Econ 105 Ch 10

• Money


  Financial assets in an economy that people regularly use to buy goods and services from other people
• Functions of money


  • Medium of exchange
  • Unit of account
  • Store of value
• Examples of money functions


  • You pay $3 for your favourite latte (medium of exchange)
  • You list prices for candy sold on your Website, www.sweettooth.com, in dollars (unit of account)
  • You deposit $2,000 in your savings account (store of value)
• Wealth


  The total of all stores of value, including both monetary and non-monetary assets
• Liquidity


  How easily an asset can be converted into a medium of exchange
• Types of money


  • Commodity money (gold, silver)
  • Fiat money (paper bills)
• Money supply


  The quantity of money circulating, including currency, demand deposits, and other monetary assets
• Measures of money stock

  • M1 (currency + demand deposits)
  • M2 (M1 + saving deposits + term deposits)
• Central bank


  An institution designed to control the quantity of money in the economy
• The Bank of Canada (BoC) is the central bank of Canada and has the roles of issuing currency, acting as a banker to commercial banks, acting as a banker to the government, and controlling the quantity of money available in the economy
• Bank notes were issued by the Department of Finance and the commercial banks, and Canada was on the gold standard


  Before the 1930s
• With the collapse of the gold standard, a need arose to control the quantity of fiat money in the economy. The government enacted the Bank of Canada Act in 1934, and the BoC was established in 1935 and nationalized in 1938
• The Bank of Canada is independent of the government, and the primary responsibility of the BoC is to act in the national interest
• Monetary policy


  The setting of the money supply by policymakers in the central bank
• The Bank of Canada has the power to increase or decrease the number of dollars in the economy, and changes in the money supply can profoundly affect the economy
• Commercial bank


  A privately owned, for-profit institution that provides a variety of financial services, such as accepting deposits, making loans, and offering wealth-management services
• 100%-reserve banking system


  Banks hold 100% of deposits as reserves, and as a result, banks make no loans
• Fractional-reserve banking system


  Banks hold only a fraction of deposits as reserves
• Reserve ratio


  The fraction of deposits that banks hold as reserves
• Money multiplier process in fractional-reserve banking

  1. 1st round bank receives $100 deposit, holds 10% as reserves and lends out 90%

  2. 2nd round bank receives $90 deposit, holds 10% as reserves and lends out $81

  3. This process continues, generating a total change in the money supply of $500
• Money multiplier


  The amount of money the banking system generates with each dollar of reserves, equal to 1/reserve ratio
• Open-market operations


  1. The purchase and sale of (usually short-term) government bonds by the central bank

  2. Buying bonds increases money in circulation and the money supply

  3. Selling bonds decreases money in circulation and the money supply
• Quantitative easing


  The purchase and sale by the central bank of non-government or government securities with longer maturity terms, used only in extraordinary circumstances
• Changes in reserve requirements

  A rise in reserve requirement decreases reserves, loans, and the money supply
• Overnight rate


  The rate of interest on very short-term loans between commercial banks that stays very close to the middle of the operating band set by the central bank
• Changes in the bank rate

  A rise in the bank rate increases the cost of borrowing from the central bank, decreasing reserves in the banking system and the money supply
• The Bank of Canada's control of the money supply is not perfect due to the central bank not controlling the amount of money that households choose to hold as deposits or the amount that commercial banks choose to lend