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Chapter 27

Economics 102: Chapter 27

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ECON 102
Robert Gateman

ECON 102: Principle of Macroeconomics Chapter 27 27.1 The Nature of Money What Is Money?  Medium of exchange: anything that is generally acceptable in return for goods/service sold o Money acts as a store of value and as a unit of account Money as a Medium of Exchange:  Barter: system in which goods/services are traded directly for others goods/services o There must be a double coincidence of wants in order to barter  This is unnecessary when a medium of exchange is used  Money makes specialization and the division of labour possible o Money must be easily recognizable and readily acceptable o Must have a high value relative to its weight o Must be divisible, because money that comes in large denominations is useless for small transactions o Must be reasonably durable, and difficult to counterfeit Money as a Store of Value:  Money is a convenient means of storing purchasing power o Goods can be bought, and money will be stored until the good can be resold  When the price level is stable, the purchasing power of a given sum of money is also stable o When the price level is variable, the purchasing power of money is unstable Money as a Unit of Account:  Money can be used purely for accounting purposes without having a physical existence o Money may not need a physical existence if it is documented is some way  A bank deposit can serve as a unit of account and a medium for exchange The Origins of Money:  Money goes as far back into antiquity o Most primitive societies are known to have made some use of it Metallic Money:  Gold and silver were precious because of the limited supply, and they were in constant demand o High/stable prices and easily divisible into smaller units  Coinage eliminated the need to weigh the metal at each transaction o Usually a king/queen were put on the seal of the coin to guarantee it o Face value: a certain weight of metal that was contained within the coin  People shaved/sliced (milled) the coins so they had to make the coins with rough edges o Coins were debased with other metals to earn profit  Consequently the amount of money in the economy increased  Caused a net increase in demand and drove up prices ECON 102: Principle of Macroeconomics  Gresham's Law: theory that bad, or debased money drives good or undebased money out of circulation o When two types of money are used side by side, the one with the greater intrinsic value will be driven out of circulation o Reason coins today only contain a fraction of value of their face value Paper Money:  Goldsmiths gave customers a receipt for their stored gold o After only the receipt was needed to pay for things instead of physically transferring gold o The paper/receipt was backed by precious metal and was convertible on demand into metal  Bank notes: paper money issued by commercial banks o In the nineteenth century used to back the holding of gold in the bank by depositors  Fractionally backed paper money: able to issue more paper money redeemable in gold than the amount of gold that banks held in their vaults o Could issue interest-earning loans to household and firms o Banks today have more claims outstanding than they actually have in their reserves Fiat Money:  Central bank took over issuing currency (both notes and coins)  Gold standard: a currency standard whereby a country's currency is convertible into gold at a fixed rate of exchange o Central banks have discretionary control over the quantity of currency outstanding  After the world wars most countries abandoned the gold standard (no longer convertible for gold)  Fiat money: paper money/coinage that is neither backed by nor convertible into anything else but is decreed by the government to be accepted as legal tender o Legal tender: anything that by law must be accepted when offered either for the purchase of goods or services or to repay a debt o Accepted as a medium of exchange, purchasing power is stable Modern Money: Deposit Money:  Commercial banks lost the right to issue money, but not the right to deposit money  Deposit money: money held by the public in the form of deposits with commercial banks o Cheques are a claim to a transfer of money, but not actual money o A balance of a bank account is money  Debit cards and automatic transfers have made it more efficient to transfer money that using cheques 27.2 The Canadian Banking System  Central bank: bank that acts as banker to the commercial banking system and often to the government o Usually a government owned institution that control the banking system and is the sole money-issuing authority ECON 102: Principle of Macroeconomics The Bank of Canada:  Central banks used to be profit-making institutions until they became instruments of government Organization of the Bank of Canada:  BOC commenced operations on March 11, 1935 o Publicly owned with all profits going to the Government of Canada o Board affairs are handled by directors composed of the governor, senior deputy governor, deputy minister of finance and 12 directors o Governor is appointed by the directors with approval of the federal cabinet (seven- year term)  BOC is designed to keep the operation of monetary policy free from day-to-day political influence o Join responsibility: governor and minister of finance are both accountable for the BOC o The government retains the ultimate responsibility for monetary policy Basic Function of the Bank of Canada:  Banker to the commercial banks: accepts deposits and transfers from commercial banks o Helps commercial banks settle debts with other commercial banks through transfers/loans o BOC is the lender of last resort for the commercial banks of Canada o During the financial crisis the BOC leant to commercial banks as they were unwilling to lend to each other  Banker to the Federal Government: BOC holds the funds of the government of Canada o Government borrows through issuing short-term treasury bills or long-term bonds  Often bought by institutions and investors, but sometime the BOC as well  A way that the BOC earns profit each year  Regulator of the money supply: the amount of currency in circulation plus deposits held by banks o BOC can change the level of its asses and liabilities in many ways  Regulator/supporter of financial markets: largely responsible to support the country's financial system and to prevent disruption by wide-scale panic and bank failures Commercial Banks of Canada:  Commercial bank: privately owned, profit-seeking institution that provides a variety
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