EC140 Lecture Notes - Open Market Operation, Mortgage Loan, Credit Union

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19 Mar 2013
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Chapter 24: Money, the Price Level, Inflation
Tuesday, February 26, 2013
1:02 PM
Money: any commodity or token that is generally acceptable as means of payment
(method of settling debt)
3 other functions:
medium of exchange
An object that is generally accepted in exchange for goods and
services
In absence of money, people would need to barter: exchange
goods and services directly (requires a double coincidence of wants,
which is rare so barter is costly)
unit of account
An agreed measure for stating prices of goods and services
store value
Money can be held for a time and later exchanged for goods and
services
Money in Canada:
Currency: the notes and coins held by individuals and firms is called
deposits at banks and other depository institutions
We use "flat money"
Notes not backed by anything tangible
Has value as medium of exchange because government says so,
government can maintain its value
Paper and coins have no intrinsic value, their value is ONLY
value of what money can do
Official measures of money
M1: consists of currency and chequable deposits of individuals and
businesses
M2: consists of M1 plus all other deposits
All items in M1 are means of payment
Some saving deposits in M2 aren't means of payments- these are
called liquid assets
Deposits are money, but cheques aren't
Cheque is instruction to bank to transfer money (deposit is the
money, not cheque itself)
Credit cards aren't money
Credit card enables holder to obtain a loan, but must be repaid
with money
The Banking System
Banking system consists of private and public institutions that:
Create money
Manage nation's monetary and payments systems
Consists of two institutions that play crucial role in financial markets
Depository institutions: firm that takes deposits from households and
firms and makes loans to other households and firms
Institutions in banking system divide into:
Chartered banks
Credit unions and caisses populaires
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Trust and mortgage loan companies
To make money (profit), banks lend money at higher rate of
interest than the rate they pay on deposits
But banks must balance profit and prudence:
Loans generate profit
Depositors must be able to obtain their funds when they
want them
Chartered bank puts depositors' funds into four types of assets
Reserves: notes and coins in its vault or its deposit at
Bank of Canada
Liquid Assets: government of Canada Treasury bills and
commercial bills
Securities: longer-term government of Canada bonds
and other bonds such as mortgage-backed securities
Loans: commitments of fixed amounts of money for
agreed-upon periods of time
Benefits:
Create liquidity: lend money when people/firms need it
Pool risk: loss of any one small loan to bank is minimal
Lower cost of borrowing: reduces search costs for
firms in finding money
Lower cost of monitoring borrowers: they are set up
to encourage good borrowing and repayment practices
The Bank of Canada
The central bank of Canada
Central bank: public authority that regulates a nation's
depository institutions and control quantity of money
Bank of Canada is
Banker to banks and government
Accepts deposits from depository institution,
government of Canada
Lender of last resort
Means that it stands ready to make loans when
banking system as whole is short of reserves
Banks lend/borrow reserves from other banks in
overnight loans market
Sole issuer of bank notes
Bank of Canada is only bank that is permitted to
issue bank notes
Bank of Canada has monopoly on this activity
Understanding Bank of Canada's balance sheet is key for
understanding money creation process (changes to its balance sheet
after the monetary base, which is one step in money creation
process)
Assets are: government securities, loans to depository
institutions
Liabilities: Bank of Canada notes, deposits of banks and
government
Monetary Base: sum of Bank of Canada notes, banks' deposits
at Bank of Canada, and coins issued by the Mint
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Document Summary

Money: any commodity or token that is generally acceptable as means of payment (method of settling debt: 3 other functions, medium of exchange. An object that is generally accepted in exchange for goods and services. In absence of money, people would need to barter: exchange goods and services directly (requires a double coincidence of wants, which is rare so barter is costly: unit of account. An agreed measure for stating prices of goods and services store value. Has value as medium of exchange because government says so, government can maintain its value value of what money can do. Cheque is instruction to bank to transfer money (deposit is the money, not cheque itself: credit cards aren"t money. Credit card enables holder to obtain a loan, but must be repaid with money. To make money (profit), banks lend money at higher rate of. Trust and mortgage loan companies interest than the rate they pay on deposits.

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