Chapter 15 Flashcards
What is money
The set of all assets that are regularly used to directly purchase goods and services
What is store of value
A certain amount of purchasing power that money retains over time
What is medium of exchange
The ability to use money to purchase goods and services
What is a barter
Directly offering a good or service in exchange for some good or service you want
What is commodity- backed money
Any form of money that can be legally exchanged into a fixed amount of an underlying commodity
What is fiat money
Money created by rule, without any commodity to back it
What are demand deposits
Funds held in bank accounts that can be withdrawn by depositors at anytime without advance notice
What are reserves
The money that a bank keeps on hand, either in cash or in deposits, at the bank of canada
What are requires reserves
The minimum fraction of deposits that banks are legally required to keep on hand
What are excess reserves
Any additional amount beyond the required reserves that a bank chooses to keep in reserve
What are desired reserves
In the absence of requires reserves, the amount of reserves a bank wishes to hold
What is the basic accounting equation
Assets = liabilities + owners equity
How do you calculate change in money supply
Change in reserves x money multiplier
What is fractional reserve banking
A system in which banks keep on reserve less than 100 percent of their deposits which allows the bank to lend out a portion of the money deposited in the bank
What is the money multiplier
The ratio of money created by the lending activities of the banking system to the money created by the central bank
We calculate it as 1/R
Where R is the reserve ratio
What is money supply and momentary base
The amount of money available in the economy
Contains: cash and bank reserves (can be used immediately) known as momentary base
What is M1+
Includes currency held by the public plus chequing account balances at charted banks, trust and mortgage loan companies, credit unions and caisses populaires (demand deposits)
*if we want to look at spending use M1+
What is M2
Includes everything M1+ has plus personal savings accounts and non-personal notice deposits where money is locked away for a specific period of time
- when looking at savings use M2
- it can give a sense of the money multiplier
What is a central bank
The institution ultimately responsible for managing the nations money supply and coordinating the banking system to ensure a sound economy
What are the four essential functions of a central bank (bank of canada)
- Being the sole issuer of Canada’s bank notes
- Conducting monetary policy via managing the money supply
- Acting as the fiscal agent for the federal government
- Acting as a lender of last resort
What is the main difference between the department of finance and the bank of canada
The department of finance executes fiscal policy
The bank of canada conducts monetary policy
What is monetary policy
It consists of actions by the central bank to manage the money supply, in pursuit of certain macroeconomic goals
What is lender of last resort
Central banks can act as a lender of last resort which means that when nobody else is willing to lend to banks facing a bank run, the bank of canada can step in and do it
What is the primary objective of the bank of canada
To enhance the wellbeing of Canadians by contributing to sustained economic growth, rising levels of employment, and improved living standards
What tools does the bank of canada use to conduct monetary policy
Reserve requirements, open-market operations, and changing the target for overnight rate
What is the reserve requirement
The most powerful tool used by the central bank but rarely used
It is the regulation that sets the minimum fraction of deposits banks must hold in reserve
What are open market operations
Sales or purchases of government securities/bonds by the central bank, to or from commercial banks, on the open market
Directly result in an increase or decrease in the money supply
What is expansionary monetary policy
Actions that increase the money supply in order to increase aggregate demand
What is contractionary monetary policy
Actions that reduce the money supply in order to decrease aggregate demand
What is the overnight rate
The interest rate at which banks chose to lend reserves held at the bank of canada to one another usually just overnight
Helps meet the goal of contractionary policy - slowing the economy down
What is the liquidity preference model
The idea that the quantity of money people want to hold is a function of the interest rate
Money demand curves slope downward, showing a negative relationship between interest rate and money demanded
In the liquid preference model, what happens when interest rates rise
We demand a lower quantity of money, moving leftward along the curve
In the liquid preference model what happens when interest rates fall
when the interest rate falls we demand a high quantity of money, moving rightward along the curve
What factors cause the demand curve to shift in the liquid preference model
- Price level: higher prices will increase demand which will shift the money demand curve to the right
- Increases (shift right) or decreases to GDP (shift left)
In the liquid preference model, what is the point where supply of money equals demand for money
The nominal interest rate (r*)
What will shift the money supply curve to the right and what is this called
Any actions that increase the money supply (expansionary monetary policy)
- decreasing the reserve requirement
- decreasing the target for the overnight rate
- buying government bonds on the open market
What will shift the money demand curve to the left and what is it called
Any action that decreases money supply (contractionary monetary policy)
What does the slope of the money demand curve determine
How the change in the money supply will change the interest rate
What happens when the slope of the demand curve is elastic
It will have a smaller effect on interest rates
What will happen if the slope of the demand curve is
inelastic
The changes in money supply will have a greater effect on interest rate
How do lower interest rates affect the rates of return on assets throughout the economy (expansionary monetary policy)
- when the bank of Canada purchases bonds on the open market, it increases the demand for those bonds, drives up prices, and lowers their expected rates of return
- this makes investors shift their portfolios towards other assets
- this shift then increases the prices of the other assets in the economy and reduces their rate of return
What is the balance sheet channel
The idea that a rise in asset prices causes firms and households to perceive an increase in their net worth which makes them increase spending
With lower interest rates people don’t save money so the aggregate demand increases and shifts to the right
Contractionary monetary policy
Actions that reduce money supply in order to decrease aggregate demand
What are the three main functions of money
- Store of value
- Medium of exchange
- Unit of account
What is the reserve ratio
The ratio of the original deposit to the amount kept as reserves
