Summary of Money and Banking Concepts

Nature of Money

Money serves as a medium of exchange, a store of value, and a unit of account. Barter is inefficient due to the double coincidence of wants. Money has evolved from metallic forms, like coins, to fiat money, which is government-decreed legal tender without intrinsic backing.

Banking System in Canada

The Canadian banking system consists of commercial banks and the central bank (Bank of Canada). Commercial banks are private institutions providing financial services and operating on a fractional-reserve banking model. The Bank of Canada regulates the money supply and acts as the banker to these commercial banks.

Money Creation

Banks create money by accepting deposits and issuing loans. The reserve ratio determines the fraction of deposits banks must hold in reserve, while the target reserve ratio indicates preferred levels. When deposits increase, deposits can expand according to the formula ΔDeposits = ΔReserves/ν, where ν represents the reserve ratio.

Money Supply Measurements

The money supply includes currency in circulation and bank deposits. Common measures of money supply include M2 and M2+, differentiating between demand deposits and term deposits. Near money refers to assets easily convertible to cash, while a money substitute, like a credit card, serves as a medium of exchange without being a store of value.

Conclusion

The commercial banking system's ability to create deposits indicates a systematic relationship between reserves and the overall money supply. Understanding this relationship is crucial for analyzing monetary policy effects conducted by the Bank of Canada.