MKT 300 Lecture Notes - Bankrate
ECN Chapter 10
The Meaning of Money
•Money: The set of assets in an economy that people regularly use to
buy goods and services from other people.
-money and wealth are not the same
-Bill gates who owns most of Microsoft Corporation, is wealthy but
this asset is not considered a form of money.
The Functions of Money
•Medium of exchange: An item that buyers give to sellers when they
want to purchase goods or services. Money is the medium of
exchange in the Canadian economy.
•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 a unit of account.
•Store of value: An item that people use to transfer purchasing power
from the present to the future. Example, when a seller accepts money
today in exchange for a good or service, the seller can hold the money
and become a buyer of another good or service at another time.
•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. Intrinsic value means that the item would have value
even if it were not used as money. Example gold: It has intrinsic value
because it is used in the industry and in the making of jewelry.
•Flat Money: Money without intrinsic value that is used as money
because of government decree. Example: Canadian paper bills. The
government has decreed its dollars to be valid money.
Money In The Canadian Economy
•Currency: The paper bills and coins in the hands of the public.
•Demand deposits: Balances in the bank accounts that depositors can
access on demand by writing a cheque or using a debit card.
The Bank of Canada
•Bank of Canada: The central bank of Canada.
•Central bank: An institution designed to regulate the quantity
of money in the economy.
The Bank of Canada Act
-The bank of Canada has related jobs. The first is to issue currency.
-The second is to act as a banker to the commercial banks. These
deposits at the bank of Canada enable the commercial banks to
make payments to eachother.
-The third job is to act as a banker to the Canadian government. The
government of Canada has a demand deposit at the bank of Canada
and demand deposits at large commercial banks. The bank of
Canada manages the governements bank accounts, as well as
manages Canada’s foreign exchange reserves and national debt on
behalf of the government.
-The fourth and most importanat job is to control the quantity of
money that is made available to the economy, called 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. The Monetary Policy
•The bank of Canada has the power to increase or decrease the number
of dollars in the economy. A simple good metaphor to explain the
monetary policy: Imagine the bank of Canada printing up $20 bills
and dropping them around the country by helicopter. Similarly, you
can imagine the BOC using a giant vacuum cleaner to suck $20 bills
out of peoples wallets.
Commercial Banks and the Money Supply
The Simple Case of 100 Percent- Reserve Banking
•Reserves: Deposits that banks have received but have not loaned out.
- 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 only
hold a fraction of deposits as reserves.
•Reserve Ratio: The fraction of deposits that banks hold as reserves.
-R= 1/10 means the reserve ratio is 10%
-If the bank holds $1000 in deposits, then the reserve ratio of 1/10
means that the bank holds $100 in reserves.
-R is the ratio of reserves to deposits at each bank
The Money Multiplier
•Money Multiplier: The amount of money the banking system
generates with each dollar of reserves.
-A reciprocal of the reserve ratio
-If the banking system as a whole holds a total of $100 in reserves,
it can only have 1000 dollars in deposits.
-Money multiplier is the ratio of deposits to reserves in the banking
-The higher the reserve ratio, the less each deposit banks loan out,
and the smaller the money multiplier.
The Bank of Canada’s Tool of Monetary Control
- The bank of Canada has used different methods for controlling the money
supply. Central banks have three main tools: Open market operations,
Changing Reserve Requirements and changes in the overnight rate.
•Open- Market Operations: The purchase or sale of government of
Canada’s bond by the bank of Canada.
-Foreign exchange market operations: The purchase of sale of
foreign money by the bank of Canada.
-Sterilization: The process of offsetting foreign exchange market
operations with open- market operations, so that the effect on
money supply is cancelled out.
•Changing Reserve Requirements
-Reserve Requirements: Regulations on the minimum amount of
reserves that banks must hold against deposits.
•Changing the Overnight Rate
-Bank rate: The interest rate charged by the Bank of Canada on
loans to the commercial banks.
-Overnight Rate: The interest rate on very short term loans
between commercial banks.
Problems in Controlling the Money Supply
•The first problem is that the bank of Canada does not control the
amount of money that households choose to hold on deposits in banks.
•The second problem with monetary control is that the bank of Canada
does not control the amount that commercial bankers choose to lend.
Once money is deposited in a bank, it creates more money only when
the bank chooses to lend it out.
•If the bank of Canada discovers that the money supply is growing too
fast, it can raise the overnight rate to slow it down.
•If the bank discovers that the money supply is growing slowly or
falling it can lower the overnight rate to increase the money supply.