Unit 5 Flashcards
(24 cards)
What is money
s any commodity or token that is generally
acceptable as a means of payment.
A means of payment is a method of settling a debt.
Money has three other functions:
▪ Medium of exchange
• Barter economy
▪ Unit of account
▪ Store of value
ARE CHECKS MONEY?
Checkable deposits are money, but checks are not– checks are instructions to
banks to transfer money.
Credit cards are not money.
Commodity money
takes the form of a commodity
with intrinsic value
Examples: gold coins,
cigarettes in POW camps
Fiat money
money without intrinsic value,
used as money because of
government decree
Example: the Canadian dollar
The 2 main official measures of money in Canada
M1:
Currency outside banks
Demand deposits at chartered banks
M2+ :
M1 plus
Personal savings deposits at chartered banks,
Nonpersonal notice deposits at chartered banks,
Deposits at trust and mortgage loan companies,
Deposits at credit unions and caisses populaires,
Deposits at other financial institutions.
Liquidity
is the
property of being
instantly convertible
into a means of
payment with little
loss of value.
Currency is the most
liquid money.
Fixed term deposits
are less liquid.
The banking system
The banking system consists of private and public
institutions that create money and manage the nation’s
monetary and payments systems.
These institutions play a crucial role in financial markets.
They are
Depository institutions
The Bank of Canada
The payments system
Depository institution
is a firm that accepts deposits
from households and firms and uses the deposits to make
loans to other households and firms.
Three types of depository institutions
▪ Chartered banks
▪ Credit unions and caisses populaires
▪ Trust and mortgage loan companies
The economic functions of depository institutions
Depository institutions are profit seeking firms.
The profit is based on interest rate spread.
Functions:
▪ Create liquidity
▪ Minimize the cost of obtaining funds
•Economies of scale
▪ Minimize the cost of monitoring borrowers
▪ Pool risk
How banks create money - fractions reserve banking system
Banks can create money by making loans using their excess reserves.
Excess Reserves = Total Reserves– Required Reserves
- Banks are required to keep a fraction of their deposits as reserves:
- Required reserves (desired reserves in Canada)
Reserve ratio = actual reserves / total deposits
What are requires reserves
The money that banks are not allowed to lend out, bank can decide what percent of reference they chose to have
The banking system - THE BANK OF CANADA
The Bank of Canada is the central bank of Canada.
A central bank is the public authority that regulates a nation’s depository institutions and control the quantity of money.
The Bank of Canada is
-> Banker to the banks and government
-> Lender of last resort
-> Sole issuer of bank notes
The bank of canadas balance sheet
The Bank of Canada’s assets are
- government securities
- last-resort loans to banks.
The liabilities are
- Bank of Canada notes
- deposits of banks and the government.
The banking system - monetary base
The monetary base is the liabilities of the Bank of Canada
-> = Bank of Canada coins and notes outside the Bank
-> + banks’ deposits at the Bank of Canada
Monetary base= hard power money=bank of Canada money
To change the monetary base, the Bank of Canada
conducts an open market operation:
purchase or sale of government of Canada secu
Money multiplayer
the ratio of the change in the quantity of money to the
change in the monetary base.
The demand for money
How much of total wealth (asset) the public want to hold in the
particular form “money” (currency + demand deposits)?
Determinants of Demand for Money
▪ The price level (+)
▪ The interest rate (-)
• Opportunity cost of holding money
▪ Real GDP (+)
▪ Financial innovation (-)
The demand for money curve
The demand for money curve is the relationship between
the quantity of real money demanded (M/P) and the
interest rate when all other things remain the same.
How increase and decrease of GDP affect the demand for money
- increase in real GDP
(Shift to the right) - dress in real GDP
(Shift to the left)
What happens to the interest rate when supply of bonds rise and fall
- excess supply of money. People buy bonds and interest rate falls
- excess demand for money. People sell bonds and interest rate rises
What happens to the interest rate when then quantity of money rises and falls
- an increase in the quantity of money lower the interest rate
- a decrease in the quantity of money raises the interest rate
The quantity theory of money
In the long run, an increase in the quantity of money
brings an equal percentage increase in the price
level.
The quantity theory of money is based on the velocity of
circulation and the equation of exchange.
Velocity if circulation
is the average number of
times in a year a dollar is used to purchase goods and
services in GDP.
How does the interest rate affect AE and real GDP
Real interest rate ( r ) = Nominal interest rate – Inflation rate
Three Channels:
Consumption ( C ):
higher r, higher S and lower C
Investment ( I ):
higher r, lower I
Net Exports (NX):
higher i, exchange rate appreciation, lower NX
