ECON C11.docx

Money

Any generally accepted medium of exchange.

Functions of Money (3)

Medium of exchange, Store of Value, Unit of account.

Medium of Exchange

Anything generally accepted in return for goods and services.

If there was no money, goods and services would have to be exchanged by …

barter

what makes a good medium of exchange? (5)

1. easily recognizable

2. high value relative to weight

3. divisible

4. durable

5. very hard if not impossible to counterfeit

Store of Value

Ability to store purchasing power.

For money to be a good store of value, it needs to have a purchasing power that is relatively _____ over time.

stable

Unit of Account

• Used for accounting purposes.

• Provides a way to measure revenue, costs, profit etc.

• Common measure of value

• ex. Canadian dollars

Metallic Money

Precious metals like gold and silver used as money.

Paper Money

Banknotes convertible into gold.

Fractionally Backed Paper Money

Paper money issued more than gold reserves.

Initially, national currencies like the Canadian and U.S. dollar were backed by ______.

gold

Gold standard

A currency standard whereby a country’s currency is convertible into gold.

Fiat Money

Paper money not backed nor convertible into anything but decreed as legal tender.

legal tender

Anything that by law must be accepted when offered for the purchase of goods or repayment of debt.

Modern Money

Deposit Money held in bank accounts.

what is deposit money

Money held by the public in the form of deposits with commercial banks

Two types of institutions make up a modern banking system:

1. central bank (bank of Canada)

2. financial intermediaries

the basic functions of the Bank of Canada: 3

1. banker to commercial banks

2. banker to the federal government

3. regulator of the money supply

Commercial Banks

privately owned institution that provides a variety of financial services

banks reserves

Physical currency + deposits with the Bank of Canada

bank run

A situation in which many depositors rush to withdraw their money.

Fractional-reserve system:

A banking system in which commercial banks keep only a fraction of their deposits in cash or on deposit with the central bank.

Reserve Ratio

Fraction of deposits held as reserves by commercial banks.

Target reserve ratio: 

The fraction of deposits that the bank would ideally like to hold as reserves.

Excess Reserves

Actual reserves minus(-) target reserves.

The bank initially has a reserve ratio of __ percent.

20

change in deposits ratio

•       ΔDeposits = ΔReserves/ν

Money Creation

Process by which commercial banks create money through loans.

If c is the ratio of cash to deposits that people want to maintain, the final change in deposits will be given by:

ΔDeposits = (New Cash Deposit)/(c + ν)

Money Supply

Total quantity of money in the economy at any time.

Money supply = Currency + Bank deposits

Demand Deposit

Chequable deposits transferable on demand.

Term Deposit

Interest-earning bank deposit subject to notice before withdrawal.

Two commonly used measures of money in Canada today are

M2 and M2+

M2

Currency plus demand and term deposits at chartered banks.

M2+

M2 plus similar deposits at other financial institutions.

Other things being equal, a rise in the price level will

decrease the purchasing power of money

What is the biggest disadvantage of a barter system compared to a system that uses money?

Each trade requires a double coincidence of wants

What do we mean in our current banking system when we say that a currency is "fractionally backed"?

Banks have many more claims outstanding against them than they have reserves available to pay those claims.

The currency that is in circulation in Canada today is

not officially backed by anything.

Basic functions of the Bank of Canada include

 

1. acting as lender of last resort to private non-financial corporations;

2. acting as banker for the chartered banks.

3. regulating the money supply.

2/3

Why is the possibility of a bank run extremely small in Canada today?

The Canadian Deposit Insurance Corporation provides deposit insurance on eligible deposits, so most depositors would not feel the need to withdraw all of their money in a panic.

What is a commercial bank's actual reserve ratio?

The fraction of its deposit liabilities that it actually holds as reserves, either as cash or as deposits with the Bank of Canada.

Suppose Bank ABC has a target reserve ratio of 10%. If Bank ABC receives a new deposit of $100 000 it will immediately find itself with

excess cash reserves of $90 000

Suppose the Canadian banking system jointly has $20 million in reserves (cash and deposits at the Bank of Canada), all banks have a target reserve ratio of 20%, and there are no excess reserves. What is the amount of deposits in the banking system?

$100 million

Suppose you found a $100 bill that was lost for many years under your grandmother's mattress and you decided to deposit this money in a commercial bank. If the target reserve ratio were 20% and all excess reserves were lent out, your new deposit of $100 would lead to an eventual expansion of the money supply of

$500

Suppose you found a $100 bill that was lost for many years under your grandmother's mattress. If the banking system has a cash drain of 5%, its target reserve ratio is 20%, and all excess reserves were lent out, your new deposit of the $100 bill would lead to an eventual expansion of the money supply of

$400

If all the banks in the banking system collectively have $20 million in cash reserves and have a target reserve ratio of 5%, the maximum amount of deposits the banking system can support is

$400 million