Notes on Money and Banking

Describe the functions, characteristics, and history of money
Explain what is and is not money, and describe the main function of modern banks as moneylenders
Explain how a small amount of cash can support many loans and create more money

Medium of Exchange
- An intermediary used to facilitate trade.
- Avoids the inconvenience of a barter system.
Store of Wealth
- Allows individuals to hold and accumulate wealth.
Unit of Account
- Can be used to value goods and services, record debts, and conduct calculations.

Gift Economies
- Involves reciprocal gifting between groups, expecting future favors.
- Led to the creation of notes to track debts.
Barter System
- Involves trading one good for another.
- Widely valued commodities such as salt, beads, or gold can become commodity money.
Coins (circa 700 BCE)
- Coinage led to the standardization of weights.
- Issues included the potential for fraud through mixing valuable metals with cheap ones (“debasing the currency”), which can result in inflation.
Paper Money
- Originated with certificates of deposit or bills of exchange in the 13th century.
- An IOU from a trustworthy individual to represent deposited wealth.
- Allowed future exchanges as paper currency.
Merchant Banks (17th Century)
- Printed their own paper money redeemable at the bank.
Chequebooks (19th Century)
- Used as instructions for banks to transfer money.
Bank of Canada (20th Century)
- Government control of currency production.
- Since 1935, the Bank of Canada issues fiat money, which is money declared by law.

Banks keep a fraction of their deposits as reserves and loan out the excess, earning interest.
People commonly write checks rather than withdrawing cash, allowing banks to leverage funds for higher returns.

Money is anything widely accepted as a medium of exchange to purchase goods or settle debts.

Role of Banks and Near-Banks:
- Act as intermediaries between households, businesses, and governments with available funds and those seeking to borrow.
Categories:
- Chartered Banks: Commercial banks under the Bank Act in Canada (e.g., Big Six).
- Near-Banks: Includes credit unions, trust companies, and mortgage & loan associations; not defined under the Bank Act.

Chequing Deposits:
- Depositors can demand full cash at any time.
Savings Deposits:
- May require advance notice before withdrawal; non-chequable.
Personal Term Deposit:
- Fixed-term deposits such as six months.

Not included as money:
- Currency held in bank vaults or tills.
- Gold or precious metals.
- Financial securities (stocks, bonds).
- Cheques, credit cards, and debit cards.

Table 8.1: Forms of Wealth Holdings:
- Description of Wealth Forms:
- Money:
  - Currency: Coins and notes.
  - Chequing (demand) deposits: Funds in chequing accounts.
  - Savings (notice) deposits: Funds in savings accounts.
- Financial Assets:
  - Term deposits: Funds for a fixed period at a fixed interest rate.
  - Treasury bills: Short-term securities issued by the federal government.
  - Bonds: IOUs with fixed interest rates and terms.
  - Stocks: Ownership claims on corporations.
  - Mutual Funds: Part-ownership of pooled investments.
  - GICs: Securities issued by financial institutions.
- Real Assets:
  - Personal assets: Cars, boats, jewelry, etc.
  - Real estate: Ownership of land and buildings.

If David deposits $240 cash into his chequing account, does the money supply change?
- Answer: No. Amount in circulation decreases, but total remains unchanged.
If later he transfers this $240 to a savings account, how does M1 and M2 change?
- Answer for M1: Yes, M1 decreases.
- Answer for M2: No change.
Calculate values for M1, M2, M2+, and M2++ with given data:
- Coins: 13 (Billion CAD)
- Deposits at near-banks: 137
- Chequing deposits: 72
- Canada Savings Bonds & mutual funds: 320
- Savings deposits: 215
- Notes: 27
- M1: $112 (coins, notes & demand deposits).
- M2: $327 (M1 + notice and personal term deposits).
- M2+: $464 (M2 + near-bank deposits).
- M2++: $784 (M2+ + Canada Savings Bonds and mutual funds).

Bank Profit Sources:
- Primarily from interest on loans.
- Spread: Difference between the interest rate charged to borrowers and the rate paid to savers.
- Target Reserve Ratio: Fraction of deposits banks want to hold in cash reserves.

Defined as the portion of deposits banks want to keep as cash.
Calculation:
ext{Target reserves} = ext{Target Reserve Ratio} imes ext{Demand Deposits}

Balance Sheet of Saymor Bank Ltd. as of December 31, 2023:
- Assets:
- Reserves: $10,000 (million CAD)
- Loans to customers: $60,000
- Securities: $30,000
- Fixed assets: $20,000
- Liabilities and Equity:
- Demand deposits: $100,000
- Shareholders’ equity: $20,000
- Total: $120,000 on both sides.
Excess Reserves: Reserves beyond what is needed as target reserves.
- Calculation:
  ext{Excess Reserves} = ext{Actual Reserves} - ext{Target Reserves}

Each time a bank issues a loan, it essentially creates money.
Example: If a new deposit of $1,000 is made:
- Demand deposits and reserves both increase by $1,000.
Target Reserves Calculation:
- Target reserves = 10% of $101,000 = $10,100.
- Excess reserves = $11,000 - $10,100 = $900 (available for loans).

Definition: The total increase in deposits resulting from a single new deposit in the banking system.
Calculation:
ext{Money Multiplier} = rac{ riangle ext{Deposits}}{ riangle ext{Reserves}}
ext{Money Multiplier} = rac{1}{ ext{Target Reserve Ratio}}
Smaller target reserve ratios yield larger multipliers and vice versa.

Over-reserved: Banks can increase lending capacity.
Under-reserved: Banks may need to recall loans to decrease deposits.
Factors affecting money multiplier size:
- Increase in target reserve ratios.
- Increase in cash held by the public.
- Insufficient applicants for loans.
- Economic conditions affecting loan demand.