ECON102 Lecture Notes - Lecture 5: Open Market Operation, Bank Reserves, Reserve Requirement

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25 Aug 2016
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Money = any means of payment to settle a debt.
Without money there would be a barter system - requires double coincidence of wants
that rarely occurs.
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Money function a medium of exchange
An agreed measure for stating the prices of goods and services
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Helps in measuring the opportunity cost of goods and services in terms of other goods
and services.
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Money function as a unit of account
Something can be held or exchanged later in goods and services
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Inflation reduces value of money and value of other commodities and tokens that are
used as money. ( gold, silver, copper, salt).
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Money's function as a store of value
Liquidity = is the property of being instantly convertible into a means of payment with little
loss of value.
Two measures of the money stock for the Canadian economy
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M1 = currency ( bank notes + coins) outside the banks + demand deposits ( transactional
accounts) located in chartered bank.
Demand deposits - funds in accounts that can be removed without notice and usually pay
little or no interest. Examples: current accounts, personal chequable accounts.
M2 = M1 + personal savings deposits + term deposits and non-personal notice deposits
located in chartered banks. ( non-chequable deposits)
Some savings deposits in M2 are not means of paymentsthey are called liquid assets.
Liquidity is the property of being instantly convertible into a means of payment with little
loss of value.
Deposits are money, but cheques are nota cheque is an instruction to a bank to transfer
money.
Credit cards are not money. A credit card enables the holder to obtain a loan, but it must be
repaid with money.
Savings deposits - bank deposits that typically earn a rate of return and require a stipulated
amount of notice to be withdrawn, though rarely enforced.
Notice deposits - deposits which have a notice requirement in the contractual agreement
with the client, although banks almost never enforce this clause.
Term deposits - bank deposits paying a market rate of return which are deposited for a fixed
term and thus have a limited liquidity.
Ch24 - Money Price level and inflation
Monday, January 25, 2016
7:27 AM
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Deposits are money, notes and coins
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What is Money
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Credit cards are not money.
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What is Not money
Without money we could trade but transaction costs are high and would prohibit some
trades taking place.
Canada savings bonds ( neither )
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Currency in the bank vault ( neither)
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Personal chequable deposits ( both )
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Currency outside banks ( M1&M2)
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Personal non-chequable deposits ( M2 )
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Which of the following is a component of M2 but not of M1?
The Banking System
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Private firms
Chartered under the bank act of 1871 to receive deposits and make loans.
Chartered banks
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A cooperative, member-owned financial institution that fulfills traditional
banking roles as well as diverse activities such as lending, insurance, investment
dealing.
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Credit unions and Caisses populaires ( credit union in French speaking places)
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Financial institutions that manages money for other people
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Fiduciary function ( duty to act solely on other parties interests)
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Each chartered bank now own a trust company
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Trust companies
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Loan to buy a house
Until 1960 the bank was prohibited to make mortgage loans.
Mortgage companies
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Maximize wealth of its owners by making loans from its deposits or buying
securities at a higher interest rate than paid to depositors.
Larger interest rate spread
Must balance their profit and prudence: can't spend every penny of the
reserves.
Loans generate profit.
Depositors must be able to obtain their funds when they want
them.
But the banks must balance profit and prudence:
By
Banks Do
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Liquid assets - Canadian government treasury bills. Because there is no trouble selling
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Depository institutions
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Liquid assets - Canadian government treasury bills. Because there is no trouble selling
them and their values are well known . Can be sold or instantly converted into reserves
with no risk of losses. Low risk thus low rate of return.
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Loans - commitments of fixed amounts of money for agreed-upon periods of time. The
balance on credit card amounts are also bank loans.
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Take deposits and are ready to repay them in the short term
Make loans which can be repaid over longer periods of time
Create liquidity
Depository institutions are in the lending business. An occasional default
can be absorbed.
Pool risk
Households and firms need not search for a source, or many sources, for
loans but spreads the cost of activity over many borrowers.
Lower the cost of borrowing
Depository institutions can more easily monitor borrowers which allows
institutions to make better decisions and reduce default risk .
Lower the cost of monitoring borrowers.
Economic benefits provided by Banks
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Lot of risk involved in this business.
Prohibits banks to lend out every single penny they have in their reserve. So they
are required by law to hold some back.
There have been two chartered bank failures in Canada.
If a Canadian banks fail, deposits are guaranteed up to 100,000 per depositor per
bank by Canada deposit insurance company.
Provincial government agencies regulate credit unions and caisses populaires.
Regulated
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economic environment and technology
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Accepts deposits from other financial institutions - that form reserves of
the banks.
Banker to banks and government
Suppose the royal bank suddenly becomes insolvent. Then every other
Canadian is run to the bank and withdraw all their money. The bank of
Canada will stand ready to solve their problem, protect the financial
system from falling.
Sole issuer of bank notes
When banking system as a whole is short of reserves.
Lender of last resort
Bank of Canada functions:
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