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Chapter 10

The Monetary System - Chapter 10.docx

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ECON 1010
Frank Miller

The Monetary System - Cash, cheque and debit cards represent a claim to goods and services in the future - Useful in complex and large societies to ease transactions - Barter: exchange of one good/service for another to obtain things that one needs o Double coincidence of wants: unlikely occurrence that two people each have a good/service that the other wants - As money flows from one person to the next, it facilitates production and trade - Allows each person to specialize in what he/she does best and raise standard of living The Meaning of Money - Money is the set of assets in the economy that people regularly use to buy goods/services from other people - Includes only those types of wealth that are regularly accepted by sellers in exchange for goods/services Functions of Money 1) Medium of exchange: item that buys give to sellers when they purchase goods/services - There is a transfer of money between buyer and seller - People must be able to accept it for what it is worth 2) Unit of Account: yardstick people use to post prices and record debts; everything is measured in terms of dollars (not comparing that one thing is 1/10 price of another) - Helps measure and record economic value 3) Store of Value: item that people can use to transfer purchasing power from the present to the future - Wealth: refers to total of all stores of value; both monetary and non-monetary assets - Liquidity: describes the ease with which an asset can be converted into economy’s medium of exchange Kinds of Money - Commodity money: when money takes the form of a commodity with intrinsic value (item would have value even if it were not used as money) - Gold is a commodity and has intrinsic value; used to make jewellery - Gold standard: when an economy uses gold as money or uses paper money that is convertible into gold on demand - Fiat money: money without intrinsic value; an order or decree; established as money by the government decree o Acceptance depends on expectations and social convention as on government decree o 1980, Russia people used cigarettes as medium of exchange as opposed to the ruble Money in Canadian Economy - Money stock: quantity of money circulating in the economy - Currency: the paper bills and coins I the hands of the public o Most widely accepted medium of exchange - Demand deposits: balances in bank accounts that depositors can access on demand simply by writing a cheque or using a debit card - Credit cards are method of deferring payment so not considered a medium of exchange o M1: chequable deposits + currency o M2: M1 + non-personal demand and notice deposits + few minor categories Where is All the Currency? - Much of the currency held by tax evaders, drug dealers and other criminals - Currency does not earn interest and it can be easily lost or stolen; more people inclined to leave money in the bank and earn interest - Canadian dollar rarely used outside of Canada Bank of Canada - Responsible for controlling sock of money - It is a central bank: institution designed to control the quantity of money in the economy; Bank of England, Japan, Federal Reserve and European Central Bank Bank of Canada Act - Before 1930’s, bank notes issued by Department of Finance and large commercial banks - Gold standard ensured bank notes could normally be exchanged for fixed quantity of cold Changes/Modernization of Banking System - The Act was enacted in 1934 - Bank of Canada was created in 1935; managed by government officials - Primary responsibility is to act in national interest; regulate credit and currency in best interest of economic life o the nation Jobs and Responsibilities 1) Issues Currency: BOC has monopoly over the right to issue notes for circulation in Canada 2) Acts as banker to commercial banks: allows commercial banks to make payments to one another (they have demand deposits at BOC); BOC makes daily loans to commercial banks to maintain stability in banking system 3) Acts as a banker to Canadian government: BOC manages the governments bank accost and also manages Canada’s foreign exchange resources and national debt on behalf of the government 4) Controls quantity of money made available in the economy - The Big 5: commercial banks link BMO, Royal bank, TD, Canadian Imperial Bank of Commerce and Bank of Nova Scotia; owned by individual shareholders - Depository institution: only accepts deposits but does not make loans Monetary Policy - Setting of money supply by policymakers in the central bank - BOC has power to increase or decrease the number of dollars in the economy - Prices rise when government prints too much money o Short-run trade-off faced between inflation and unemployment Commercial Banks and the Money Supply - Includes credit unions, caisses populaires and trust companies - Behaviour of banks can influence quantity of demand deposits in the economy and affect the money supply Simple Case of 100 Percent-Reserve Banking - In a world without banks, currency is only form of money; total quantity of money is $100 - Reserves: deposits that banks have received but have not loaned out - In imaginary economy all reposts held as reserves - If banks hold all deposits in reserve, they do not influence supply of money - Each deposit in the bank reduces currency and raises demand deposits by same amount; money supply unchanged Money Creation with Fractional-Reserve Banking - Banking system in which banks hold only fraction of deposits as reserves - Families needing to buy a new house or businesses that need capital investments would not mind paying the interest - Reserve ratio: fraction of deposits that banks hold as rese
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