Chapter 14 Flashcards
Definition of money
the set of all assets that are regularly used to directly purchase goods and services
3 functions of money
store of value - money represents a certain amount of purchasing power
medium of exchange - money can be used to purchase goods and services; without it we would have a barter system
unit of account - money provides a standard unit of comparison
2 basic considerations that make certain money better than others
stability of value - early versions of money generally took the form of a physical material that was durable and had intrinsic value; money now doesn’t need this
convenience - technology allowing the development of more convenient forms of money
Definition of commodity backed money
How does this differ from fiat money?
any form of money that can be legally exchanged into a fixed amount of an underlying commodity
Money created by rule without any commodity backing it
What is the money supply?
the amount of money available in the economy; this supply is managed by the Bank of Canada
Bank of Canada’s classification of money
M1 - cash plus chequing account balances
M2 - M1 + savings accounts and other financial instruments
Definition of ‘Fractional Reserve Banking’?
the idea of creating money and how banks make money
lending a fraction of deposited funds and collecting interest on these loans
What are demand deposits a fancy word for
savings - these are funds held in bank accounts that can be withdrawn by depositors at any time, without advance notice
Definition of Reserves and reserve ratio
Reserves refer to the money that banks keep on hand; there are two kinds
Required reserves & Excess (required is by law and excess is up to the bank)
This amount is dictated by the reserve ratio - the ratio of the total amount of demand deposits at the bank to the amount kept as cash reserves
Definition of the money multiplier
the ratio of money created by the lending activities of the banking system to the money created by the central bank:
Money multiplier = 1/Reserve Ratio
What institution is responsible for managing the nation’s money supply?
The central bank
4 essential functions of the bank of Canada
- sole issuer of Canada’s bank notes
- implementing monetary policy via managing the money supply
- acts as the fiscal agent for the federal government
- acts as a lender of last resort
Definition of ‘Monetary Policy’
refers to the actions made by the central bank to manage the money supply
Difference between the department of finance and bank of canada
DoF executes Fiscal Policy and the Bank conducts monetary policy
What is the objective of the bank?
to preserve the value of money by keeping inflation low, stable and predictable
What tool can monetary policy use to create a nominal anchor and help shake market expectations about future inflation
inflation targeting;
current target is at 2%
aim to ensure a stable price environment over the medium term
3 tools of monetary policy
- the reserve requirement -
controlling the amount money banks must hold affecting availabilty of credit in the banking system - open market operations
sales or purchases of government bonds by the bank of canada to or from banks on the open market - targeting the overnight interest rate
commercial banks choose to maintain a certain level of reserve on account at the bank of canada
The overnight rate is the interest rate at which banks choose to lend reserves to one another; other interest rates move in the same direction as the overnight rate
What is Contractionary monetary policy
and what is expansionary monetary policy
contractionary is when the money supply is decreased to lower aggregate demand -
reducing supply of reserves, the price of borrowing reserves rises ; a lower quantity of money and higher interest rates; encourages saving
expansionary policy is when the money supply is increased to raise aggregate demand; higher quantity of money and lower interest rates
what is the liquidity preference model?
This model refers to the idea that the quantity of money people want to hold is a function of the interest rate.
This model shows that money demand curve slopes downward
High interest rate, people demand a small amount; low interest rate - people want a lot of it
Challenges and advantages that monetary policy has
challenges - the bank faces time lags and imperfect information ie) sometimes months can pass before the bank’s impacts do anything and sometimes actions are mis timed
Advantages - the bank does not have to wait for politicians to come to a policy consensus; the bank is made up of prominent economic policy makers
