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Chapter 10 The Monetary System.docx

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ECN 204
Paul Missios

Chapter 10: The Monetary System -If there were no money, people would have to depend on barter which is the exchange of one good/service for another good/service. It requires the double coincidence of wants, the unlikely occurrence that two people each have a good or service that the other wants. -With money, trading is easier because it is a standard form Money: the set of assets in an economy that people regularly use to buy goods and services from other people (money = wealth) Three Functions of Money 1) A Medium of Exchange: an item that buyers give to sellers when they wants to purchase goods or services 2) Unit of Account: the yardstick people use to post prices and record debts. When we want to measure and record economic value, we use money as the unit of account 3) Store of Value: an item that people can use to transfer purchasing power from the present to the future. The value in which it can be hold, money fluctuates but the prices of houses may hold more value in the future. Wealth is used to refer to the total of all store of value. Liquidity: the ease with which an asset can be converted into the economy’s medium of exchange The Kinds of Money Commodity Money: money that takes the form of a commodity with intrinsic value (item would have value even if it were not used as money). Example would be gold, cigarettes Fiat Money: money without intrinsic value that is used as money because of government decree. The paper money in your wallet has been decreed by the Canadian government to be valid money. Money in the Canadian Economy Money Stock: the quantity of money circulating in the economy has a powerful influence on many economic variables If you were to Measure Money: Currency: the paper bills and coins in the hands of the public Demand Deposits: balances in bank accounts that depositors can access on demand by writing a cheque or using a debit card The Bank of Canada Bank of Canada: central bank of Canada Central Bank: an institution designed to regulate the quantity of money in the economy The Bank of Canada Act -in 1934, Parliament enacted the Bank of Canada Act, the bank was established in 19354 and nationalized in 1938, therefore it is owned by the Canadian government -Bank of Canada is managed by a board of directors composed of the governor, the senior deputy governor, and 12 directors including the deputy minister of Finance.Four Related Jobs: 1) Issue Currency, the Bank of Canada has the monopoly over the right to issue notes for circulation in Canada 2) Act as a banker to the commercial banks, the commercial banks have demand deposits at the Bank of Canada which enables them to make payments to each other. Bank of Canada also makes loans to these banks when they need to borrow money. 3) Act as a banker to the Canadian Government, the government has a demand deposit at commercial banks and the Bank of Canada. The Bank of Canada managers the government bank account and manages Canada’s foreign exchange reserves and national debt 4) Control the quantity of money that is made available to the economy (money supply) Money Supply: the quantity of money available in the economy Monetary Policy: the setting of the money supply by policymakers in the central bank Monetary Policy -the Bank of Canada has the power to increase or decrease the number of dollars in the economy, either by injecting more in or by taking money out. Commercial Banks and the Money Supply  The Simple Case of 100 Percent-Reserve Banking Reserves: deposits that banks that have received but have not loaned out -100% reserve banking is an imaginary economy that all deposits are held at reserves -If banks hold all deposits in reserve, banks do not influence the supply of money  Money Creation with Fractional-Reserve Banking Fractional Reserve Banking: a banking system in which banks hold only a fraction of deposits as reserves Reserve Ratio: the fraction of deposits that banks hold as reserves which is a combination of government regulation and bank policy Reserve Requirement: some central banks place a minimum on the amount of reserves that banks hold Excess Reserves: banks may hold reserves above the legal minimum so they can be more confident that they will not run short of cash -If the bank has a 10% reserve ratio, it keeps 10% of its deposits in reserve and loans out the rest -When the bank makes loans, the money supply increases. The depositors will still have de
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