March 12 & 17 Flashcards
3 characteristics of money
- medium of exchange
- store of value
- unit of account
money as a medium of exchange - if there was no money…
goods would have to be exchanged in a system of BARTER
barter = very inefficient due to the double coincidence of wants
money as a store of value: without inflation, money…
without inflation, money RETAINS ITS VALUE WELL
metallic money
- before invention of coins, was necessary to CARRY THE METALS in BULK
- invention of coinage eliminated need to WEIGH the medal with each transaction
- but coins often couldn’t be taken at face value, because of practice of CLIPPING THIN SLICE off the edge of the coin
Gresham’s law
theory that ‘BAD’ (or debased/clipped/mixed) money drives ‘GOOD’ money out of circulation
paper money
- GOLDSMITHS needed secure safes, and public began to DEPOSIT with them for safekeeping
- goldsmiths would GIVE DEPOSITORS RECEIPTS promising to return the gold on demand
- if goldsmiths were known to be reliable, buyers began to TRANSFER the goldsmith’s receipt when MAKING A PURCHASE
- this transferring of paper receipts rather than gold was essentially the INVENTION OF PAPER MONEY
bank notes
early paper money
later became issued by banks
were BACKED by PRECIOUS METAL and convertible on demand into this metal
early on, goldsmiths and banks discovered…
discovered that it wasn’t necessary to keep one ounce of gold in the vaults for every claim to one ounce circulating as paper money
currency is FRACTIONALLY BACKED by the reserves
as time went on, what happened currency (notes and coins) issued by private banks?
they became less common
because CENTRAL BANKS TOOK CONTROL over issuing currency
eventually, ONLY central banks were permitted by law to issue currency
nowadays, are private banks allowed to issue currency?
nope
only the central bank
what is our money today called?
fiat money
fiat money
paper money or coinage that’s NEITHER BACKED BY NOR CONVERTIBLE into anything else but is decreed by government to be LEGAL tender
- if fiat money is generally acceptable, it’s a medium of exchange
- it its purchasing power remains stable, its a satisfactory store of value
- if both the above are true, its a satisfactory unit of account
deposit money
money held as deposits with commercial banks and other financial institutions
bank deposits = an important part of the money supply
how do banks create money?
by issuing more PROMISES TO PAY (deposits) than they have in cash reserves
cryptocurrencies
another form of money
bitcoin, ethereum, ripple
most banking systems have which two components
- a central bank
- many financial intermediaries
3 main characteristics of the central bank
- acts as a bank to the banking system
- usually government owned
- the sole money-issuing authority
when was the Bank of Canada created?
1935
organization of the BoC is designed to do what?
to keep the operation of monetary policy free from day-to-day political influence
BoC has CONSIDERABLE AUTONOMY, but the ULTIMATE responsibility for the Bank’s actions rests with the government
formally accountable to the Minister of Finance and Parliament
joint responsibility system
BoC has considerable autonomy but is formally accountable to the Minister of Finance and Parliament
4 basic functions of the BoC
- act as a banker to commercial banks
- act as fiscal agent of the federal government
- regulate the money supply
- regulate, support, monitor financial markets
what did the gov of Cad do in early 2020?
they issued a massive amount of NEW SECURITIES to provide FINANCIAL RELIEF to unemployed workers and businesses whose revenue had collapsed
BoC played important role by PURCHASING a large amount of these newly issued securities, thereby EXPANDING the amount of MONEY in the banking system
commercial bank
privately owned, profit seeking institution
provides variety of financial services
important FINANCIAL INTERMEDIARIES - crucial for the smooth operation of credit markets
when we say commercial banks are financial intermediaries, what do we mean?
means they ACCEPT DEPOSITS and PROVIDE CREDIT
are crucial to the smooth operation of credit markets
balance sheet of commercial bank: categories
assets:
1. reserves (R)
2. government securities (G)
3. loans (L)
liabilities:
1. deposits (D)
liabilities
something we must respond to
ie. deposits - we must respond to demand for its withdrawal
balance sheet of central bank: categories
assets:
1. government securities (G)
liabilities:
1. C (notes in circulation)
2. D (reserves)
banks’ cash reserves are normally quite…
small
because only a small fraction of depositors want their money at a time
reserve ratio
the fraction of its deposit liabilities that it actually holds as reserves
^ either in vault cash or deposits with the central bank
target reserve ratio
the fraction of deposits the bank wants to hold as reserves
^ this is the optimal ratio
^ below it is risky, above it is unnecessary
Canadian banking system as a fractional-reserve system…
in March 2019, they held less than 1% of their deposits in resserves
excess reserves
any reserves in excess of target reserves
these are central in the process of MONEY CREATION
simplifying assumptions in money creation by the banking system
- banks invest only in LOANS (no gov securities)
- there are only DEMAND DEPOSITS
- there’s a FIXED TARGET RESERVE RATIO
- there’s NO CASH DRAIN from the banking system (no withdrawals)
what’s a new deposit?
a deposit of cash that’s NEW to the BANKING SYSTEM
3 examples:
- an individual may IMMIGRATE to Canada
- an individual who had cash STASHED UNDER THE BED decides to deposit into bank account
- BoC purchases a GOVERNMENT SECURITY from an INDIVIDUAL/FIRM
a single new deposit begins…
a long sequence of deposit creation
with a target ratio of 20%, a new deposit of $100 creates…
a total expansion of deposits of $500
(because initial $100 - $80 is lent out and $20 is kept at reserves - the $80 re-enters as investment in loans - then the $80 is spent and received by a second-round bank in new deposits - new bank expands its loans by $64 etc etc etc)
with no cash drain, a banking system with a target reserve ratio of v will change its deposits by…
1/v times any change in reserves (the new deposit)
change in deposit = (1/v) (change in new deposits)
difference between new deposits and addition to reserves
will always be NEW LOANS
what dampens the deposit-creation process?
if households HOLD A FRACTION of their deposits in CASH
^ cash drain
^ introduces the CURRENCY-DEPOSIT RATIO
if c is the currency-deposit ratio, the final change in deposits is given by:
change in deposits = (1/(c+v) (new cash deposit)
^ accounts for the cash drain
c and v
c = currency-deposit ratio (in case of a cash drain)
v = target reserve ratio
example: currency-deposit ratio is 5%, reserve-deposit ratio is 1%. $100 cash injection will eventually lead to a total change in deposits equal to…
change in deposits = (1/(c+v)) (new cash deposit)
change in deposits = 1/(0.05+0.01)($100) = $1666.67
money supply
total quantity of money that’s in the economy at any time
several definitions of money
generally, money supply equals
currency + deposits
long standing distinction between money and other highly liquid assets
- money was a medium of exchange that DID NOT EARN INTEREST
- other assets earned interest, but were NOT a MEDIUM OF EXCHANGE
but today, the distinction is very BLURRED
M2 definition of money
currency + chequable and non-chequable deposits held at the chartered banks
M2 versus M2+ verus M3 etc
difference in the types of deposits included in the definition - become broader as the numbers increase
come to include less liquid deposits
near money
- STORE OF VALUE
- READILY CONVERTED into a medium of exchange
ie. short term bonds
ie. term deposits
2 types of near money
short term bonds
term deposits
money substitutes
- serve as a TEMPORARY MEDIUM OF EXCHANGE but are not a store of value
ie. credit cards
choosing a measure of money
- no single timeless or best definition of money
- new financial assets = continually being developed that serve some of the functions of money
