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Economics for Management Studies
Iris Au

Chapter 27 Money and Banking Notes 27.1 The Nature of Money What is Money? N medium of exchange anything that is generally accepted in return for goods and services sold N barter a system in which goods and services are traded directly for other goods and services N the double coincidence of wants is unnecessary when a medium of exchange is used The Origins of Money N Greshams law the theory that bad, or debased, money drives good, or undebased, money out of circulation N law predicts that when 2 types of money are used side by side, one with greater intrinsic value will be driven out of circulation N bank notes paper money issued by commercial banks N gold standard a currency standard whereby a countrys currency is convertible into gold at a fixed rate of exchange N fiat money paper money or coinage that is neither backed by nor convertible into anything else but is decreed by the government to be accepted as legal tender N legal tender anything that by law must be accepted for the purchase of goods and services or the repayment of a debt N if fiat money is generally acceptable, it is a medium of exchange; it 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 N deposit money money held by the public in the form of deposits with commercial banks N 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 N 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 controls the banking system and is the sole money-issuing authority The Bank of Canada N 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 N basic functions of the bankbanker to the commercial banks, banker to the federal government, regulator of the money supply, and regulator and supporter of financial markets Commercial Banks in Canada N 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 N clearing house an institution where interbank indebtedness, arising from the transfer of cheques between banks, is computed and offset and net amounts owing are calculated Reserves N the reserves needed to ensure that depositors can withdraw their deposits on demand will normally be quite small N bank run a situation in which many depositors rush to withdraw their money, probably leading to a banks financial collapse N fractional-reserve system a banking system in which commercial banks keep only a fraction of their deposits in cash or on deposit with the central bank N reserve ratio fraction of its deposits that commercial bank holds as reserves in form of cash or deposits with central bank N target reserve ratio the fraction of its deposits that a commercial bank wants to hold as reserves N excess reserves reserves held by a commercial bank in excess of its target reserves 27.3 Money Creation by the Banking System The Creation of Deposit Money N if v is target reserve ratio, new deposit to banking system will increase total amount of deposits by 1v times new deposit N with no cash drain from the banking system, a banking system with a target reserve ratio of v can change its deposits by 1v times any change in reserves Excess Reserves and Cash Drains N deposit creation does not happen automatically; it depends on the decisions of bankers; if banks do not choose to lend their excess reserves, there will not be an expansion of deposits N the larger is the cash drain from banking system, the smaller will be total expansion of deposits created by a change in reserves 27.4 The Money Supply N money supply the total quantity of money in an economy at a point in time; also called the supply of money Kinds of Deposits N term deposit an interest-earning bank deposit, subject to notice before withdrawal N the long-standing distinction between money and other highly liquid assets used to be that, narrowly defined, money as a medium of exchange that did not earn interest, whereas other liquid assets earned interest but were not media of exchange; today, this distinction has almost completely broken down Definitions of the Money Supply N M1 currency plus demand deposits www.notesolution.com
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