Chapter 4 - The Monetary System Flashcards
Money definition?
stock of assets readily used to make transactions (incl. fin assets)
anything generally accepted as payment for G&S or in the settlement of debts and is distinct from income or wealth
Is morny more defined by form or function?
Function
has many forms
‘generally accepted’
money is a social convention in sense people are willing to acceppt
3 functions of money
medium of exchange (key function)
store of value (carry pp over time)
unit of account: common unit by everyone measures price and values
Two types of money and examples
Fiat money: no intrinsic value
EX. paper currency used
Commodity money: has intrinsic value
EX. Gold coins, tooniess, cigarettes in war
What is not money
cheques, debit cards, credit cards
what is money
currency, demand deposits (chequing account), time deposits (certification of deposits, have time restrictions)
Money supply definition?
quantity f money available in the eeconomy
What are the two measures of money supply and their equations? Compare them
- Monetary Base (aka high-powered money)
M base = C+R
(currency in circulations and in reserves) - Money supply: how the public pay for transactions
M supply = C + D
(current in circulation and bank deposits)
comparison: M base > M Supply
because base has multiplier
M1 define money:
M1 currency outside banks (narrow and liquid definition of money supply)
M1 = chartered ba bank chequable deposit - inter bank chequable deposits
M2 Currency outside banks (wider and less liquid due to time restrictions)
Includes:M1 + notice deposits + personal deposits
does M1 to M2 get wider/narrower, or more/less liquid?
from 1-2
definition gets wider
less liquid
What three players control money supply?
Central bank
Depository institutions: banks/credit union
Public; household/citizens
how is money controlled?
monetary policy: controlled by central bank
Whst 2 tools used to control money (monetary policy tools)?
Open-market operations and deposit switching
What is oppen market operations?
purchase and sales of gov bonds
sell securities to public –> reduce Ms
bank purchased gov securities -> rise Ms
SPRA:
cnoducting repo
Deposit swifting?
shifting funds from and to the gov account held at the central bank and charter banks
increase supply -> transfer from the central bank to commercial (more reserves)
Decrease supply -> transfer from commercial to chartered (fewer reserves)
is open market operations or deposit seitching preferred
deposit switching because can do it on own (do not need the bank and customers, can do it internally)
What is the traditional role of banks in the monetary system?
financial intermediation (b/w lenders and borrowers)
- Pay less interest to depositors and charge higher interest to borrowers
banks profit by making deposits -> loans
In the bank POV, classify assets vs liabilities
deposits, reserves, outstanding loans
Assets: reserves, outstanding loans
Liabilities: deposits
What are reserves: what are the two types of banking and their rules.
Reserves: portion deposits banks not lend (used to satisfy demand for withdrawals)
Types of reserves:
1. 100% reserve banking: D = R
RULE: no impact on money supply
2. Fractional-reserve banking: R < D
RULE: creates money through loans
What is the legally required reserve % in canada
0%
In no banks scenario, how does M = C+D hold true
D=0 since no banks
M = C
In 100% reserve banking, what is the result on M=C+D
As more deposits made, D increases, C decreases, and M = their sum
TF: no impact on Ms size
Fractional reserve banking, what is the result on M=C+D
when deposits are made:
Assets increase (reserves, loans)
Liabilities increase (deposits)
TF: creates money supply
Equation for total money supply
total money supply = OG deposit + sum of each bank’s lending + other lending
Total money supply = 1/rr*initial deposit
where Deposit multiplier = 1/rr
where reserve ratio rr = reserve/deposits
What relationship does rr have on money supply
rr has a negative relationship with the money supply
high rr –> less in C –> Ms small
lower rr –> more in C –> Ms bigger
What are the assumptions held to the deposit multiplier?
Deposit multiplier = 1/rr
Assumptions:
1. all banks keep same rr
2. no cash drain (when new loan given, all of it comes back as new deposit)
Define bank capital
bank capital: resources a bank’s owners have to put into the bank
owner’s equity of the bank
Define leverage. are banks high or low leverage
leverage: use of borrowed money to supplement existing funds for purpose of investment
banks: highly leveraged, small decline in bank assets have huge impact on bank capital
What is the leverage ratio formula? what does it tell you
Leverage ratio = assets/capital = assets/OE
where… capital = A - L (ALOE)
For every dollar of owned equity, the bank has assets of __$.
In financial crises, what happends to bank
bank assets value falls and cannot revocer own equity (leverage)
Banks pay lenders first (owners paid leftover)
Insolvency: liabilities > assets (leads to bank failure)
Define capital requirement
capital requirement: minimum amount of capital mandated by regulators
What are the exogenous (fixed) variables in model of Money supply?
Monetary base: controlled by the central bank (B = C+R)
Reserve-deposit ratio: depends on regulations and bank policies (rr=R/D)
Currency-deposit ratio: depends on household preference (cr=C/D)
in the model of money supply, what is the equation for Money supply, short and long form?
what is the change equation if there is changes in monetary base?
M = m*B
M = (cr+1)/(cr+rr) * B
where… multiplier: m = (cr+1)(cr+rr)
long form:
M = (C/D + 1)/(C/D + R/D) * (C+R)
Change:
changeM = m*changeB
The money multiplier define
increase in Ms due to 1$ rise in B
if rr<1 –> m>1
If households hold more money (as currency) and less deposits,what is the impact?
cr increases (cr = C/D) >0
since D falls, C increase -> m falls -> Ms falls
aka. less deposits -> less bank loans -> less money creation
Summary: define money, list functions, and list types, controlled by?
- Definition: stock of assets used for transactions
- Functions: Medium of exchange, store value, unit account
- Types: commodity (intrinsic value), fiat (no intrinsic value)
- Money supply is controlled by the central bank
How does fractional reserve banking create money?
because each dollar of reserves generates many dollars in demand deposits (which continue to become loans)
What three things does money supply depend on?
cr = C/D (currency-deposit ratio)
rr = R/D (reserve ratio)
B = C+R (monetary base)
The money multiplier define
increase in Ms due to 1$ rise in B
if rr<1 –> m>
How does the central bank control money supply
open-market operations
- increase Ms: bank buys gov securities
- decrease Ms: gov sell securities to public
deposit switching
- increase Ms: transfer Central -> commercial
- decrease Ms: transfer commercial -> central
