Chapter 14

Question 1

Definition of money

Answer 1

the set of all assets that are regularly used to directly purchase goods and services

Question 2

3 functions of money

Answer 2

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

Question 3

2 basic considerations that make certain money better than others

Answer 3

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

Question 4

Definition of commodity backed money

How does this differ from fiat money?

Answer 4

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

Question 5

What is the money supply?

Answer 5

the amount of money available in the economy; this supply is managed by the Bank of Canada

Question 6

Bank of Canada’s classification of money

Answer 6

M1 - cash plus chequing account balances

M2 - M1 + savings accounts and other financial instruments

Question 7

Definition of ‘Fractional Reserve Banking’?

Answer 7

the idea of creating money and how banks make money

lending a fraction of deposited funds and collecting interest on these loans

Question 8

What are demand deposits a fancy word for

Answer 8

savings - these are funds held in bank accounts that can be withdrawn by depositors at any time, without advance notice

Question 9

Definition of Reserves and reserve ratio

Answer 9

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

Question 10

Definition of the money multiplier

Answer 10

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

Question 11

What institution is responsible for managing the nation’s money supply?

Answer 11

The central bank

Question 12

4 essential functions of the bank of Canada

Answer 12

1. sole issuer of Canada’s bank notes
2. implementing monetary policy via managing the money supply
3. acts as the fiscal agent for the federal government
4. acts as a lender of last resort

Question 13

Definition of ‘Monetary Policy’

Answer 13

refers to the actions made by the central bank to manage the money supply

Question 14

Difference between the department of finance and bank of canada

Answer 14

DoF executes Fiscal Policy and the Bank conducts monetary policy

Question 15

What is the objective of the bank?

Answer 15

to preserve the value of money by keeping inflation low, stable and predictable

Question 16

What tool can monetary policy use to create a nominal anchor and help shake market expectations about future inflation

Answer 16

inflation targeting;

current target is at 2%

aim to ensure a stable price environment over the medium term

Question 17

3 tools of monetary policy

Answer 17

1. the reserve requirement -
   controlling the amount money banks must hold affecting availabilty of credit in the banking system
2. open market operations
   sales or purchases of government bonds by the bank of canada to or from banks on the open market
3. 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

Question 18

What is Contractionary monetary policy

and what is expansionary monetary policy

Answer 18

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

Question 19

what is the liquidity preference model?

Answer 19

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

Question 20

Challenges and advantages that monetary policy has

Answer 20

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