Chapter 8: Money, Price Level & Inflation

Definition of money

Set of assets people regularly use to buy goods / services

What are the 3 functions of money?

1. Medium of exchange

2. Store of value

3. Unit of account

What’s a medium of exchange?

Object used to get goods/services

Whats a unit of account?

Agreed measure for price of goods / services

• Ex. this apple is $2

What is a store of value?

Present to future, transfer of purchasing power

Why is money an imperfect store of value?

inflation

Money is the most ____ form of asset

liquid

As price (inflation) goes up, the value of money goes…

Down

What are the 3 types of money?

1. Commodity money (has intrinsic value. ex. silver, gold)

2. Fiat money (has no intrinsic value. ex. coins, bills)

3. E-money (chequing, savings)

An efficient medium of exchange is…

1. Easily standardized

2. Easily accepted

3. Divisible

4. Easy to carry

5. Doesn’t deteriorate quickly

What are the money aggregates (measures)?

• M1+

• M2+

What is M1+?

Currency in circulation and demand deposits

What is M2+?

M1+ and non chequable deposits

Why are etransfers, debit cards, credit cards and mobile wallets NOT money?

Debit, etransfer, mobile wallets: Instructions given to bank to withdraw funds from demand deposits

Credit: payments for loans to lending company

Double coincidence of wants

I have something you want, you have something I want

Why is money important?

Without it, we’d be in a barter economy (trading goods for goods), which means we HAVE to have a double coincidence of wants.

Relative price of x =

price of x / price of y

Relative price of y =

price of y / price of x

The banking system is split into 2

Depository institutions and central bank

What are depository institutions?

They take deposits and make loans (ex. indirect finance, they earn profit: interest!)

Types of depository institutions

• Chartered banks

• Credit unions and caisses populaires

• Trust and loan companies

What are the functions of depository institutions?

1. Creating liquidity

2. Pooling risk

3. Minimizes cost of obtaining funds (risk sharing)

4. Minimizes cost of monitoring

What are the problems with asymmetric information?

1. Adverse selection

2. Moral hazard

What is a central bank (ex. BOC)?

The central bank of a country control supply of money and regulates depository institutions

What are the functions of a central bank?

• Banker of government

• Banker and regulator of depository institutions

• Lender of last resort

• Sole issuer of bank notes (prints money)

Fun fact: who governed BOC and BOE?

Carney!

Monetary base =

bank notes + coins + bank deposits with central bank

Monetary base, a.k.a.

High powered money

Central bank B/S

Assets: sources of funds

• Government securities

• Loans to depository institutions

Liabilities: uses of funds

• Bank notes

• Reserves of depository institutions

Depository institution B/S

Assets: sources of funds

• Deposits

• Borrowing and own capital

Liabilities: uses of funds

• Reserves

• Loans

• Short term securities

• Long term securities

Who controls the SUPPLY of money?

Central bank

BOC’s monetary toolbox

1. The open market operation (OMO)

2. Change in overnight rates

3. Change in required reserve ratio (RRR)

Expansionary policy vs contractionary policy

Expansionary: Money supply up

Contractionary: Money supply down

How does OMO change supply?

Purchase (supply up) and sale (supply down) of government securities

How do overnight rates change supply?

Increased rate (supply down), decreased rate (supply up)

How does RRR change supply?

Increased RRR (supply down), decreased RRR (supply up)

Making money: RRR =

reserves ÷ deposits

When would we make money? 3 cases

1. No banking system

2. 100% reserve banking system

3. Fractional reserve banking system