The Monetary System Flashcards
Most common form of money
Currency
Money
set of assets that people in an economy regularly use to buy goods and services
2 types of money
Commodity Money and Fiat Money
Intrinsic Value
Item that would have value even if it wasn’t used as money.
Commodity Money
Money in the form of a commodity that has intrinsic value
Fiat Money
Money that has no intrinsic value that is used as money because of government decree
Why is currency not a commodity money?
It has no intrinsic value
3 Functions of Money
Medium of Exchange, Unit of Account, Store of Value
Are Credit Cards a form of money? Why or why not?
Not money. You are storing debt, not value
Debit Cards and Cheques are what type of money?
Liquid money
Liquidity
The ease to which an asset can be converted to an economy’s medium of exchange
Most important function of the Bank of Canada
Regulate the amount of money in circulation
Which Canadian Institution prints money?
Royal Canadian Mint
4 primary functions of the Bank of Canada
Issue Currency, Act as a banker to Commercial Banks (Second Floor Banking, Act as a banker to Canadian government, Control money supply
T-Account
Banks’ accounting system
Deposits are what for the banks?
Liabilities, because they are not the banks’ money
T-Account divided into these two section
Assets and Liabilities
Reserves (R)
Deposits that banks received but have not yet loaned out
Two types of reserves
Required and Excess
Required Reserves are required by who?
Bank of Canada
How do we measure money supply?
Currency + Demand Deposits
Currency
The paper bills and coins in the hands of the public
Demand Deposits (D)
Balances in bank accounts that depositors can access on demand by writing a check or using a debit card.
100% Reserve Banking
Money Supplied = Currency + Demand Deposits
Banks don’t lend your money
Fractional Reserve Banking
Modern Banking - Banks keep a portion of your deposits as reserves and loans the rest out to the public - banks create money
Reserve Ratio (R)
Fraction of deposits that banks hold as reserves
Money Multiplier
The amount of money the banking system generates from each dollar of reserves
Money Multiplier Formula
1/R (Reserve Ratio)
Bank Run
A situation in which banks cannot repay their depositors because their loans are not recoverable
Three tools that the Bank of Canada can use to alter the amount of money in circulation (Money Supply)
Open Market Operations and Foreign Exchange Market Operations, Changing Reserve Ratio, Changing Key Bank Rate
What can the Bank of Canada buy with Canadian Currency to increase money supply?
Bonds and foreign currencies
Sterilization
Central Bank counteracts the effects of money supply of buying bonds by selling foreign currencies. The reverse is also possible
Key Bank Rate
Short term (day to day) interest rate for loans given by the Bank of Canada to commercial banks.
Who determines the Key Bank Rate
The central bank - eg Bank of Canada
When banks don’t have enough excess reserves to loan money, what can it do?
Loan money from Central Bank (Bank of Canada) or loan money from other commercial banks
What does the Bank of Canada call itself? Why?
Lender of last resort. It does not like lending money and will only lend if no one else will lend money to the bank.
Name of the interest rate applied on loans given by commercial banks to other banks
Overnight rate
Key Bank Rate and Overnight Rate Relationship
Key bank rate must be 2 basis points higher than overnight rate
Basis point
.01%
When Key bank rate changes, the overnight rate…
along with other rates like mortgage rates, immediately adjusts to be slightly lower than the key bank rate
Bank of Canada faces two problems that arise from fractional reserve banking:
Bank of Canada cannot control the amount of money that households choose to deposit in banks and the amount of money banks choose to lend
A bank is solvent when
assets exceed liabilities
