Money and the Banking System Flashcards
What are the three functions that money performs?
1) Medium of exchange: an asset that people use to trade for goods and services rather than for their own consumption.
-The use of money eliminates the problem of the “double coincidence of wants” where two people have something that the other person wants.
2) Store of value: an asset that allows us to store our purchasing power.
3) Unit of account: a commonly accepted measure people used to set prices and make economic calculations.
-It enables people to compare two products to one another.
What is a commercial or chartered bank?
A bank is a financial intermediary that accepts deposits from savers, converts these deposits into loans to borrowers.
-If you look at the balance sheet of a commerical or chartered bank, you will see loans and bank reserves in assets.
-And their liability and shareholders equity will be deposits, and equity(which is the bank’s capital).
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For any bank’s balance sheet, what elements must equal one another? How do you calculate equity/banks capital?
-Loans+Bank reserves=Deposits+Equity
-Equity=Loans+Bank reserves-Deposits=Bank’s capital.
What is the fractional reserve banking system?
The fractional reserve banking system is when banks accept deposits, but they only hold a small fraction of the deposits, which they accept as reserves, and loan out the remaining amount.
What is the reserve ratio?
-The reserve ratio is the fraction of deposits that a bank holds as reserves.
-rr=Bank reserves/Deposits
-The reserve ratio must be between 0 and 1.
How do we find the amount of reserves that a commercial bank will hold?
-Reserves=ddrr
-Where dd is demand deposits they accept, and rr is reserve ratio.
-DD=(1/rr)reserves
Why was the fractional reserve banking system work?
It works because we have faith in the banking system. We can withdraw money whenever we want, and we will be able to take money from our account.
What is the Office of Superintendent of Financial Institutions used for?
It’s used to regulate commercial banks?
How does OSFI stablizie the banking sector?
1) Provision of deposit insurance
-If our bank shuts down, as long as the deposit in a particular checquing account is $100,000 or less, the government will bail out the commercial bank and cover the individual’s losses.
2) Capital requirements
-banks are required to hold more assets than the value of their bank deposits.
-Banks that are so large that they are “too big to fail” are required to hold more assets value than their bank deposits.
What does Money Supply equal?
MS=Currency in circulation (CC)+Demand Deposits (DD)
What does excess reserves equal?
Excess reserves=Actual reserves-Desired reserves
When an individual makes a deposit, how is the bank affected?
-When a deposit is made, the the bank has excess reserves.
-To bring the reserve ratio(r.r.) back to 0.1 the bank will make more loans, and have to loan out some of that money.
How is the change in demand deposit formula similar to the multiplier effect? What is it’s formula?
-Change in demand deposit=1/reserve rate*change in reserves
-The change in demand deposit shows the maximum potential increase in deposits that the banking system can create from a given increase in reserves, under a fractional reserve banking system.
What is a central bank? What are it’s functions?
-A central bank is an institution that oversees and regulates the banking system, designs and implements the monetary policy.
-The bank of Canada is Canada’s central bank.
1) The BOC serves as the lender of last resort.
-It is the banker’s bank. In case banks are struggling with liquidity, typically the banks borrow from one another. If the banking system is under distress, the banks won’t be able to loan to one another, and they will need to go to the Bank of Canada.
-The interest rate they charge is called the bank rate?
2) The BOC acts as a banker for the federal government.
-The bank of canada holds the government’s accounts, depositing tax revenues, and from these accounts, the government pays for programs, infrastrucutre, salaries, and more. The Bank of Canada handles all federal government payments including direct deposits to idnividuals, and interest payments on government bonds.
3) THE BOC issues currency
-The BOC can print money.
4) The BOC conducts monetary policy
-The BOC does not have complete control over the money supply, and commercial banks still have an impact as well.
-But they have good control over the country’s monetary base, the sum of currency in circulation and bank reserves.
What is the bank rate?
-The bank rate is the interest rate that the central bank charges to individual banks to loan money from them.
-Bank rate=overnight rate+0.25%
What is the monetary base?
Monetary base=Currency in circulation+Base reserves
What is the money multipler? What is it’s formula?
-The money multiplier is how much money supply will change when there is a change in monetary base–the rtatio of the Money Supply to the Money Base.
-AMoney multiplier=Money supply/Monetary base
What is the overnight funds market?
The overnight funds market is chartered or commercial banks lending to one another.
What happens if the Bank of Canada raises the overnight rate?
-The chartered bank will hold more reserve ratio, because then it will become more costly to borrow from the central bank and the overnight funds market.
-Consequently, as the reserve ratio increases, demand deposits decrease, which then decreases money supply.
What are open market operations?
Open market operations refer to the purchases and sales of government bonds by the central bank.
When the central bank purchases government bonds, what happens? When the central bank sells government bonds, what happens?
-When the central bank purchases government bonds, the central bank carries out an open market purchase.
-When the central bank sells government bonds, the central bank carries out an open market sale.
What is deposit switching?
-Deposit switching refers to the moving of fovernment deposits between the BOC and the chartered banks. It is used by the BOC in its day to day operations.
-By transferring government deposits between the BOC and the chartered banks, the BOC can change the monetary base (via a change in bank reserves).
What is interest rate targetting?
Refers to the practice of the central bank trying to keep interest rate at a pre-specified level.
-It’s a bit easier for the government to have individuals react the way they want by targeting interest rate than money supply targetting.
What is money supply targeting?
-Refers to the practice of keeping money supply at a pre-specified level.
-The BOC does not have complete control over the money supply, but it can control the overnight rate almost perfectly.
-It is easier for housholder and firms to understand the implications of a change in interest rate than a change in money supply.
