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ECN 204 (348)

Chapter #10 ECN.doc

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ECN 204
Christopher Gore

Chapter #10 The 3 Functions of Money - Money: the set of assets in an economy that people regularly ise to buy goods and services from other people - Medium of exchange: an item buyers give to sellers when they want to purchase g&s  when you buy a shirt at a clothing store, the store gives you the shirt, and you give the store you money  you are confident that the store will accept you money since it’s a medium of exchange - Unit of account: the yardstick people use to post prices and record debts  A shirt may cost $20 and a hamburger costs $2  It is accurate to say that the price of a shirt is 10 hamburgers and the price of a hamburger is 1/10 of a shirt, but prices are never quoted like that  If you take a loan from a bank, the size of your future loan repayments will be measured in dollars, not in a quantity of goods and services  When you want to measure and record economic value, we use money as the unit of account - Store of value: an item people can use to transfer purchasing power from the present to the future  A seller accepts money today in exchange for a good or service, that seller can hold the money and become a buyer of another food or service at another time  Money is not the only store of value in the economy because a person can also transfer purchasing power from the present to the future by holding other assets  Term is known as wealth where the total of all stores of value, including both money and nonmonetary assets - Liquidity: the ease with which an asset can be converted into the economy’s medium of exchange  Money is the most liquid asset available  bonds and stocks are easy to sell as well and are able to turn into cash  Houses in contrast takes time to turn into cash and it takes more time and effort hence its less liquid - When people decide in what form to hold their wealth, they have to balance the liquidity of each possible asset against the asset’s usefulness as a store of value - Money is liquid but it’s far from perfect as a store of value  Prices rise, the value of money falls  When goods and services become more expensive, each dollar in your wallet can buy less The 2 Kinds of Money - Commodity money: takes the form of a commodity with intrinsic value o the item would have value even if it were not used as money o Examples: gold coins, cigarettes in POW camps - Fiat money: money without intrinsic value, used as money because of government decree o Example: the Canadian dollar o American dollar is widely used, so if you go to a foreign country, you are confident that they will accept your money 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? Two candidates: o Currency: the paper bills and coins in the hands of the general public o Demand deposits: balances in bank accounts that depositors can access on demand by writing a cheque or using a debit card. o Money supply = Currency + Deposits The Bank of Canada - Central bank: an institution designed to regulate the money supply in the economy. - Bank of Canada: 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. o Current governor, Mark Carney, was appointed in 2008 o 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 o Big 5 Bank of Montreal, Bank of Nova Scotia, The Royal Bank, Toronto – Dominion Bank, and Canadian Imperial Bank of Commerce o Four Primary Functions of the Bank of Canada  Issue currency • Gives the Bank a monopoly over the right to issue notes for circulation in Canada  Act as banker to the commercial banks • When a customer demands for deposits, a bank is in demand as well from Bank of Canada • Bank of Canada makes daily loans to banks when banks themselves need to borrow money to make payments to other banks • If a commercial bank is financially troubled when they are short of cash  Bank of Canada acts as a lender  Act as banker to the Canadian government • The government has a demand deposit at the Bank of Canada as well as demand deposits at the large commercial banks • The Bank of Canada manages the government’s bank account and as well as Canada’s foreign exchange reserves and nation debt. On behalf of the government  Control the money supply • Control the amount of money made available to the economy • Decided by the money supply constitute monetary policy • Monetary Policy: the setting of the money supply by policymakers in the central bank • Money supply = Currency + Deposits • Decisions by policymakers concerning the money supply constitute monetary policy Commercial Banks and the Money Supply - Although the Bank of Canada alone is responsible for Canadian monetary policy, the central bank can control the supply of money only through its influence on the entire banking system. - 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. - Reserves are the cash that commercial banks hold - 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
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