Lecture 36-Money

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1 Aug 2010
Tuesday, March 9th, 2010.
(Canada: Currency + Bank Deposit)
1. Purposes
I. Medium of Exchange
II. Store of Value
III. Unit of Account
2. Alternative to Money: Barter (very inefficient)
Banking System
1. Central Bank (Bank of Canada)
Uses control of money supply and interest rates to influence Aggregate Demand
2. Commercial Banks
Create money as by-product of profit-seeking activities
How do Banks Create Money?
Simplifying Assumptions
1. All banks have same desired/target reserve ration *
2. No cash drain (amount of cash held by public is fixed) *
3. Bank capital is zero (for numerical examples)
* Important assumptions
Desired Reserve Ratio of Bank
Simple Balance Sheet
Assets (A) Liabilities (L)
Reserves 40 Deposits 400
Loans 360
Reserves = Vault Cash + Deposits at Bank of Canada
Reserves earn low or zero interest
Loans earn market interest rate
Desired Reserve Ratio = Desired Reserves / Deposits
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