Chapter 11 - Money and Banking Flashcards
What are the 3 main functions of money?
Medium of exchange, store of value, unit of account
What makes money a good medium of exchange?
Must be recognizable, portable, divisible, durable, high value-to-weight, and hard to counterfeit
What affects money’s ability to be a store of value?
Inflation — stable prices are key to preserving purchasing power over time
What’s an example of money failing as a store of value?
Hyperinflation in Germany (prices rising >50%/month)
What does “unit of account” mean?
A standard way to measure and compare the value of goods/services
What’s the role of the Bank of Canada (BoC)?
Runs monetary policy, acts as banker to gov & banks, and regulates the money supply
How is monetary policy different from fiscal policy?
Monetary: BoC adjusts interest rates & money supply
Fiscal: Gov changes spending & taxes
What does the BoC do as a banker to commercial banks?
Acts as lender of last resort, moves deposits between banks to settle interbank debts
What did the BoC do during the pandemic?
Issued new securities (to help support gov relief), increased reserves, liabilities rose 360%, but currency in circulation remained stable
How do banks make money?
Pay low interest on deposits, charge high interest on loans, and provide financial advising
What are the main services of commercial banks?
Accept deposits, make loans, buy securities, provide financial services, enable credit flow
What is the fractional-reserve system?
Banks keep a fraction of deposits in reserve and lend the rest to create new money
What is the reserve ratio (v)?
The % of deposits held in reserve by a bank
What is the target reserve ratio (TRR)?
The ideal % of deposits a bank wants to keep as reserves
What happens if banks hold excess reserves?
Deposit expansion slows down because less money is being loaned out
What is deposit expansion/deposit multiplier/simple deposit multiplier?
The process where banks take a deposit, keep a small part as reserves, and lend out the rest—creating more deposits in the system. This lending-spending cycle keeps repeating, increasing the total money in the economy.
What’s the difference between deposit expansion and fractional reserve banking?
Fractional-reserve banking is the system where banks keep only a fraction of deposits as reserves and lend out the rest.
Deposit expansion is the process that happens because of that system — when banks lend out money, it gets re-deposited and re-loaned, increasing total deposits and the money supply.
What is the formula for total deposit expansion (no cash drain)? (also known as the deposit multiplier)
Total deposits = (1/v) × initial deposit
(where v = reserve ratio and initial deposit is the initial amount deposited in a bank)
What is a cash drain?
When people keep some money as physical cash instead of deposits, reducing money creation
How does the deposit expansion formula change with a cash drain?
Deposits = new deposit / (cash-deposit ratio + reserve-deposit ratio)
or
Change in deposits = (new cash deposit)/(c + v)
(where c = cash-deposit ratio and v = reserve-deposit ratio)
What is “near money”?
Assets that store value & can be converted into money, but aren’t used directly (e.g. term deposits)
What are money substitutes?
Used as a medium of exchange but not a store of value (e.g. credit cards)
What’s the formula for money supply?
Money Supply = Currency + Bank Deposits
What’s included in M1?
Currency + chequable (demand) deposits at chartered banks
