Chapter 10 Flashcards
What are the three primary functions of money?
Medium of exchange – Money is used to facilitate transactions.
Unit of account – Prices and debts are measured in terms of money.
Store of value – Money retains purchasing power over time.
What is the difference between commodity money and fiat money?
Commodity money has intrinsic value (e.g., gold, silver).
Fiat money has no intrinsic value but is accepted as money by government decree (e.g., Canadian dollars).
What is liquidity in economics?
Liquidity refers to how easily an asset can be converted into a medium of exchange (cash).
What is the money supply?
The total quantity of money in an economy, including currency, demand deposits, and other liquid assets.
What are demand deposits, and are they considered money?
Demand deposits are bank account balances that can be accessed on demand (e.g., chequing accounts). They are considered money because they function as a medium of exchange.
Are credit cards considered money? Why or why not?
No, credit cards are not money. They represent deferred payment (borrowing), not an actual medium of exchange.
What are the four main functions of the Bank of Canada?
Issuing currency
Serving as a banker to commercial banks
Serving as a banker to the Canadian government
Controlling the money supply through monetary policy.
What is monetary policy?
The process by which the Bank of Canada controls the money supply and interest rates to influence the economy.
What are the three primary tools of monetary policy used by the Bank of Canada?
Open-market operations – Buying/selling government bonds.
Changing the reserve requirement – Adjusting the fraction of deposits that banks must keep as reserves.
Changing the overnight rate – Adjusting the interest rate on short-term bank loans.
How do open-market operations affect the money supply?
The Bank of Canada buys bonds → Money supply increases.
The Bank of Canada sells bonds → Money supply decreases.
What is the overnight rate, and how does it impact the economy?
The overnight rate is the interest rate banks charge each other for short-term loans. A higher overnight rate discourages borrowing, reducing the money supply, while a lower overnight rate encourages lending, increasing the money supply.
What are reserve requirements, and how do they affect the money supply?
Reserve requirements are the minimum amount of reserves banks must hold.
Higher reserve requirements → Lower money supply (less lending).
Lower reserve requirements → Higher money supply (more lending).
What is the fractional-reserve banking system?
A system in which banks keep only a fraction of deposits as reserves and loan out the rest, thereby creating money.
What is the money multiplier, and how is it calculated?
The money multiplier determines how much money is created for each dollar deposited. It is calculated as:
Money Multiplier = 1 / Reserve Ratio.
If the reserve ratio is 10%, what is the money multiplier?
Money Multiplier = 1 / 0.10 = 10.
This means each dollar of reserves supports $10 of money creation.
Suppose the Bank of Canada buys $10 million in bonds, and the reserve requirement is 5%. By how much could the money supply increase?
Money Multiplier = 1 / 0.05 = 20.
Increase in Money Supply = 20 × 10M = 200M.
The money supply could increase by $200 million if all new reserves are loaned out.
What happens when a person withdraws $1,000 in cash from their bank account?
The money supply does not change—it simply shifts from demand deposits to currency in circulation.
What happens when the Bank of Canada lowers the overnight rate?
Borrowing increases, leading to higher investment and spending, which stimulates economic growth.
What happens when the reserve requirement increases from 5% to 10%?
The money multiplier decreases, reducing the ability of banks to create money, shrinking the money supply.
A bank has $10,000 in deposits and a reserve ratio of 20%. How much can it lend out?
Reserves Required = 10,000 × 0.20 = 2,000.
Loans Possible = 10,000 − 2,000 = 8,000.
The bank can lend out $8,000.
Why is the Bank of Canada’s control over the money supply imperfect?
The Bank of Canada cannot directly control:
How much money households deposit in banks.
How much money banks choose to lend.
Why don’t banks hold 100% reserves?
Banks earn higher profits by lending out deposits instead of keeping them as reserves.
What happens if people suddenly hold more cash instead of deposits?
The money multiplier falls, reducing the money supply because banks have fewer reserves to lend.
What is the difference between M1 and M2 money supply measures?
M1 includes currency and demand deposits (chequing accounts)—most liquid assets.
M2 includes M1 plus savings deposits, time deposits, and money market funds—less liquid assets.
What are the limitations of the Bank of Canada in controlling the money supply?
Household Behavior – The BoC cannot control how much money people deposit in banks.
Banking Behavior – The BoC cannot control how much banks choose to lend.
What happens when banks hold excess reserves instead of lending?
The money multiplier decreases, leading to lower money supply growth and slower economic expansion.
How does the Bank of Canada use foreign exchange market operations to influence the money supply?
Buying foreign currency → Increases the money supply (injecting Canadian dollars into circulation).
Selling foreign currency → Decreases the money supply (removing Canadian dollars from circulation).
What is sterilization, and why does the Bank of Canada use it?
Sterilization is when the BoC offsets foreign exchange market operations with open-market operations to neutralize the impact on the money supply.
