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34 Cards in this Set
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Money |
any commodity or token that is generally acceptable as a means of payment. |
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means of payment |
a method of settling a debt. |
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Money has three other functions: |
Medium of exchange Unit of account Store of value |
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Medium of Exchange |
an object that is generally accepted in exchange for goodsand services |
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Unit of Account |
an agreed measure for stating the prices of goods and services. |
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Store of Value |
As a store of value, money can be held for a time and later exchanged for goods andservices. |
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Money in Canada consists of |
Currency Deposits of individuals and businesses at banks and other depository institutions |
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Currency |
the notes and coins held by households and firms. |
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why are Deposits money? |
because the owners of the deposits can use them to makepayments |
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M1 |
consists of currency and checking deposits held by individuals and businesses |
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M2 |
consists of M1 plus all other deposits ─ non-chequable deposits and fixed term deposits held by individuals and businesses. Some components of M2 can easily be converted into a means of payment without lossin value. They are called liquid assets. |
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Liquidity |
the property of being instantly convertible into a means of payment with little loss of value. |
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Why are cheques and credit cards not money? |
A cheque is an instruction to a bank to transfer money. A credit card enables the holder to obtain a loan, but it must be repaid with money |
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depository institution |
a firm that takes deposits from households and firms and makes loans to other households and firms. |
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Types of Depository Institutions Deposits at three institutions make up the nation’s money. They are |
Chartered banks A chartered bank is a private firm, chartered under the Bank Act of 1991 to receive deposits and make loans. Credit unions and caisses populaires A credit union is a cooperative organization that operates under the Cooperative Credit Association Act of 1991 and that receives deposits from and makes loans to its members. A caisse populaire is a similar type of institution that operates in Quebec Trust and mortgage loan companies |
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The goal of any bank is to.... to achieve this... |
maximize the wealth of its owners. To achieve this objective, the interest rate at which it lends exceeds the interest rate it pays on deposits. |
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A chartered bank puts the depositors’ funds into four types of assets: |
Reserves—notes and coins in its vault or its deposit at the Bank of Canada Liquid assets—Canadian government Treasury bills and commercial bills Securities—longer–term Canadian government bonds and other bonds such as mortgage-backed securities Loans—commitments of fixed amounts of money for agreed-upon periods of time |
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Depository institutions provide four benefits: |
Create liquidity Pool risk Lower the cost of borrowing Lower the cost of monitoring borrowers Depository institutions make a profit from the spread between the interest rate they pay on their deposits and the interest rate they charge on their loans |
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Bank of Canada (central bank) |
the public authority that supervises other banks and financial institutions, financial markets and the payments system, and conducts monetary policy |
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The Bank of Canada is: (3) |
Sole issuer of bank notes The Bank of Canada is the only bank that is permitted to issue bank notes. The Bank of Canada has a monopoly on this activity. Banker to the banks and government The Bank of Canada accepts deposits from depository institutions that make up the payments system and the government of Canada. Lender of last resort which means that it stands ready to make loans when the banking system as a whole is short of reserves |
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The Bank of Canada has two main assets... Its liabilities are ... |
The Bank of Canada has two main assets (i) government securities, and (ii) loans to depository institutions Its liabilities are (i) Bank of Canada notes, and (ii) depository institution deposits |
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Monetary Base |
The monetary base is the sum of Bank of Canada notes, coins, and depository institution deposits at the Bank of Canada MB = C + R |
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To achieve its objectives, the BOC uses two main policy tools: |
• Open market operations the purchase or sale of government securities by the Bank of Canada from or to a chartered bank or the public. When the Bank of Canada buys securities, it pays for them with newly created reserves held by the banks. When the Bank of Canada sells securities, they are paid for with reserves held by banks. So open market operations influence banks’ reserves. • Bank rate The Bank of Canada makes short-term loans, typically one-day loans, to major depository institutions when the banking system is short of reserves. The interest rate on these loans is bank rate. Bank rate acts as an anchor for other short-term interest rates and is closely related to the Bank’s target for the overnight loans rate. |
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The effects of an open market purchase on the balance sheets of the Bank of Canada and CIBC. The effects of an open market sale on the balance sheets of the Bank of Canada and CIBC. |
The open market purchase increases bank reserves. The open market sale decreases bankreserves. |
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The quantity of deposits that banks can create is limited by three factors: |
The monetary base MB = C + R Desired reserves A bank’s actual reserves consists of notes and coins in its vault and its deposit at the BOC. The desired reserve ratio is the ratio of the bank’s reserves to total deposits that a bank plans to hold. The desired reserve ratio exceeds the required reserve ratio by the amount that the bank determines to be prudent for its daily business. Desired currency holding People hold some fraction of their money as currency.So when the total quantity of money increases, so does the quantity of currency that people plan to hold. If bank deposits increase, desired currency holding also increases.Thus, when banks make loans that increase deposits, some currency leaves the banks. This leakage of bank reserves into currency is called the currency drain.The ratio of currency to deposits is the currency drain ratio |
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Money creation process (what is the story?) Suppose that the BOC conducts an open market operation in which it buys securities from a bank (say, Premier Bank). |
The money creation process begins with an increase in the monetary base. Suppose that the BOC conducts an open market operation in which it buys securities from a bank (say, Premier Bank). The BOC pays for the securities with newly created bank reserves. Premier Bank now has more reserves ($100) but the same amount of deposits, so they have excess reserves. Instead of keeping the $100 in their vault or deposit at the BOC, suppose that Premier Bank decided to loan all of it to an individual and the individual in turn deposit the $100 to Bank A. Excess reserves = Actual reserves – Desired reserves. *** Assume that the desired reserve ratio is 0.10 and the currency-deposit ratio is 0 *** Bank A will now find itself with a $100 deposit. What to do with it? • $10 of which needs to be kept in reserve and $90 can be loaned out. • Bank A decided to loan the $90 to another individual and the individual in turn deposit the $90 to Bank B. Bank B now has a $90 deposit: need to keep $9 in reserve and loan the remaining $81. |
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money multiplier if the BOC increases the monetary base by $100,000 and the quantity of money increases by $250,000, the money multiplier is ... |
the ratio of the change in the quantity of money to the change in the monetary base. m is (C/D + 1) / (C/D + R/D). In general,the quantity of money created depends on the desired reserve ratio and the currency drain ratio.The smaller these ratios, the larger is the money multiplier. ....2.5 |
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The Influences on Money Holding
The quantity of money that people plan to hold depends on four main factors: |
The price level if price goes up, cash holding goes up
The nominal interest rate The nominal interest rate is the opportunity cost of holding wealth in the form of money. as nominal interest rate goes up, you want to hold less cash
Real GDP as income goes up, you want to hold more cash (to buy more things)
Financial innovation increase in innovation decreases cash holding.
for example credit cards. you dont need cash to pay, you can use the card |
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Money Market Equilibrium |
occurs when the quantity of money demanded equals the quantity of money supplied. Adjustments that occur to bring about money market equilibrium are fundamentally different in the short run and the long run. |
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Long-Run Equilibrium what stays the same, what changes? |
In the long run, nothing real has changed. Real GDP, employment, quantity of real money, and the real interest rate are unchanged. In the long run, the price level rises by the same percentage as the increase in thequantity of money |
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quantity theory of money it is based on... |
the proposition that, in the long run, an increase in the quantity of money brings an equal percentage increase in the price level The quantity theory of money is based on the velocity of circulation and the equation of exchange |
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velocity of circulation |
the average number of times in a year a dollar is used to purchase goods and services in GDP Denote the velocity of circulation as V, the price level P, real GDP Y, and the quantity of money M:V = PY ÷ M V = PY ÷ M |
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equation of exchange states that |
MV = PY. The equation of exchange becomes the quantity theory of money if M does notinfluence V or Y. So in the long run, the change in P is proportional to the change in M |
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the lower the control the central bank of canada, the ______ the inflation |
higher |
