Macro Midterm 2

Three primary functions of banks

* Financial intermediation 
* Provide Liquidity
* Allow for diversification of risk

Financial Intermediaries

It is any entity that arranges transactions between savers and borrowers. It brings about equilibrium in the loanable funds market such that savings = investment spending.

Types of Financial Assets

* Equity
* Debt
* Derivatives

Equity (stock ownership)

* Pay dividends
* Pay capital gains (or losses)
* Risky for purchaser, as both payments can be extremely variable

Debt

* Bonds (fixed-income securities)
* Are extremely tradeable before the maturation date
* Pay interest
* Pay capital gains (or losses)

Derivatives

* Any financial asset whose value is derived from (or based on) the value of some other assets
* Futures contract is one example
* The design can be extremely complicated, which makes them difficult to value
* Rife with fraud and shenanigans

National Savings Equation

S= Y-C-G

I= Y-C-G

S=I

savings = private investment spending

Total Savings Equation

S = (Y – T – C ) + (T – G)

* Total S is thus decomposed into private saving (on the left) and public saving (on the right)

Disposable Income Equation

= Y-T

* d whatever remains after consumption spending is private saving

Public Saving Equation

= T-G

* The governments balance
* Almost always negative

The market for loanable funds

* It is the savers who SUPPLY the loanable funds
* It is the investors and households who DEMAND the loanable funds
* The price of loanable funds is the interest rate
* saving is the source of supply
* investment is the source of demand

Law of Demand for Loanable Funds

* As the interest rate goes up (down), the quantity demanded for them goes down (up)
* Related to the rate of return on investment

Law of Supply for Loanable Funds

* As the interest rate goes up (down), the quantity supplied for them goes up (down)

Policies to encourage saving

* Lower taxes on the returns to saving and instead shift the incidence of taxation to consumption
* Increase tax shelters for retirement saving

Policies to encourage investment

* These days a lack of investment in the capital stock and innovation
* Investment tax credit
* ‘right-wingers’ favour this
* Current policy debate surrounds further cuts to the corporate income (i.e. profit) tax rate

‘crowding out’ effect

* a decrease in investment that results from government borrowing

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* Result from running a deficit
* It is the increase in borrowing that ‘crowds out’ would-be private investment spending

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It has to do with fiscal policy. The government runs a deficit and finances it by borrowing. This restricts the supply of loanable funds, which places upward pressure on interest rates, which in turn reduces private investment spending. It is the public spending and the resulting borrowing that crowds out would-be private investment spending.

Unemployment Conditions

* Without work and ‘ACTIVELY’ seeking work
* On layoff expecting recall
* Hired, but waiting to start work within a month

Labour Force Participation Rate Equation

= (Number in Labour Force/ Adult Population) x 100

Unemployment Rate Equation

= (Number of Unemployed Workers/ Labour Force) x 100

Labour Force Equation

= employment + unemployment

Private Saving

The income that households have left after paying for taxed and consumption

Public Saving

The tax revenue that the government has left after paying for its spending

Budget surplus

An excess of tax revenue over government spending

Budget deficit

A shortfall of tax revenue from government spending

Saving vs Investing

Investment: The purchase of new capital

Saving: Putting your money into a product. (ex. bank account, buying a bond, stock, etc.)

Government Debt

The sum of all past budget deficits and surpluses

Labour Force

Total number of workers, including both the employed and the unemployed

Significance of the savings-investment identity

National Savings= Investment Spending (S=I). National Savings= Public savings + private savings. It is linked to the framwork of the loanable funds market. The forces of the supply and demand for loanable funds interest to yield an equilibrium combination for the rate of interest and quantity of loanable funds that is consistent with that identity.

Public saving vs private saving

* Public saving is carried out by the government.
* = taxes - government spending= T-G
* Private saving does not involve the government. Constitutes the total pool of savings available.
* = national income - consumption spending - taxes= Y-C-T

Types of Unemployment

* Frictional
* Structural
* Cyclical/demand deficit

Frictional Unemployment

Unemployment that results because it takes time for workers to search for the jobs that best suit their tastes and skills

* associated with normal turnover as good labour market matches take time to form

Structural Unemployment

Unemployment that results because the number of jobs available in some labour markets is insufficient to provide a job for everyone who wants one

* pool of jobless workers ill-suited for jobs that are available
* Poor job training and education

Cyclical Unemployment

The deviation of unemployment from its natural rate

* a global shortage of jobs in the labour market

Discouraged workers

Individuals who would like to work but have given up looking for a job

Natural Rate of Unemployment

The rate of unemployment to which the economy tends to return in the long run

* Occurs when the economy is near its capacity

Factors that may stop wage rates from falling

* Minimum Wages
* Unions
* Efficiency Wages

Minimum Wage Laws

* “If the wage is kept above the equilibrium level for any reason, the result is unemployment”
* Applies to only low-skilled workers
* An extremely emotive issue
* Empirical evidence suggests that it does reduce the growth in employment, but it doesn’t ‘kill jobs’

Unions and Collective Bargaining

* Learn institutional details on your own
* Model works just like the minimum wage, with a going wage above the equilibrium level, that can contribute to structural unemployment
* Also an extremely emotive issue towards which views tend to be subjective

Efficiency Wages

* Like the case of the minimum wage and the union wage, the going wage exceeds the equilibrium level, which contributes to realwage, classical unemployment
* Unlike the two previous cases, the employer pays this wage voluntarily
* Various rational reasons why he/she might pay more than the going wage, but the level of employment is likely to be lower than what would otherwise be the case

3 functions of money

* Medium of Exchange
* Unit of Account
* Store of Value

Medium of Exchange

An item that buyers give to sellers when they want to purchase goods or services

* Money is the commonly accepted one

Unit of Account

The yardstick people use to post prices and record debts

* Money is what we use when we want to measure and record economic value

Store of Value

An item that people can use to transfer purchasing power from the present to the future

* Ex. a person can trasnfer purchasing power from the present to the future by holding other assets

Liquidity

The ease with which an asset can be converted into the economys medium of exchange (cash)

* Cash is the most liquid
* Stocks and bonds can be sold easily so they are relatively liquid
* Physical assets (house, painting, car, etc.) are less liqiud

Kinds of Money

* Commodity Money
* Fiat Money

Commodity Money

Money that takes the form of a commodity with intrinsic value. This means the item would have value even if not used as money.

* Ex. gold was once used as money but also to make jewlerry
* Cigarettes

Fiat Money

Money without intrinsic value that is used as money because of government decree

* A canadina dollar is valid money but monopoly money is not

Unit of Account vs Store of Value

Unit of account, also termed measure of value, means that prices are stated in terms of money. Store of value means that value, the satisfaction of wants and needs, can be stored over time using money.

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* Unit of account is the yardstick.
* It would be relating everything back to dollars when detemining how expensive they are.
* Store of value is where that money is store.
* It could be a bond or just physical money.
* One is a unit such as km, m, L, etc. the other is where it is stored.

Fractional Reserve

A banking system in which banks hold only a fraction of deposits as reserves

Money Multiplier

The amount of money the banking system generates with each dollar of reserves

* reciprocal of the reserve ratio

Bank Capital

The resources a bank’s owners have put into the institution

Leverage

The use of borrowed money to supplement existing funds for purposes of investment

Leverage Ratio

The ratio to assets to bank capital

Bank Rate

The interest rate charged by the Bank of Canada on loans to the commercial banks

Functions of the central bank

* Issue currency
* Act as the bankers bank
* Act as banker for the federal government
* Regulate the supply of money through monetary policy

Overnight Rate

The interest rate on very short-term loans between commercial banks

Monetary Policy

The setting of the money supply by the policymakers in the central bank

* Can influence short-term interest rates
* Controls money supply, not demand

Primary instruments of monetary policy

* open market operations is a potent instrument 
* Quantitative easing is open market purchases BIG TIME 
* Changes in the ‘overnight rate’ that it charges on the loans that it makes
* the interest rate that a commercial bank pays when it borrows money from another one.

Open-Market Operations

The purchase or sale of the government of Canada bonds by the Bank of Canada

* To __increase__ the money supply, the central bank has to __inject__ new reserves __into__ the financial system __from__ outside of it
* And vice versa (decrease, withdraw, from, to)
* Bank of Canada can trade in either bonds or foreign currency (foreign exchange market operations)

Quantitative easing

Open market purchases of government bonds AND non-government securities writ large

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* The purchase and sale by the central bank of nongovernment securities or government securities with long maturity terms

Foreign Exchange Market Operations

The purchase or sale of foreign money by the bank of Canada

Sterilization

The process of offsetting foreigh exchange markt operations, so that the effect on the money suplly is cancelled out

Reserve Requirements

Regulations on the minimum amount of reserves that banks must hold against deposits

Labour Force Statistics (Jan 2023)

* Employment increased by 150,000 (+0.8%) in January,
* the unemployment rate held steady at 5.0%.
* Only 1 million people are unemployed
* employment gains were driven primarily by people aged 25 to 54
* Employment also increased among people aged 55 and older
* Upward employment trend