11.4 The Money Supply

Question 1

Definition of The Money Supply

Answer 1

Money supply

The total quantity of money in an economy at a point in time. Also called the supply of money.

Question 2

What do the several different definitions for money supply have in common?

Answer 2

Economists use several alternative definitions for the money supply. Each definition includes the amount of currency in circulation plus some types of deposit liabilities of the financial institutions.

Question 3

Function for money supply

Answer 3

Question 4

What are the distinctions between the two different kinds of deposits?

Answer 4

From our point of view, the most important distinction is between deposits that can be readily transferred by cheque, online banking, automatic transfer, or debit card, and those that cannot be so easily transferred.

The deposits that are easily transferred are media of exchange; the second type are not.

Question 5

In the past, what were the two different kinds of demand deposits and what made them different?

Answer 5

For many years, the distinction lay between demand deposits, which earned little or no interest but were transferable on demand (by cheque), and savings deposits, which earned a higher interest return but were not easily transferable.

Today, however, it is so easy to transfer funds between almost all accounts that the distinction is almost meaningless.

Question 6

What is a term deposit?

Answer 6

Term deposit

An interest-earning bank deposit, subject to notice before withdrawal. Also called a notice deposit.

 Has a specified withdrawal date a minimum of 30 days into the future, and which pays a much reduced interest rate in the event of early withdrawal. Term and other “notice” deposits pay significantly higher interest rates than do regular bank deposits.

Question 7

What are money market mutual funds and money market deposits?

Answer 7

Non-bank financial institutions, such as asset-management firms, now offer money-market mutual funds and money-market deposit accounts.

These accounts earn higher interest and are chequable, although some are subject to minimum withdrawal restrictions and others to prior notice of withdrawal.

Question 8

What was the long standing distinction between money and other highly liquid assets?

Answer 8

The long-standing distinction between money and other highly liquid assets used to be that, narrowly defined, money was a medium of exchange that did not earn interest, whereas other liquid assets earned interest but were not media of exchange.

Today, this distinction has almost completely disappeared.

Question 9

What differentiates the different definitions of the money supply?

Answer 9

Different definitions of the money supply include different types of deposits.

Question 10

Until recently, what was thes the common definition of the money supply used by the Bank of Canada called. What did it not include?

Answer 10

Until recently, a common definition of the money supply used by the Bank of Canada was called M1, which included currency in circulation plus demand (chequable) deposits held at the chartered banks.

But M1 did not include similar deposits at other financial institutions or any non-chequable term or notice deposits.

Question 11

Two commonly used measures in Canada today are…

Answer 11

M2 and M2+

Question 12

What is M2

Answer 12

M2

Currency plus demand and notice deposits at the chartered banks.

Question 13

What is M2+ ?

Answer 13

M2+

M2 plus similar deposits at other financial institutions.

 (trust and mortgage-loan companies, credit unions and caisses populaires) and holdings of money-market mutual funds.

Question 14

M2 and M2+ Table

Answer 14

Question 15

What are other measures of money supply. What does it mean as we move up the rankings?

Answer 15

Question 16

What is Near Money?

Answer 16

Near money

Liquid assets that are easily convertible into money without risk of significant loss of value. They can be used as short-term stores of value but are not themselves media of exchange.

Question 17

Example of near money

Answer 17

Term deposits are a good example of near money. When you have a term deposit, you know exactly how much purchasing power you hold and, given modern banking practices, you can turn your deposit into a medium of exchange—cash or a demand deposit—at a moment’s notice (though you may pay a penalty in the form of reduced interest if you withdraw the funds before the end of the specified term).

Question 18

So why doesn’t everyone keep their money in such deposits instead of in demand deposits or currency?

Answer 18

The answer is that the inconvenience of continually shifting money back and forth may outweigh the interest that can be earned. One week’s interest on $100 (at 5 percent per year) is only about 10 cents, and not worth the hassle for most people. For money that will be needed soon, it would hardly pay to shift it to a term deposit.

Question 19

What is a Money Substitute?

Answer 19

Money substitutes

Something that serves as a medium of exchange but is not a store of value.

Question 20

Example of a money substitute

Answer 20

Credit cards are a prime example. With a credit card, many transactions can be made without either cash, a debit card, or a cheque.

The credit card serves the short-run function of a medium of exchange by allowing you to make purchases, even though you have no cash or bank deposit currently in your possession.

But this is only temporary; money remains the final medium of exchange for these transactions when the credit-card bill is paid.