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Canada (162,462)
Economics (385)
ECO100Y5 (290)
Chapter 27

Chapter 27- Money and Banking.docx

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Kalina Staub

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Chapter 27- Money and Banking 27.1 The Nature of Money What is Money? • Money as a Medium of Exchange  Medium of Exchange- Anything that is generally accepted in return for g/s sold  Barter- A system in which g/s are traded directly for other g/s  The double coincidence of wants in unnecessary when a medium of exchanged is used  Characteristics of money: o Must be easily recognizable and readily acceptable o Must have a high value relative to its weight o Must be divisible o Must be reasonably durable o Must be difficult to counterfeit • Money as a Store of Value  Money is a convenient means of storing purchasing power; goods may be sold today for money and the money may then be stored until it is needed for some future purchases  Money must have a relatively stable value; when price level is stable, the purchasing power of a given sum of money is also stable  Hyperinflation- very high inflation • Money as unit of Account  Money is used for accounting purposes even if it has no physical existence  Use of money in this context suggest that money is a unit of account The Origins of Money • Metallic Money  Precious metals came to circulate as money as be used in many transactions because in constant demand, easily recognized, divisible into small units, and not easily worn out  Invention of coinage eliminated the need to weigh the metal at each transaction but a royal had to affix his/her seal, guaranteeing the amount of precious metal that the coin contained  Debasing of coinage allowed ruler to earn profit by minting more new coins than the number of old ones collected and putting the extras in the royal vault  Result of debasement was inflation  Gresham’s Law o Gresham’s Law- The theory that “bad” or debased, money drives “good” or undebased, money out of circulation o Predicts that when two types of money are used side by side, the one with the great intrinsic value will be driven out of circulation • Paper Money  Transferring of paper receipts rather than gold was the invention of paper money  Paper money was backed by precious metal and was convertible on demand into this metal  Bank Notes- Paper money issued by commercial banks  Fractionally Backed Paper Money o Banks have more claims outstanding against them than they actually have in reserves available to pay those claims o Problem: Maintaining its convertibility into the precious metal behind it • Flat Money  Gold Standard- A currency standard whereby a country’s currency is convertible into gold at a fixed rate of exchange  Central banks had substantial control over the quantity of currency outstanding but it would nonetheless have complete discretion in choosing this fraction; the smaller the fraction held in reserves, the larger the supply of paper currency that could be supported with a given stock of gold  Fiat Money- Paper money or coinage that is neither backed by nor convertible into anything else but is decreed by the government to be legal tender  If fiat money is generally acceptable, it is a medium of exchange; its purchasing power remains stable, it is a satisfactory store of value; if both of these things are true, it serves as a satisfactory unit of account; today, almost all currency is fiat money Modern Money: Deposit Money • Deposit Money- Money held by the public in the form of deposits with commercial banks • Three ways: withdraw cash, write a cheque, or electronic transfer of funds (debit card) • Bank deposits are money; today, just as in the past, banks create money by issuing more promises to pay (deposits) than they have cash reserves available to pay out 27.2 The Canadian Banking System • Central Bank- A bank that acts as banker to the commercial banking system and often to the government as well; usually a government owned institution that is the sole money issuing authority The Bank of Canada • Organization of the Bank of Canada  The system of joint responsibility keeps the conduct of monetary policy free from day to day political influence while ensuring that the government retains ultimate responsibility for monetary policy • Basic Functions of the Bank of Canada  Banker to the Commercial Banks o Central bank accepts deposits from commercial banks and will transfer them to the account of another way and this way, the central bank provides the commercial banks with the means of settling debts to other banks  Banker to the Federal Government o Central bank hols funds of the federal government in an account into which government can make deposits and on which they can write cheques o When government requires more money than it collects in taxes, it needs to borrow and it does so by issuing government securities  Regulator of the Money Supply o By changing its liabilities (currency plus reserves) the bank of Canada can change the money supply; can change levels of its assets and liabilities in many ways and as its liabilities rise and fall, so does the money supply  Supporter of Financial Markets o Institutions are in the business of accepting deposits from customers and then using these funds to extend long term loans to borrowers o Large increases in interest rates squeeze these institutions Commercial Banks in Canada • Commercial Bank- A privately owned, profit seeking institution that provides a variety of financial services, such as accepting deposits from customers and making loans and other investments • The Provision of Credit  Financial intermediary: Banks borrow from households and firms that have money that they do not currently need, and they lend to those households and firms that need credit to achieve their objectives Banks act as intermediaries in credit market  Credit is the “lifeblood” of a modern economy • Interbank Activities  Commercial banks have number of interbank cooperative relationships and its most important form is cheque clearing and collection, in
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