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Chapter 24

Economics 1022 Chapter 24 notes

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Economics 1022A/B
Jeannie Gillmore

Chapter 24 Money  Means of payment: Method of settling a debt. When the payment has been made, neither party have any obligations.  Money: Any commodity that is generally acceptable as a mean of payment; Used as: o Medium of exchange  Any object that is generally accepted in exchange for goods and services.  Without money, people must barter, exchange goods and services directly for other things.  To barter, double coincidence of wants is necessary, which is rare and inefficient.  Money isn‟t the only medium of exchange, but sources such as credit cards are not considered money. o Unit of account  An agreed measure for stating the prices of goods and services.  To get the most out a budget, the opportunity cost must be calculated, which is easier with money. o Store of value  Money can be held and exchanged later for goods and services.  Must be so to be a means of payment. Does not have to be money, but it is the most stable commodity.  Inflation lowers the value of money and other commodities. To be useful, inflation rate must be low.  Money in Canada: Consists of: o Currency: Notes and coins held by individuals and businesses  Money inside banks are not currency because they are not held by individuals or businesses  Convenient for settling small debts and buying low priced items o Deposits of individuals and businesses at banks and other institutions.  Money because owner of deposits can use them to make payments.  Official measures of money: o M1:  Currency held by individuals and businesses  Personal chequable deposits  Non-personal chequable deposits o M2:  Personal non-chequable deposits  Non-personal chequable deposits  Fixed term deposits o Currency is considered money as stated above. o Chequable deposits are considered money because they can be transferred using a cheque or a debit card. o Savings accounts are considered money because they are liquid assets (assets that can be easily converted into a means of payment without loss in value) o Cheques and credit cards are not money, they are simple means of payment. Banking System  Depository institution: Private firm that takes deposits from households and firms and make loans to others. They are: o Chartered banks:  A private firm, chartered under the Bank Act of 1992 to receive deposits and make loans.  By far the largest institutions in the banking systems and conduct various types of banking issues. o Credit unions and caisses populaires  A cooperative organization that operates under the cooperative credit association of 1992  Receives deposits from and makes loans to its members (caisses populaires in Quebec) o Trust and mortgage loan companies  Privately owned depository institution that operates under the trust and loans companies‟ act of 1992.  Receive deposits, make loans, and act as trustees for pension funds and estates. o As of 1992, all the institutions are called „banks‟, under the laws created in 1992. o Earn income from:  Cheque clearing, account management, credit card and internet banking, through service fees  Using funds received from depositors to make loans and buy securities that earn a higher interest rate than that paid to the depositor. These assets are:  Reserves: o Notes and coins in a depository institutions vault or its deposit account at the BoC. o Used to meet depositors‟ currency withdrawals and payment to other banks o Usually, 0.5% of deposits are kept as reserves.  Liquid assets: o Government treasury bills and commercial bills. o Can be sold and instantly converted into reserves with almost no risk of loss. o Low interest rate due to low risk.  Securities: o GoC bonds and other bonds such as mortgage backed securities. o Can be converted into reserves, but prices fluctuate. o Riskier than liquid assets and therefore higher interest rate.  Loans: o Commitments of funds for an agreed upon period of time o Are made to corporations to finance purchase of capital, and to individuals to fiancé consumer durable goods (credit card bill, boat, car, etc.) and homes. o Riskiest of assets, and earn the highest interest rate. o Provides benefits including:  Create liquidity: Banks “borrow short and lend long”, which create liquidity.  Pool risk: Banks take multiple customers, which causes % loss to be minimal.  Lower the cost of borrowing  Lower the cost of monitoring borrowers  Bank of Canada (BoC): Canada‟s central bank; public authority that supervises other banks and financial institutions, financial markets, and the payments system, and conducts monetary policy. o Accepts deposits, makes loans, and holds investment securities. However, special in that they are:  Banker to banks and government  Restricted list of customers; charted banks, credit unions, trust and mortgage companies o Bank of Canada and central banks of other countries o Chartered banks,  The customers‟ deposits become part of the reserves of the bank  Lender of last resort  Stands ready to make loans when the banking system as a whole is short of reserves  An individual bank needing reserves can get an overnight loan from another bank  Sole issuer of bank notes o Influences the economy by changing the interest rate, by changing the quantity of money in the economy. This amount depends on:  Assets:  Government securities (treasury bills that is bought from the bills market)  Loans to depository institutions  Liabilities:  Bank of Canada notes  Depository institution notes  Monetary base: Sum of BoC notes, coins, and depository institution deposits at the BoC  Acts like a base that supports the nation‟s money o Open market operation: Purchase or sale of government securities by the BoC in the open market  Changes the monetary base  Open market purchase: If the BoC makes a $100 purchase of government securities  The BoC pays for securities by placing $100 at CIBC‟s deposit account at the BoC  CIBC has $100 less securities (assets) and the BoC has $100 more securities (assets).  CIBC‟s total assets are unchanged.  The BoC‟s assets and liabilities increase by $100.  Open market sale: If the BoC sells $100 sale of government securities:  CIBC pays for the securities using $100 of its reserve deposits  CIBC has $100 more securities and the BoC has $100 less securities.  CIBC‟s total assets are unchan
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