Topic 9- The Monetary System Flashcards
Define money
any commodity/asset that is generally acceptable in exchange for g/s and debts
barter economies
WHERE G/S ARE TRADED DIRECTLYYY for g/s
Double coincidence of wants
in barter ecnonomy every transaction needs this!!
you must find someone who has what i want and wants what i have
what does double coincidence wants increased
transaction costs
you spend a lot of time finding the ideal person
commodity money
any good that can be USED EITHERRR AS MONEY, OR HAS ANOTHER VALUE/USE
Ex: people barter with barley, salt
They can either use it as money and it also has a value independant of its use as money (they can eat it)
common ex of commodity money
gold and silver
cIGS in prison
limestone in certain places
Fiat money
papedr currency that only has one value= to be used as money
no other valye
what is the use of fiat money
ONLY as currency
who issues fiat money
only ceentral abnk
legal tender
the federal govt requires that it be accepted in payment of debts, public and private
LEGALLY,, PEOPLE SHOULD ACCEPT LEGAL TENDER CURRENCY
The functions of money
unit of account
medium of exchange
STORE OF VALUE
Unit of account
money is a way of measuring market value in the ecnomy in terms of money
100 cents=1 dollar
1 chicken /= 1 cow
In barter econ, there is not a single measre of value, and no unit of accoount
of relative prices for N g/s= (N(N-1))/2
Without fiat money, what happens
high transaction costs
people would avoid market transactions
how many prices in a money economy
of Relative Prices for N g/s= N
1 egg price=1 egg
1 egg 3 cookie= 1 egg 3 cookie
medium of exchange
-Definition
-barter
-fiat
-Sellers are willing to accept the currency in exchange for g/s
-Barter: HARD TO DO THIS, because any trading parter needs to satisfy the doublel coincidence of wants [HIGH TRANSACTION COSTS]
storw of value
-what assets can do this
-what is the most liquid asset
-If you do not wanna use all the money today, your money stores value for th efuture <3
-All assets can act as a store of value generally (wine, cheese, diamonds)
-MFiat oney is the msot liquid store of value
Lydian coins
Alex the great coin
first paper money
bank deposit money
COINS made from silver
alex’s coings
china intrdouced
introduced in usa 1791
what is canadian tire money not
why is not a typical currency
it is not legal tender
because it is not generally acceptable in a majority of stores
The Definitions of Money Supply
M1
What is M1+
MOST BASIC LEVEL= MOST LIQUID
-currency outside banks + The value of all checking account deposits (chequable deposits)
M1++ Money Supply
(M1+ All non-chequable deposits)
this level is less liquid and it contains all
Not in the test-> M2 deposit
currency outside banks+ personal deposit at banks +fixed term deposits
things that are not liquid
M1+ —————————-> M2++
Most liquid to least liquid
Money Supply fomrula
Currecncy outside banks + checkable deposits
Why do banks play an important role in determining how much money in th economy
balances in all chequing account deposits are included in the money supply
Money supply= Currency outside banks+ Checking acc deposits
**
Is there more money held in checking accounts than there is actual currency in the eocnomy
YES! so money is being created by banks
How do financial firms get funds
Borrowing: they borrow from their government
Deposit: Banks receive funds from households, firms, govt; this is called a liability
Issuing Bonds: They issue bonds and people buy them
What do financial firms do with the money
Loan it out: charge interest from the loans, this is an asset
Buy financial securities: stocks and bonds, this is an asset
why do banks hold reserves
-To cover cash withdrawals from depositors (if people want to withdraw money)
-To cover the payment of cheques which are deposited in other banks (If an RBC client deposits a check from CIBC, RBC should be able to go to CIBC and get that money)
-To fulfill the legal reserve requirement set by central bank
Bank Reserves = Reserve Ratio * Chequable Deposits
Reserve Ratio
the ratio of bank reserves to Chequable deposits!!! SET BY CENTRAL BANK
Bank Reserve/Chequable Deposits
Bank Reserve formula
this dictaties the amount of reserves a bank must have
Reserve ratio* Chequable Deposit
Liabilites
sources of funds
(depositors, bonds, borrowing)
Assets
the uses of funds (what is the bank gonna do with these funds)
(bank reserves, loans they give out, investing in stocks and bonds)
bank capital=net worth=stakeholder’s equity
bank capital=net worth=stakeholder’s equity
What are the bank’s assets
the value of ANYTHING that is OWNED! by the bank
-reserves, loans, securities
-banks use the money deposited with them to make loans and buy securities
Assets= Liabilities + Capital
Liabilites
Anything that the bank OWES!!!!
- deposits, borrowing
Money that people deposited in the bank, and money the bank has borrowed
Capital
-Alternative names for capital (2 others)
The difference between total assets and total liabilities
Shareholder’s equity=net worth= bank capital
Reserves
-Required
-Excess
banks are required to keep a frfaction of deposits within the bank (AS VAULT CASH! OR DEPOSIT W THE CENTRAL BANK_
-Required Reserves: min fraction of deposits that banks are required to keep as reserves is called the reserve ratio
-Excess Reserves: any reserves that banks hold over the required amounts are called excess resrves!
Are banks in Canada required to hold a specific level of reserves?
NO! this allows them to make more loans-> this makes more INVESTMENT -> MORE ECON GROWTH
Why do banks have excess reserves
TO AVOID BORROWING! BC THE COST OF BORROWING IS:
THE MONEY YOU BORROW+ INTEREST RATE
Bank’s T- Account
shows how a transaction changes a bank’s balance sheet!
What is the fundamental Identity of accounting
this creates a double entry bookeeping, with every single transaction, two entries are recorded for that one transaction!
If someone deposits 1000, it becomes a 1000 liability, and also record it in reserves, it becomes a 1000 value reserve
if 1000 is in circulation in economy, but
no banking system
money supply is 1000
money supply=money outside bank+ chequable deposits
if 1000 is in circulation in economy, but
bank is reuqired to hold 100% as reserves
(Assets= 1000 reserve|Liabilities= 1000 chequable deposits)
money supply is 1000
money supply= money outside banks+ chequable deposits
chequable deposit is still 1000
IMPORTANT!! KEEP AN EYE OUT FOR DEPOSIT VERSUSSSSSSSSSSSSSSSSSSSSSS CURRENCY!!!!!!!!!!!!!!!!!!!!!!!
Currency is the cash in hand
Desposit is
CASE 3: When Central Bank requires Banks to hold a fraction of deposits as their reserves
If Depositors Deposit 1000, and Bank has to reserve 10% as reserves; but
1)first we record the $1000 deposit as a Liability,
2)and then consider what the bank reserves that is a $100 Asset
3) loans out the extra funds of $900
ASSETS LIABILITIES
R:+$100 D: +$1000
L:+$900
Therefore MS increases by 900 (non reserved amount and money supply increases)
Money Supply= Currency+Deposits
= $900+ $1000
When banks keep a fraction of their money as reserves, and loan out the rest…
the MONEY SUPPLY INCREASES!!
they create money
The Money Multiplier
Let Rd=The Reserve Ratio, then for each bank
Reserves= Rd * Deposits
How much currency is outside banks if all people deposit their money in the bank
NONE, it is all deposit
What is 1/Rd
1/Reserve Ratio
THE MONEY MULTIPLIER
What can you do by manipulating the Money Multiplier
figure out what deposits is equal to! This will then contribute to your Money Supply Formula
What does a 10 percent required reserve ratio tell us about the money multiplier
A deposit will be multiplied by 10 times
In reality, why is the money multiplier not perfect?
Why is the real world money multplier smaller than the aactual money multiplier?
Banks may not choose the same reserve ratio!
- Some Banks hold more reservers (make fewer loans, and have a smaller money mulitplier)
- Consumers keep some currency out of the bank (not everyone gives all money to the bank)
Bank PANIC
when all banks experience a run
What is the lender of last resort
THE CENTRAL BANK! giving loans to these banks so they can pay off depositors
What are the responsibilities of the central bank
Conduct monetary policy
issue currency
promote stable financial system
manages federal govt finances
ENGAGES in important economic research
Bank Rate
the interest rate charged by the Bank of Canada on loans to the commercial banks
Advances
SPECIAL NAME: the loans that bank of canada makes to other banks
The overnight Interest Rate
the interest rate on very short-term loans between commercial banks (24 hour loans)
How is overnight interest rate determined
by the supply and demand of funds
if there is a shortage of funds, then high overnight interest rate
if there is a surplus of funds, then low overnight interest rate
What is the purpose of overnight loans
the loans are used among banks to borrow money to balance their sheets; to pay off the daily debt
who issues overnight interest rate?
who gives the loans? who uses these loans?
issuesd by central bank
any bank issues the loans (rbc/cibc), other lil banks use these loans (rbc)/(cibc)
WHAT IS A BALANCED BUDGET
total saving=PRIVATE SAVINGS
(Public saving+ priv saving)= pri saving
public saving =0
Formula for # Relative prices for N goods and services
-Barter economy
-Fiat Economy
Barter Economy: N(N-1)/2
Fiat Economy: N
What does the value of money depend on
its purchasing power (inflation can make it not valuable)
EFT, NEFT, digital money
EFT: electronic transfer of money from one bank to another
NEFTl electronic funds transger maintained by INDIAN RESERVE BANK
Digital MOney: stored and managed over the internet
Fiat vs legal tender
fiat= paper money
legal tender= legally accepted to pay debts
Why do we use the M1+ defintion of the money supply
IT CORRESPONDS WITH THE IDEA OF MONEY AS A MEDIUM OF EXCHANGE
How do banks create more money supply?
Whenever people deposit money into their checking accounts, banks reserve 10% and then they loan out the rest
the loan people take out, if they deposit it in another bank, the bank will reserve 10% and loan out the rest again
As the cycle continue the money supply increases because of the money supple formula
it goes from
MS= Currency outside bank+checking acc deposits
to
MS= Currency outside bank (0)+ checking acc deposit (inital loan) + new loan + new loan
How to calculate what the max amount your money could change the maount of currency available?
Calculate the money multiplier
Multiply iti with the amount of money you deposited in bank
SUBTRACT YOUR ORIG DEPOSIT FROM THIS NUMBER!!!
See the growth
How would you calculate the min amoun tyour money could influence the amount of money supply
Banks are not obligated to make loans!!! They could keep all money as reserves and then
Money supply= Currency falls by XYZ+ Deposits increaee by XYZ
Overnight interest rate Operating Band
-Upper Limit
-Lower Limit
-Midpoint
Upper Limit: bank rate (lending rate)
=If overnight interest rate reaches this level, Bank of Canda will loan funds (they put a cieling on the overnight interest rate)
Midpoint: what the bank of canda targets as overnight interest rate
Lower limit: deposit rate
=If overnight interest rate reaches this level then BoC will accept depoists at this rate (putting afloor under overnight interest rate)
Open Market Operations
-Increase money suppply
-Decrease money supply
This is the buying and selling og govt bonds created by BoC to control money supply
To Increase the MOney supply:
-Buys govt bonds (by creating currency)
-Increases money supply in economy
To Decrease money supply:
-Sells govt bond (by taking in money from people and removing it from circulation)
-decreases the amount of money in economy
Why are open market operatiions called open market operations
they happen inthe open market for bonds
3 Bank of Canada operations
1) Open Market operations
2) chanigng overnight interest rate
3) changing reserve requirements
open market operations (buying and selling govt bonds to increase/decreas money in eocnomy)
Changing overnight interest rate (chaning the cost of borrowing and selling money between banks for a short time, BY CHANGING THE BANK RATE (CIELING))
chanigng how much money is required to be saved by banks
Changing overnight interest rate
Banks can change the overnight interest rate by changing the bank rate (highest amount of interest rate on loans that banks give out))
Bank rate low:
Banks can borrow from BoC , make loans, increase deposits, INCREAS EMONEY SUPPLY
Bank Rate high:
Banks do not borrow from BoC, nno loans, decreases the amount of money supply in economy
How does chanigng the reserve requiremnt affect the amount of money in the eoncomy
Lower reserve requirement, more money to make loans, more money
HIgher reserve requirmeent, less money to make loans, less omney
If overnight interest rate is low, then what happens?
BANKS MAKE MORE LOANS, increas emoney supply INCREASE RESERVES
If overnight interest rate is high then what happens
banks make less loans, decreases moeny supply
more loans?
more money supply
open market operations names
buying bonds
purchase and resale agreement
