CH11 - Money and Banking Flashcards
What are the 3 functions money serves?
- Medium of exchange
- Store of value
- Unit of account
Paper money and coins that are not convertible into anything with intrinsic value, but are declared by the government to be legal tender, are known as?
Fiat Money
What are the 3 main functions of the Bank of Canada?
- Banker to the commercial banks
- Banker to the Federal Government
- Regulator of the Money Supply
After the invention of coinage, authorities had to approve the face value of the coins. However, coins often could not be taken at their face value due to the common practice of ________
Clipping
What is the practice of clipping?
Clipping a thin slice off the edge of the coin and keeping the valuable metal
The practice of debasement by the ruling authorities resulted in what?
Inflation
Gresham’s law states that when two types of money are used side by side, the one with ________ will be driven out of circulation.
The insights of this law are likely to be observed in a _________ economy.
greater intrinsic value
high-inflation
Fiat money:
A. is different from paper money.
B. has no intrinsic value.
C. is not legal tender.
D.is backed by gold.
E.is not used as a unit of account.
B. has no intrinsic value.
What is the target reserve ratio equation?
Reserve / Deposits
Why is it said that the Canadian banking system is a fractional-reserve system?
Because commercial banks keep only a fraction of their total deposits in reserves.
What can a bank do to get rid of excess reserves?
A bank can lend when it has excess reserves to adjust its actual reserves toward its target level
With the presence of a cash drain, the ability of the banking system to create money is ______
reduced
Following a new deposit, the _____ the more money will be created by the banking system.
smaller the target reserve ratio
Is a Canadian $100 bill money?
Yes
Why isn’t a credit card considered money?
Because it is not a store of value.
Why may commercial banks may have chosen to “hoard cash” rather than lend it to borrowers (2)
(In 2011, after the worst of the global financial crisis was over)
- The banks were concerned regarding the credit-worthiness of many (especially corporate) borrowers.
Your answer is correct. - Many firms and households chose to reduce their demand for credit because of the quickly slowing economy.
What is the barter system and what does it require?
Goods and services are exchanged directly with each other
It requires a double coincidence of wants
What is unnecessary when using a medium of exchange?
The double coincidence of wants
What are the characteristics for money to be a medium of exchange? (6)
- Easily recognizable
- Readily acceptable
- High value relative to its weight
- Must be divisible
- Must be reasonably durable
- Must be hard/impossible to counterfeit
What is the condition for money to be a satisfactory store of value?
It’s purchasing power should be relatively stable over time
In the overall economy, there is more money in the form of bank deposits or physical money?
bank deposits
The invention of what eliminated the need to weight the metal at each transaction?
Coinage
What is milling?
Minting the coins with a rough edge
Why did debasement lead to inflation?
Because the recipients of the extra coins could be expected to spend them, causing a net increase in demand, biding up the prices
What is Gresham’s Law
The theory that “bad” or debased money drives “good”, or undebased, money out of circulation
The one with the greater intrinsic value will be driven out of circulation
What are/were bank notes?
Paper money issued by commercial banks
They were convertible into gold (on demand)
What was the major problem with a fractionally backed currency?
Maintaining the convertibility into the precious metal
What does it mean to be fractionally backed for banks
It means that banks have many more claims outstanding against them than they actually have in reserves available to pay those claims
What is the gold standard?
A currency standard whereby a country’s currency is convertible into gold at a fixed rate of exchange
What were the roles of goldsmiths?
They would store gold for people, for safekeeping
What is something that is legal tender?
Anything that by law must be accepted when offered either for the purchase of the goods or services, or to repay a debt
True or False
Today, almost all currency is fiat money?
True
What is deposit money?
Money held by the public in the form of deposits with commercial banks
True or False
Bank deposits are considered money
True
What are the 2 institutions that make up a modern banking system?
- The Central Bank
- Financial Intermediaries (e.g. commercial banks)
What is the central bank?
A bank that act as the banker to the commercial banking system and often to the government as well. Usually a government-owned institution that is the sole money-issuing authority
Why are financial intermediaries called intermediaries?
Because they stand between savers and borrowers
Accept deposits from savers
Make loans to borrowers
What are commercial bank?
A type of financial intermediary that accept deposits and create deposit money
What are 4 examples of commercial banks?
- Chartered banks
- Trust companies
- Credit unions
- Caisses populaires
How is the organization of the Bank of Canada designed?
To keep the operation of monetary policy free from day-to-day political influence
Why is the Central Bank system is known as “joint responsibility”?
Because the ultimate responsibility of the Bank’s actions rests with the government
What are 2 examples of government securities?
When do governments issue them?
- T-bills and longer-term bonds
- When they require more money than they collect in tax revenues
(They are debt instruments)
What did the Canadian government do to provide financial relief to unemployed workers and businesses during the pandemic?
It issued a massive amount of new securities
True or false?
All private-sector banks in Canada are referred as commercial banks
True
What is a clearing house?
An institution in which interbank indebtedness, arising from the transfer of cheques between banks, is computed and offset and net amounts owing are calculated.
How do commercial bank attract deposits (2)?
- By paying interest to depositors
- By providing them with services (clearing cheques, ATMs, Debit cards, online banking)
How to banks earn profits?
By lending and investing money deposited with them for more than they pay their depositors in terms of interest and other services provided
Also through the wealth-management and investment services they provide to customers.
What is a bank run?
A situation in which many depositors rush to withdraw their money, possibly leading to a bank’s financial collapse
What is the difference between the reserve ratio and the target reserve ratio?
The reserve ratio is the fraction of its deposits that the bank ACTUALLY holds as reserves,
While the target reserve ratio is what it would IDEALLY like to hold
What are 2 simplifying assumptions about money creation?
- There are no excess reserves
- There is no cash drain from the banking system
What are 3 examples of new deposits?
- Immigrant bringing cash to Canada
- Individual finding long-forgotten cash stashed and deposit it
- Individual depositing a cheque from selling a government security to the Bank of Canada
What are 3 examples of new deposits?
- Immigrant bringing cash to Canada
- Individual finding long-forgotten cash stashed and deposit it
- Individual/firm depositing a cheque from selling a government security to the Bank of Canada
What are second-round banks, third-round banks, and so on?
Banks that receive deposits from the proceeds of the initial loan
What are 2 instances when banks could decide not to lend their excess reserves?
- If the risk is too great (if the borrower defaults)
- If the interest rates are expected to rise, they might wait until then, to make more profitable loans
The cash drain _____ the multiple expansion of bank deposits.
reduces
What is the ∆deposits equation if there is a cash drain?
new cash deposit/ (c.d. + r.r.)
What is a cash drain?
It is when people decide to hold an amount equal to a fixed fraction of their bank deposits
What is the money supply (definition)
The total quantity of money in an economy at a point in time
What is the money supply (equation)
Currency + Bank Deposits
What is a term deposit?
An interest-earning bank deposit, subject to notice before withdrawal. Also called a notice deposit
near money
What is part of M1
Currency in circulation + Demand deposits held at chartered banks
What is part of M2
M1 + business checking account + personal savings account
Currency + demand & notice deposits at the chartered banks
What is part of M2+
M2 + money market mutual funds + money deposited at near banks (desjardins)
What is 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
What are money substitutes?
Something that serves as a medium of exchange but is not a store of value
(e.g. credit card)
