Chapter 10 Flashcards
THE MEANING OF MONEY
Money is the set of assets in the economy that people regularly use to buy goods and services from other people.
The Functions of Money
Medium of exchange is an item that buyers give to sellers when they want to purchase goods or services.
Unit of account is the yardstick people use to post prices and record debts.
Store of value is an item that people can use to transfer purchasing power from the present to the future.
- Wealth is the total of all stores of value, including both monetary and non-monetary assets.
- Liquidity describes the ease with which an asset can be converted into a medium of exchange.
Money is the most liquid of assets.
The Kinds of Money
Commodity money is money that takes the form of a commodity with intrinsic value.
The term intrinsic value means that the item would have value even if it were not used as money. One example of commodity money is gold.
Fiat money is money without intrinsic value that is accepted as money because of government decree.
Example is money in wallet vs. monopoly money, money in wallet is accepted as it was declared by government.
Money in the Canadian Economy
The quantity of money circulating in the economy is called the money stock.
- It has a powerful influence on many economic variables.
Currency is the paper bills and coins in the hands of the public.
Demand deposits are the balances in bank accounts that the depositors can access on demand by writing a cheque or using a debit card.
THE BANK OF CANADA
The Bank of Canada (BoC) is the central bank of Canada.
Central bank is an institution designed to regulate the quantity of money in the economy.
The Bank of Canada Act
Prior to the 1930s:
- Bank notes were issued by the Department of Finance and the commercial banks.
- Canada was on the gold standard.
With the collapse of the gold standard as a result of the Great Depression, a need arose to control the quantity of fiat money in the economy.
The Bank of Canada Act (cont’d)
The government enacted the Bank of Canada Act in 1934.
The BoC was established in 1935 and nationalized in 1938.
The BoC is managed by a board of directors, including:
* The governor, the senior deputy governor, and 12 directors, including the deputy minister of finance.
The current governor of the BoC is Tiff Macklem.
In practice, the BoC is independent of the government.
The Bank of Canada Act (cont’d)
The primary responsibility of the BoC is to act in the national interest.
The BoC has four main functions:
- issue currency
- banker to the commercial banks
- banker to the Canadian government
- control the money supply
Money supply and monetary policy
Money supply is the quantity of money available in the economy.
Monetary policy is the setting of the money supply by policymakers in the central bank.
Monetary Policy
The Bank of Canada:
* has the power to increase or decrease the number of dollars in the economy
* is an important institution because changes in the money supply can profoundly affect the economy
FIGURE 10.1 Two Measures of the Money Stock for the Canadian Economy
Two important measures of the money stock are what the Bank of Canada defines as M1+ and M2.
M1 is the chequable deposits taking the majority of the bar and currency taking up a sliver of the bar
M2 is everything in M1 + Nonpersonal demand and notice deposits + a couple minor categories
Obviously M2 is larger as it includes M1
COMMERCIAL BANKS AND THE MONEY SUPPLY
Although the Bank of Canada alone is responsible for Canadian monetary policy, the central bank can control the supply of money only through its influence on the entire banking system.
What is the role played by commercial banks (which include credit unions, caisses populaires (French equal to credit union), and trust companies) in the monetary system?
The Simple Case of 100 Percent-Reserve Banking
Assumptions:
* Currency is the only form of money.
* The initial supply of money is $100.
* Now suppose someone opens a bank: First National Bank.
* All deposits received by First National Bank are held as reserves: 100 percent-reserve banking.
Reserves are deposits that banks have received but have not loaned out.
The Simple Case of 100 Percent-Reserve Banking: T Accounts
Using a T-account to show changes in the bank’s assets and liabilities.
The T-account for First National Bank if the economy’s entire $100 of money is deposited in the bank:
On the left-hand side of the T-account are the bank’s assets of $100 (the reserves it holds in its vaults).
On the right-hand side of the T-account are the bank’s liabilities of $100 (the amount it owes to its depositors).
Each deposit in the bank reduces currency and raises demand deposits by exactly the same amount, leaving the money supply unchanged.
Thus, if banks hold all deposits in reserve, banks do not influence the supply of money.
Money Creation with Fractional-Reserve Banking
Fractional-reserve banking is a banking system in which banks hold only a fraction of deposits as reserves.
Reserve ratio is the fraction of deposits that banks hold as reserves.
Assuming a reserve ratio of 10 percent …
They work with other banks for loaning and such, so each bank can have a rate and each rate applies to the deposit amount from one bank to another
