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ECON 1P92 03/05/13 Chapter 27 Money and Banking Two Perspectives on Money The Classical View of Money  Relative prices and real GDP are determined only by real things (i.e. technology and preferences)  Money is neutral o Change in the money supply causes no change in real variable  Change in the money supply does lead to a proportionate change in the price level The Modern View Short Run:  Changed in money do generate changes in output an other real variables  Shifts- change output and price level Long Run:  Output is fixed, price level continues to increase  Money is neutral  Changes in money and the price level are closely linked *Countries with high inflation rates often have higher rates of growth of the money supply The Nature of Money  Money is a medium of exchange o Acceptable as payment for goods and services  Without money, we would need something like a barter system o Barter is inefficient o Requires double coincidence of wants *Not a problem when general medium of exchange is used  Money is a store of value o Without high inflation, money retains its value  Money is a unit of account o The unit of measure we use to keep our financial accounts The Origins of Money Metallic Money  Coin worth market value of metal  Led to debasing Gresham’s Law:  ‘Bad money drives out good’ *When two types of money are used, one with greater intrinsic value will be driven out of circulation. Paper Money:  Backed by precious metal  Convertible on demand  Referred to as bank notes because it was issued by private banks ECON 1P92 03/05/13 Fractionally Backed Paper Money  Goldsmiths (banks) found they didn’t need to keep 1 0z. of gold in vaults for every receipt for 1 oz.  Issued more ‘receipts’ than the gold in their vaults Flat Money  Paper money or coinage  Neither backed by nor convertible into anything else  Decreed by the government to be acceptable as legal tender  Most currency today is fiat Modern Money Deposit Money:  Money held by the public in forms of deposits with commercial banks and other financial institutions  Bank deposits are money Money Creation:  Banks create money by issuing more deposits than they have available in their cash reserves The Canadian Banking System Consists Of:  Commercial banks  A central bank Central Bank  Acts as a bank to commercial banking system  Usually government-owned (unless it’s a dictatorship)  Sole money-issuing authority *Bank of Canada (BOC) is the central bank in Canada BOC  Operates under a system of joint responsibility (1967)  Operates monetary policy on a day-to-day basis  Free of political influence  Ultimately answerable to Parliament  Basic Functions: 1. Banker to commercial banks o Accepts deposits (comm
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