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CA (538,613)
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ECO100Y1 (439)
Jack Carr (32)
Lecture

Money & interest rates

9 Pages
113 Views

Department
Economics
Course Code
ECO100Y1
Professor
Jack Carr

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Money & Interest Rates
Money an asset that is sufficiently liquid to exchange for an immediate purchase
or acceptable for immediate sale
oCurrency in circulation and Deposits (Demand)
Functions of money
oMedium of exchange
oStore of Value
oUnit of Account
Currency
oLegal Tender (acceptable for payment of debt)
oFiat (trust) money inconvertible currency
Deposits
oBank liabilities sufficiently liquid for immediate use in purchase and sale
Money Supply definitions (for Canada)
oM1 = Currency in circulation (outside banks) and Demand (chequing)
deposits at chartered banks
oM2 = M1 + Personal Savings Deposits + Non-personal Notice Deposits at
chartered banks
oM2+ = M2 + Deposits at Near banks (Trust companies, credit unions, etc)
BANKING
oBusiness of borrowing money to lend money or to buy financial assets for a
higher interest rate
oFractional Reserve Banking
Occurs when Bank Deposits are a fraction of Bank Reserves
oBank Reserves:
www.notesolution.com
Legal tender held by private banks (currency in vaults/ deposits at central
bank) to pay out withdrawals
Do not receive interest if they are currency in banks but may receive interest
as bank deposits at central bank
oReserve Ratio
Ratio of existing bank reserves to existing deposit liabilities
= Actual Reserves / Deposits
oRequired Reserve Ratio (RR)
Legal min reserves/ deposits ratio dictated by gov to assure banks’ ability to
satisfy deposit withdrawals
oTarget Reserve Ratio (RR)
Reserve/ deposit ratio desired by banks to maximise profit
Reserves either do not yield interest or yield low interest that profit
maximisation by banks implies an optimal reserve/ deposit ratio that
maximises profit while still maintaining sufficient liquidity to meet
withdrawal demands
oDeposit (Money) Multiplier (Bank creation of Deposit Money)
Assume:
No excess Reserves (i.e. banks lend all excess reserves)
oExcess Reserves = Actual Reserves – Target (required) Reserves
No Excess Currency in Circulation
oAssume the public deposits all currency in excess of historical
requirements into banks
Example of Bank expansion:
oSuppose that Target Reserve Ratio = 10% of 0.1
o public deposits 100,000 currency in bank
Assets
Reserves = + 10 000
www.notesolution.com
Excess Reserves = + 90 000
Liabilities
Deposits = + 100 000
oExcess Reserves are immediately loaned (or used to buy
interest bearing securities) therefore at eqb: Excess Reserves =
Loans
oEQB amount of Deposits for given Reserve:
= Reserves/ RR
RR 1 Excess Reserves
oDeposit Multiplier
Ratio of Deposits to Reserves (Deposits/ Reserves) at eqb
= 1/ (Reserves/ Deposits)
= 1/ RR
Deposits = Reserves / RR
Since Money Supply = Currency in Circulation + Reserves/ RR
o= currency in circulation + [Currency in Banks + Bank
(Private) Deposits at Central Bank]/ RR
oDeterminant of Money Supply Change:
Currency in circulation + currency in banks = Legal Tender issue (of central
bank), and
Legal Tender Issue + Bank Deposits at Central Bank = Liabilities of Central
Bank, therefore determinant of Money Supply change:
Change in Central Bank liabilities
Change in Currency in circulation
Change in RR
oBank of Ca (1935)
www.notesolution.com

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Description
Money & Interest Rates Money an asset that is sufficiently liquid to exchange for an immediate purchase or acceptable for immediate sale o Currency in circulation and Deposits (Demand) Functions of money o Medium of exchange o Store of Value o Unit of Account Currency o Legal Tender (acceptable for payment of debt) o Fiat (trust) money inconvertible currency Deposits o Bank liabilities sufficiently liquid for immediate use in purchase and sale Money Supply definitions (for Canada) o M1 = Currency in circulation (outside banks) and Demand (chequing) deposits at chartered banks o M2 = M1 + Personal Savings Deposits + Non-personal Notice Deposits at chartered banks o M2+ = M2 + Deposits at Near banks (Trust companies, credit unions, etc) BANKING o Business of borrowing money to lend money or to buy financial assets for a higher interest rate o Fractional Reserve Banking Occurs when Bank Deposits are a fraction of Bank Reserves o Bank Reserves: www.notesolution.com
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