class 9 Flashcards
what is money supply?
the quantity of money available in an economy
what are the 3 types of money supply?
M0
M1
M2
what is M0?
notes and coins in circulation (in the hands of the public)
what is M1?
M0 + all chequable deposits at depository institutions like banks and credit unions
what is M2?
M1+ term deposits, certificates of deposits, savings accounts
what is an example of M0?
all of the cash that the public has in their wallets
what is an example of M1?
all of the cash that the public has in their wallets and all of the money in checking accounts in banks and credit unions
what is an example of M2?
all of the cash that the public has in their wallets, all of the money in checking accounts in banks and credit unions and all of the money in savings accounts and at a bank for a certain term
are credit cards a part of money supply?
no they are not
who are the 3 players who control the money supply process?
the central bank
banks (depository institutions)
depositors
how do central banks control the money supply?
they are the ones who conduct monetary policy and who are responsible for how much cash and money is in circulation (impacting M0,M1,M2)
how do banks and depository institutions control the money supply?
they are the ones responsible for accepting deposits from individuals and institutions and they make loans (impacting M0,M1,M2)
how are depositors responsible for controlling money supply?
they make the decision of how much cash they hold, impacting M0
what are the 2 things that make up bank reserves?
settlement balances
vault cash
what are settlement balances?
banks have an account at the bank of canada in which they hold deposits, those balances are called settlement balances
what is vault cash?
the cash that banks hold in their vault to meet the withdrawal needs of their depositors
why do banks hold reserves?
to meet the withdrawal demands of their depositors and to manage their liquidity requirements
what are desired reserves (DR)/ required reserves?
reserves that are held to meet the central banks requirement for every dollar of deposits (demand deposits+ fixed term deposits) at a bank, a certain fraction must be kept as reserves
what is the desired reserve ratio?
the fraction of deposits (both fixed term deposits and demand deposits) that a bank desires to be kept as reserves
what is an example of a desired reserve ratio?
if the bank has 50 million worth of demand deposits and 50 million in fixed term deposits, they would have to keep 10 million as reserves if the desired reserve ratio was 10%, 10% of total reserves
what is the required reserve ratio in the US?
10%
what are excess reserves?
any reserves that a bank keeps that is more than the required reserve ratio
what canada have a required reserve ratio?
no, the banks can decide their own desired reserve ratio
what does a bank do if they don’t have enough reserves to meet their depositors withdrawal needs, what do they have to do?
they must borrow overnight funds from other banks or the BoC
what makes up a banks reserves?
both desired reserves and excess reserves
what are the 2 things on the bank of Canadas balance sheet?
assets
liabilities
what are the 2 things on the bank of Canadas liabilities side of their balance sheet?
currency in circulation
reserves
why is currency in circulation a liability to the bank of canada?
because when the currency is issued, they owe it to the holders of the currency to back the paper money so it has value
do bank notes in the hands of depository institutions count as currency in circulation?
no they do not, only the currency in the hands of the public counts
why are reserves a liability to the bank of canada?
because they have the obligation and liability to pay back that money back to the depositors they got it from
what are the 2 things on the bank of Canadas assets side of their balance sheet?
government securities
loans to a financial institutions
why are government securities an asset to the bank of canada?
they are used to affect money supply and earn interest
why are loans to financial institutions assets to the bank of canada?
bank of canada provides loans to banks and they charge the bank rate, giving the bank of canada interest
what is monetary base (high powered money)?
currency in circulation (notes and coins held by the public) plus the total reserves in the banking system (vault cash + settlement balances)
who creates monetary base?
the bank of canada
why does the bank of canada create monetary base?
because the control all of the currency in circulation and the total reserves in the banking system
what is another term for monetary base?
high powered money
what percentage of currency in circulation is made up of coins?
less than 1%
what are the 2 ways the bank of canada controls the monetary base?
open market operations
advances to banks and financial institutions
how does the bank of canada control the total reserves in the baking system?
total reserves are made up of vault cash and settlement reserves, they are in control of the the amount of cash in circulation depending on how much they issue, and they control settlement reserves by how much they lend banks, issue bonds and buy bank bonds
what is open market operation?
the purchase or sale of bonds by the bank of canada
when reserves increase, how does that impact the overnight rate?
it would go down and vice versa
if the bank of canada purchases 100m worth of bonds from TD, and pays them with a 100m cheque, how will that impact the banking system?
this will cause the assets and the liabilities of the bank of canada to increase by 100m on each side because the bank of canada would gain assets of 100m from the purchase of the bonds, and would gain liabilities of 100m from the bank depositing the 100m from the sale of the bonds in to the bank account TD holds with the bank of canada and increase the reserves of the bank of Canada by 100m
the bank would lose 100m in securities due to the sale of their bonds, but they would also have the gain of 100m of reserves from the cash from the sale of the bonds
if the bank of canada purchases 100m worth of bonds from TD, and pays them with a 100m cheque, how will that impact monetary base?
the net result would cause reserves of the bank of canada to increase by 100m, no change in currency circulation, causing the reserves in monetary base to rise by 100m and causing monetary base to rise in 100m
how will a rise in BoC reserves, and monetary base impact money supply?
it will eventually cause M1 to increase because the bank of canada reserves will increase the amount that banks can lend out
if the bank of canada sells 100m worth of bonds, how will that impact the banking system?
if they sell 100m worth of bonds the assets of the bank of Canada would go down by 100m because they sold the bonds to TD and their reserves would go down because they would take 100m out of TDs account to pay for the bonds and removing 10m from the bank of Canadas reserves
TDs assets will gain 100m of securities and they would lose 100m worth of reserves to pay for the bonds
if the bank of Canada sells 100m worth of bonds to TD, how will that impact monetary base?
it will cause the reserves of the bank of Canada to go down by 100m it will cause monetary base to decrease by the same amount of the sale
when reserves decrease, how does that impact the overnight rate?
the overnight rate increases
how does an open market purchase always impact monetary base?
a purchase from the BoC will alway increase the monetary base by the amount of the purchase
how does an open market sale always impact monetary base?
a sale from the BoC will always decrease the monetary base by the amount of the sale
what is the most common open market operation by the bank of canada?
repurchase transactions
if the bank of canada makes a 100m loan to TD, how does that impact the banking system?
the bank of Canadas assets increase by 100m from the loan, the bank of canada reserves increase by 100m because TD would deposit that loan in the their account they hold at the bank of Canada
TDs assets would increase their reserves by 100m from the loan and their liabilities would increase by 100m from the loan that they have to pay back
if the bank of canada makes a 100m loan to TD, how does that impact the banking system?
it will cause monetary base to increase by 100m because the bank of Canadas reserves increase by 100m
if a non-bank withdraws 100m in cash, how will that impact the banking system?
the banking system loses 100m in depots and 100m in reserves but they gain 100m in currency in circulation
if a non-bank withdraws 100m in cash, how will that impact monetary base?
monetary base will not change, the withdrawal decreases reserves by 100m and the cash withdrawn increase the currency in circulation by 100m, this causes each other to cancel out causing no change
if TD withdraws 100m in cash, how will that impact the bank of canada?
it will cause their liability to increase by 100m because of the new currency in circulation and cause their liability to decrease by 100m because their reserves decreases due to the money being takin out and in circulation, causing no changing to monetary base
who fully controls open market operations?
the bank of canada
what are the 2 ways the bank of canada controls monetary base?
open market operations
loans to the bank
what are the 2 components of monetary base?
non-borrowed monetary base
borrowed reserves
what makes up non-borrowed monetary base?
open market operations
what makes up borrowed monetary base?
borrowed reserves (loans to banks)
what component of monetary base is easy to control?
non-borrowed monetary base, open market operations they can control because they can chose what securities to buy and what to sell
what component of monetary base is not easy to control?
borrowed reserves, they cannot control banks to take out loans
how does open market purchase impact M1?
first national bank get 100M from the bank of canada due to open market operations, they loan (loans +100M) that money out causing chequable deposits (liabilities) at first national bank to increase because that loaned out money goes in to the bank accounts of the account holders at the bank
after they money is loaned out to their customers, their customers would use that money until first national banks deposits get to 0, that money would make its way to another bank, then that bank would get 100M of chequable deposits, making 10m reserves and 90 loans, this process would go on creating more and more chequable deposits until nothing is left. causing the money multiplier
what is the formula for deposit multiplier?
change D= 1/rd X change R
R= change in chequable deposits
what are 3 critiques of the simple deposit multiplier model?
holding cash stops the process, since currency does not have multiple deposit expansion
banks may not use all of their excess reserves to make loans or buy securities
depositors decisions of how much currency to hold and the banks decisions of how much excess reserves also cause the money supply to change
what are 5 factors that determine the money supply?
changes in the non-borrowed monetary base (open market operations)
changes in borrowed reserves from the bank of canada
changes in the desired reserves ratio
changes in excess reserves
changes in currency holdings
how is money supply and changes in non-borrowed monetary base related?
they are positively related, when non-borrowed monetary base goes up so does money supply
how are changes in borrowed reserves and money supply related?
they are positively related, when borrowed reserves from the bank of canada goes up money supply goes up aswell
how are changes in desired reserve ratio and money supply related?
they are negatively related, when deserve ratio goes up the money supply goes down
how are changes in excess reserves and money supply related?
they are negatively related, when excess reserves go up money supply goes down
how are changes in currency holdings and money supply related?
they are negatively related, when currency holdings increase money supply decreases
what is the money multiplier?
a formula that is used to tell us how much the money supply changes for a given change in monetary base
what is the relationship between money supply and monetary base?
money supply= money multiplier X monetary base
what is “c”?
currency ratio, currency/ chequable deposits
what is “e”?
excess reseve ratio, excess reserves/ chequable deposits
what is “R”?
total amount of reserves, = desired reserves+excess reserves
what is “DR”?
deserted reserves, reserve ratio X chequable deposits
what is the formula for monetary base?
MB= reserves +currency
MB= (reserve ratio X chequalbe deposits) + excess reserves + currency
what is the formula for money multiplier?
m= 1+c / rd+e+c
suppose,
desired reserve ratio: 10%
currency in circulation= 400 B
chequable deposit= 800B
excess reserves= 0.8B
money supply= 1200 B
currency ratio=0.5
excess reserve ratio= 0.001
what is the money multiplier?
m= 1+.05 / 0.1+0.001+0.5= 2.5
meaning that a 1 dollar increase in monetary base leads to a 2.5 dollar increase in the money supply
if the money multiplier is 2.5, and the monetary base increase by one dollar, how much will money supply increase?
a 1 dollar increase in monetary base leads to a 2.5 dollar increase in the money supply
if the first national bank receives an extra $100 of reservers but decides not to lend out any of these reserves. how much deposit creation takes place for the entire banking system?
none, because they decide not to lend any of it out, they just hold it as reserves
if a bank depositor withdraws 1000 of currency from an account and holds it, what happens to reserves, chequable deposits and the monetary base?
reserves goes down 1000$ from the withdrawal
chequable deposits goes down 1000$
monetary base stays the same, currency goes up 1000 but reserves goes down 1000 so it levels out
if a bank sells 10 million of bonds to the bank of canada to pay back 10 million on the loan it owes to the bank of canada, what is the effect on the levels of cheque able deposits?
nothing happens, the banks gains 10 million but then it instantly goes to the bank of canada to pay off their debt
“the bank of canada can perfectly control the amount of reserves in the system” is this statement true or false?
it is false, they can only control the desired reserve rate but not how much excess reserves the banks keep
if you decide to hold 100 less cash then usual and therefore deposit 100 more cash in the bank, what effect will this have on chequable deposits in the banking system?
the chequable deposits will increase by 100
if the bank of canada sells 2 million of bonds to the first national bank, what happens to reserves and the monetary base?
“the money multiplier is necessarily greater than 1” true or false?
false, its normally less than 1
assuming the banks do not hold excess reserve. if reserves in the banking system increase by 100, then checkable deposits will increase by 500 in the simple model of deposit creation what is the desired reserve ratio?
0.2
a bank has excess reservers of 4000 and demand deposit liabilities of 100,000 when the desires reserve ratio is 20%. if the desired reserve ratio is raised to 25%, what will the banks excess reserves be?
-1000 because they will have less than the requires reserves and 0 excess reserves
assuming the banks do not hold excess reserves. when the monetary base is equal to 200 B, the desired reserve ratio his 0.1 and the currency ratio is 0.2. what is the money multiplier and money supply?
money multiplier= 4
money supply= 800B
