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ECON1000 CH. 10.docx

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ECON 1000
Nick Rowe

Chapter 10: The Monetary System What Money Is, and Why It's Important •Without money,trade would require barter: the exchange of one good or service for another •Every transaction would require a double coincidence of wants--the unliekly occurrence that two people each have good the other wants •Most people would have to spend time searching for others to trade with--a huge waste of resources • This searching is unnecessary with money; the sets of assets that people regularly use to buy goods and services from other people The Functions of Money •Medium of Exchange: an item buyers give to sellers when they want to purchase goods and services •Unit of Account: the yardstick people use to post prices and record debts •Store Value: an item people can use to transfer purchasing power from the present to the future. The Two Kinds of Money •Commodity money: takes the form of a commodity with intrinsic value. Examples would be gold coins and cigarettes (POW camps) •Fiat money: money without intrinsic value, used as money because of government decree. Examples are the Canadian dollar Money in the Canadian Economy •The money supply (or money stock): the quantity of money available in the economy •What assets should be considered part of the money supply? Here are two candidates: o Currency: the paper bills and coins in the hands of the (non-bank) pubic o Demand deposits: balances in bank accounts that depositers can access on demand by writing a check or using a credit card The Bank of Canada Central bank: an institution designed to regulate the money supply in the economy. The Bank of Canada is the central bank of Canada. •The Bank of Canada was established in 1935 and nationalized in 1938, so it is now owned by the Canadian government. •The Structure of the Bank of Canada: o Managed by a board of directors, composed of the governor, the senior deputy governor, and 12 directors, including the minister of Finance •Current governor, David Dodge, was appointed in 2001 •All members of the board of directors are appointed by the minister of Finance with 7- year terms for the governor and senior deputy governor and 3-year terms for the other directors •Four primary functions of the Bank of Canada o Issue currency o Act as banker to the commercial banks o Act as banker to the Canadian government o Control the money supply •Controlling the money supply: o The money supply is the quantity of money available in the economy o Decisions by policymakers concerning the money supply constitute monetary policy Commercial Banks and the Money Supply • Commercial banks include credit unions, caisses populaires and trust companies • Commercial banks can influence the quantity of demand deposits in the economy and the money supply Bank Reserves • In a fractional reserve banking system, banks keep a fraction of deposits as reserves and use the rest to make loans • Banks may hold more than this minimum amount if they choose • The Reserve Ratio, R o Fraction of deposits that banks hold as reserves o Total reserves as a percentage of total deposits Bank T-Account • T-account: a simplified accounting statement that shows a bank's assets & liabilities • Example: First National Bank Assets Liabilities Reserves $10 Deposits $100 Loans $90 • Banks' liabilities include deposits, assets include loans and reserves • In this example, notice that R=$10/$100 = 10% Banks and the Money Supply: An Example Suppose $100 of currency is in circulation. To determine the banks' impact on money supply, we calculate the money supply in 3 different cases: 1. No banking syst
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