Midterm 2 Flashcards
what is money
money is any commodity or token that is generally accepted as a means of payment
what are the three other functions of money
medium of exchange
unit of account
store of value
what does money in Canada consist of
currency
deposits at banks and other depository institutions
what is the M1 measure of money
currency held outside banks by individuals and businesses, and checkable deposits owned by individuals and businesses
what is the M2 measure of money
M1 plus all other non checkable deposits held by individuals and businesses
what is a depository institution
a firm that takes deposits from households and firms and makes loans to other households and firms
what are the four assets chartered banks puts deposits into
reserves: notes and coins in its vaults or in its deposits at the bank of Canada
liquid assets: canadian government treasury bills and commercial bills
securities: longer dated government bonds and other bonds such as MBS
loans: commitments of fixed amounts of money for agreed upon periods of time
what is a central bank
a public authority that regulates a nations depository institutions and controls the quantity of money
what are the three roles of BOC
the banker to the banks and government
the lender of last resort
the sole issuer of bank notes
what is the monetary base
the sum of bank of Canada notes outside the bank of Canada, banks deposits at the bank of Canada, coins held by households firms and banks
what is open market operation
the purchase and sale of government of Canada securities by the BOC in the open market to control the monetary base
what are the bank of Canadas two main policy tools
open market operation
bank rate
what is the bank rate
the interest rate on the short term loans the BOC makes to depository institutions when the banking system is short of reserves
what limits the quantity of deposits banks can create
the monetary base
desired reserves
desired currency holding
what are a banks actual reserves
notes and coins in the banks vaults and deposits at the BOC
what is the banks desired reserve ratio
the ratio of the banks reserves to the total deposits it plans to hold
what is the banks excess reserves
actual reserves minus desired reserves
what is the currency drain
the leakage of reserves into currency caused by individuals and firms desired currency holding
what is the currency drain ratio
the ratio of currency to deposits
what are the steps in the money creation process
BOC increases monetary base through open market operations, banks reserves increase, excess reserves are created, banks lend more to decrease excess reserves, loans create new deposits, new deposits are used to make payments and are drained into currency, desired reserves increase
what is the money multiplier
the ratio of the change in the quantity of money to the change in monetary base
what are the four factors affecting how much money people plan to hold
the price level
the nominal interest rate
real GDP
financial innovation
what is the quantity theory of money
the proposition that in the long run an increase in the quantity of money brings an equal increase in the price level
what is the velocity of circulation
the average number of times in a year a dollar is used to purchase goos or services in GDP
what is the equation of exchange
MV = PY
what is the formula for the money multiplier
MM = (1 + C/D)/C/D + R/D)
what is the demand for money
the relationship between the nominal interest rate and the quantity of real money demanded
when is the money market in long run equilibrium
when the inflation rate equals the expected inflation rate, real GDP equals potential GDP
what is foreign currency
foreign bank notes, coins, and deposits
what is the foreign exchange market
the market in which currency of one country is exchanged for another
what is the quantity of Canadian dollars demanded
the amount of Canadian dollars traders plan to buy during a given time at a given exchange rate
what 4 factors affect the quantity of Canadian dollars demanded
the exchange rate, world demand for Canadian exports, interest rates in the US and other countries, the expected future exchange rate
what is the law of demand for foreign exchange
other things remaining the same as the exchange rate rises the quantity of CAD demanded in the foreign exchange market decreases
what is the exports effect
as the exchange rate decreases the value of canadian exports rises so the demand for those exports and therefore CAD increases
what is the expected profit effect(demand)
a lower exchange rate means it is cheaper to purchase CAD so the demand for CAD increases on the expectation that it will appreciate and create profit for those traders
what is the quantity of CAD supplied
the amount of CAD traders plan to sell in a given time period at a given exchange rate
what factors affect the quantity of CAD supplied
the exchange rate, Canadian demand for imports, interest rates in Canada and other countries, the expected future exchange rate
what is the law of supply of foreign exchange
other things remaining the same, the higher the exchange rate the greater the quantity of CAD supplied in the foreign exchange market
what is the imports effect
a higher exchange rate means Canadian imports are more valuable as the CAD has more foreign purchasing power so the quantity of CAD supplied increases
what is the expected profit effect(supply)
all else equal a lower exchange rate means greater expected profit from holding CAD so the supply of CAD is lower
what is the Canadian interest rate differential
the Canadian interest rate minus the foreign interest rate
what is arbitrage
the practice of seeking profit by buying in one market and selling in another for a higher price
what outcomes are created by arbitrage in the foreign exchange market
the law of one price
no round trip profit
interest rate parity
purchasing power parity
what is the law of one price
if an item can be traded in more than one place the price will be the same in all locations
what is no round trip profit
you can’t profit from using currency A to buy B then using B to buy A
what is interest rate parity
interest rate parity means you can earn the same returns from different currencies
what is purchasing power parity
when two different quantities of two different currencies can purchase the same quantity of goods and services
what is the real exchange rate
the relative price of Canadian produced goods and services to foreign produced goods and services
what is the formula for the real exchange rate
RER = (nominal exchange rate x price level)/price level of other country
what is a flexible exchange rate
an exchange rate policy that allows supply and demand to determine the rate with no intervention from the government of central bank
what is a fixed exchange rate policy
an exchange rate that is pegged to a certain value and managed by direct intervention by governments and or central banks
what is a crawling peg policy(managed float)
a policy that follows a path for the exchange rate set out by government and or central bank
what are a countries balance of payments accounts
accounts that record a countries international trading, borrowing, and lending
what are the three balance of payment accounts
current account
capital and financial account
official settlements account
what does the current account record
receipts of exports, payments for imports, interest paid abroad, net transfers abroad such as foreign aid payments
what is the formula for the current accounts balance
exports - imports + net interest income + net transfers
what does the capital and financial account record
foreign investment in Canada minus canadian investment abroad
what does the official settlements account record
the change in official canadian reserves
what are canadian official reserves
Canada’s holding of foreign currency
what is the quantity of real GDP supplied
the total quantity that firms plan to produce in a given period
what is aggregate supply
the relationship between the quantity of real GDP supplied and the price level
what is long run aggregate supply
aggregate supply when real GDP equals potential GDP
what is short run aggregate supply
aggregate supply when the money wage rate, prices of other resources, and potential GDP remain constant
what factors can shift aggregate supply
changes in potential GDP
changes in the money wage rate and other factor prices
what can cause potential GDP to increase
full employment quantity of labour increases
quantity of capital increases
an advance in technology occurs
what is the quantity of real GDP demanded
the total amount of final goods and services produced in Canada that firms, people, and governments plan to purchase in a given time period
what is aggregate demand
the relationship between the quantity of real GDP demanded and the price level
what is the wealth effect
a rise in the price level other things equal decreases the quantity of real wealth, people increase savings and decrease spending, the quantity of real GDP demanded decreases
what are the substitution effects
intertemporal substitution effect
international substitution effect
what is the intertemporal substitution effect
a rise in the price level other things equal decreases the real value of money and increases the interest rate, people borrow and spend less, quantity of real GDP demanded decreases
what is the international substitution effect
a resent he price level other things equal increases the price of domestic goods relative to foreign goods, imports increase and exports decrease, the quantity of real GDP demanded decreases
what factors can shift aggregate demand
expectations
fiscal policy
monetary policy
the world economy
how do expectation effect aggregate demand
increase in expected future income increases aggregate demand
increased expected future inflation increases aggregate demand
increased expected future profit increases aggregate demand
how does fiscal policy effect aggregate demand
an increase in disposable income increases aggregate demand
an increase in government expenditure increases aggregate demand
how does monetary policy effect aggregate demand
an increase the quantity of money increases aggregate demand
a decrease in interest rates increases aggregate demand
how does the world economy effect aggregate demand
a fall in the foreign exchange rate increases aggregate demand
a rise in foreign income increases aggregate demand
what is short run macroeconomic equilibrium
when quantity of real GDP supplied and demanded are equal and the AD and SAS curves intersect
what is long run macroeconomic equilibrium
when real GDP equals potential GDP and the AD curve intersects the LAS curve
how does the AS-AD model show the business model
the SAS and AD curve fluctuate but the money wage rate does not change as fast so the intersection of the SAS and AD curve move while the long run economic equilibrium point and potential GDP stay constant
what is stagflation
when there is inflation and an increase in unemployment
what factors change the money wage rate
departure from full employment
inflation expectations
what is the Keynesian model
a way to describe the economy is the vey short run when prices are fixed
the price level is fixed
aggregate demand determines real GDP
what is the two way link between AE and real GDP
an increase in AE increases real GDP
an increase in real GDP increases AE
what is disposable income
aggregate income minus net taxes
YD = Y - T
what are the two formulas for YD
YD = Y -T
YD = C + S
what is the consumption function
the relationship between consumption expenditure and disposable income other things equal
what is the saving function
the relationship between saving and disposable income other things equal
what is autonomous consumption
the consumption expenditure when disposable income is 0
what is induced consumption
consumption expenditure that is in excess of autonomous consumption induced by an increase in disposable income
what are the three factors other than disposable income that influence consumption and saving
wealth
the real interest rate
expected future income
what is the marginal propensity to consume
MPC is the fraction of a change in disposable income spent on consumption
change in consumption expenditure / change in disposable income
what is the marginal propensity to save
MPS is the fraction of a change in disposable income that is saved
change in saving / change in disposable income
what factors can change disposable income
a change in real GDP
a change in net taxes
what is the marginal propensity to import
the fraction of a change in real GDP spent on imports
what is aggregate planned expenditure
the sum of planned consumption, planned investment, planned government spending, and planned net exports
which parts of aggregate planned expenditure are influenced by real GDP
planned consumption expenditure and planned imports
what is the aggregate expenditure curve
a graph of the table showing the relationship between aggregate planned expenditure and real GDP
what is induced expenditure
consumption expenditure minus imports
what is autonomous expenditure
the sum of investment, government spending, and exports
why are aggregate planned expenditure and aggregate expenditure different
firms can have unplanned changes in inventory
what is equilibrium expenditure
the level of aggregate expenditure that occurs when aggregate planned expenditure is equal to real GDP
what is the multiplier
the amount by which a change in autonomous expenditure is magnified or multiplied to determine the change in equilibrium expenditure and real GDP
why does the multiplier exist
an increase in any component of autonomous expenditure increases aggregate expenditure and real GDP, the increase in real GDP creates further increases in induced expenditure leading to a further increase in aggregate expenditure and real GDP, real GDP and aggregate expenditure end up increasing more than the original increase in autonomous expenditure
how is the size of the multiplier calculated
the change in equilibrium expenditure / the change in autonomous expenditure
how does the sloper of the AE curve determine the multiplier
multiplier = 1 / (1 - AE slope)
what two factors reduce the size of the multiplier
imports and income taxes
how does the business cycle relate to autonomous expenditure
when autonomous expenditure increases there is a unexpected decrease in inventories causing an expansion
when autonomous expenditure decreases there is an unexpected increase in inventories causing a recession
what is the multiplier in the long run
zero
