Chapter 14: Money and the Monetary System

Question 1

Define ‘Money’.

Answer 1

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

Question 2

Define ‘Store of value’.

Answer 2

A certain amount of purchasing power that money retains over time.

Question 3

Define ‘Medium of exchange’.

Answer 3

The ability to use money to purchase goods and services.

Question 4

Define ‘Barter’.

Answer 4

Directly offering a good or service in exchange for some good or service you want.

Question 5

Define ‘Unit of account’.

Answer 5

A standard unit of comparison.

Question 6

Define ‘Commodity-backed money’.

Answer 6

Any form of money that can be legally exchanged into a fixed amount of an underlying commodity.

Question 7

Define ‘Fiat money’.

Answer 7

Money created by rule, without any commodity to back it.

Question 8

Define ‘Demand deposits’.

Answer 8

Funds held in bank accounts that can be withdrawn (“demanded”) by depositors at any time without advance notice.

Question 9

Define ‘Reserves’.

Answer 9

The money that a bank keeps on hand, either in cash or in deposits at the Federal Reserve.

Question 10

Define ‘Reserve ratio’.

Answer 10

The ration of the total amount of demand deposits at a bank to the amount kept as cash reserves.

Question 11

Define ‘Desired reserves’.

Answer 11

In the absence of required reserves, the amount of reserves a bank wishes to hold.

Question 12

Define ‘Excess reserves’.

Answer 12

Any additional amount, beyond the required reserves, a bank chooses to keep in reserve.

Question 13

Define ‘Money multiplier’.

Answer 13

The ratio of money created by the lending activities of the banking system to the money created by the central bank.
MM = 1/ reserve ratio

Question 14

Define ‘Fractional-reserve banking’.

Answer 14

A banking system in which banks keep on reserve less than 100 percent of their deposits.

Question 15

Define ‘Money supply’.

Answer 15

The amount of money available in the economy.

Question 16

Define ‘M1’.

Answer 16

Definition of money that includes cash plus chequing account balances.

Question 17

Define ‘M2’.

Answer 17

Definition of money that includes everything in M1 plus savings accounts and other financial instruments where money is locked away for a specified amount of time; less liquid than M1.

Question 18

Define ‘Central bank’.

Answer 18

The institution ultimately responsible for managing the nation’s money supply and coordinating the actions of the banking system to ensure a sound economy.

Question 19

Define ‘Monetary policy’.

Answer 19

Actions by the central bank to manage the money supply, in pursuit of certain macroeconomic goals.

Question 20

Define ‘Reserve requirement’.

Answer 20

The regulation that sets the min fraction of deposits banks must hold in reserve.

Question 21

Define ‘Open-market operations’.

Answer 21

Sales or purchases of government bonds by the central bank, to or from commercial banks. on the open market.

Question 22

Define ‘Contractionary monetary policy’.

Answer 22

Actions that reduce the money supply in order to decrease aggregate demand.
Contractionary monetary policy involves raising interest rates; the higher rates shrink aggregate demand, helping to slow the economy.

Question 23

Define ‘Expansionary monetary policy’.

Answer 23

Actions that increase the money supply in order to increase aggregate demand.
Expansionary monetary policy involves lowering interest rates; the lower rates increase aggregate demand, helping to expand the economy.

Question 24

Define ‘Overnight rate’.

Answer 24

The interest rate at which banks choose to lend reserves held at the Bank of Canada to one another, usually just overnight.

Question 25

Define ‘Liquidity preference model’.

Answer 25

The idea that the quantity of money people want to hold is a function of the interest rate.

Question 26

What are the 3 main functions of money?

Answer 26

1. A store of value
2. A medium of exchange
3. A unit of account

Question 27

What are the characteristics that make something a good choice as money?

Answer 27

Money needs to have stability of value and be convenient. Money also needs to be widely accepted.

Question 28

Since 1933, Canadian money has been ___ money, created by rules rather than backed by a commodity such as gold.

Answer 28

Fiat.

Question 29

The Bank of Canada classifies different types of money by their liquidity - by how easily an asset is to convert immediately to cash without losing value. Cash reserves held physically at the Bank of Canada are ___ ___, which can be used in transactions without delay. M1 and M2 definitions.

Answer 29

Hard money.

Question 30

What is the role of the central bank?

Answer 30

• In any nation, it’s duties generally include maintaining the money supply and coordinating the banking system.
• In Canada, the Bank of Canada has 4 functions: it is the sole issuer of Canada’s bank notes, conducts monetary policy via managing the money supply, acts as the fiscal agents for the federal government, and acts as a lender of last resort.

Question 31

What are the 3 tools the Bank of Canada has to enact monetary policy?

Answer 31

1. Changing the reserve requirement. Usually seen as a rather blunt tool - powerful but inappropriate for most day-to-day economic maintenance.
2. Change in overnight rate, a lending facility run by the Bank of Canada that allows any bank to receive cash in exchange for certain non-cash assets like government bonds; the interest rate charges for these loans is the overnight rate. The change in overnight rate is one of the Bank of Canada’s primary tools for providing liquidity to the markets and acting as a lender of last resort.
3. The most used tool is open-market operations, in which the Bank of Canada sells or buys government bonds in the open market. Use of this tool alters banks reserves and influences overall interest rates.

Question 32

The liquidity-preference model explains that the quantity of money people want to hold (the demand for money) is a function of the interest rate, which the Bank of Canada controls. As the quantity of money supplied changes, the price of that money, reflected in interest rates, will change as well. Increasing the money supply…?

Answer 32

Increasing the money supply (such as by buying government bonds on the open market) decreases interest rates. Decreasing the money supply (such as by selling government bonds) will increase interest rates.