada use to conduct monetary policy

Answer 25

Reserve requirements, open-market operations, and changing the target for overnight rate

Question 26

What is the reserve requirement

Answer 26

The most powerful tool used by the central bank but rarely used It is the regulation that sets the minimum fraction of deposits banks must hold in reserve

Question 27

What are open market operations

Answer 27

Sales or purchases of government securities/bonds by the central bank, to or from commercial banks, on the open market Directly result in an increase or decrease in the money supply

Question 28

What is expansionary monetary policy

Answer 28

Actions that increase the money supply in order to increase aggregate demand

Question 29

What is contractionary monetary policy

Answer 29

Actions that reduce the money supply in order to decrease aggregate demand

Question 30

What is the overnight rate

Answer 30

The interest rate at which banks chose to lend reserves held at the bank of canada to one another usually just overnight Helps meet the goal of contractionary policy - slowing the economy down

Question 31

What is the liquidity preference model

Answer 31

The idea that the quantity of money people want to hold is a function of the interest rate Money demand curves slope downward, showing a negative relationship between interest rate and money demanded

Question 32

In the liquid preference model, what happens when interest rates rise

Answer 32

We demand a lower quantity of money, moving leftward along the curve

Question 33

In the liquid preference model what happens when interest rates fall

Answer 33

when the interest rate falls we demand a high quantity of money, moving rightward along the curve

Question 34

What factors cause the demand curve to shift in the liquid preference model

Answer 34

1. Price level: higher prices will increase demand which will shift the money demand curve to the right 2. Increases (shift right) or decreases to GDP (shift left)

Question 35

In the liquid preference model, what is the point where supply of money equals demand for money

Answer 35

The nominal interest rate (r*)

Question 36

What will shift the money supply curve to the right and what is this called

Answer 36

Any actions that increase the money supply (expansionary monetary policy) - decreasing the reserve requirement - decreasing the target for the overnight rate - buying government bonds on the open market

Question 37

What will shift the money demand curve to the left and what is it called

Answer 37

Any action that decreases money supply (contractionary monetary policy)

Question 38

What does the slope of the money demand curve determine

Answer 38

How the change in the money supply will change the interest rate

Question 39

What happens when the slope of the demand curve is elastic

Answer 39

It will have a smaller effect on interest rates

Question 40

What will happen if the slope of the demand curve is | inelastic

Answer 40

The changes in money supply will have a greater effect on interest rate

Question 41

How do lower interest rates affect the rates of return on assets throughout the economy (expansionary monetary policy)

Answer 41

- when the bank of Canada purchases bonds on the open market, it increases the demand for those bonds, drives up prices, and lowers their expected rates of return - this makes investors shift their portfolios towards other assets - this shift then increases the prices of the other assets in the economy and reduces their rate of return

Question 42

What is the balance sheet channel

Answer 42

The idea that a rise in asset prices causes firms and households to perceive an increase in their net worth which makes them increase spending With lower interest rates people don’t save money so the aggregate demand increases and shifts to the right

Question 43

Contractionary monetary policy

Answer 43

Actions that reduce money supply in order to decrease aggregate demand

Question 44

What are the three main functions of money

Answer 44

1. Store of value 2. Medium of exchange 3. Unit of account

Question 45

What is the reserve ratio

Answer 45

The ratio of the original deposit to the amount kept as reserves