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Canada (161,660)
York University (12,802)
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ECON 1010 (256)
Jean Adams (10)
Chapter 24

ECON 1010 - Class Notes - Chapter 24.docx

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ECON 1010
Jean Adams

MONEY, THE PRICE LEVEL,AND INFLATION CHAPTER 24 ECON 1010 • Money is: o Ameans of payment o Amedium of exchange o Aunit of account o Store of value • Types of money: o Currency: Notes and coins held by individual o Deposits: Deposits of individuals and businesses at banks and other institutions • Measures of money: o M1: consists of currency held by individuals and businesses plus chequable deposits owned by individuals and businesses o M2: consists of M1 plus all other deposits – non-chequable and fixed term o Money counted in M1 & M2:  Means of payment: actual money  Deposits: liquid assets • Not money: o Cheques o Credit cards • The Banking system consists of: o Depository institutes  Chartered banks • Private firm chartered under the bank act  Credit unions and caisses populaires • Cooperative organization that operates under CCAAct  Trust and mortgage loan companies • Privately owned company that receives deposits, makes loans etc. o Bank of Canada • What Depository Institutions Do: o Reserves: Notes and coins in a bank’s vault or in its deposit account at the Bank of Canada o Liquid Assets: Government of Canada treasury bills and commercial bills o Securities: Bonds from BofC or other asset-backed bonds; prices fluctuate o Loans: Commitments of funds for an agreed-upon period of time; riskiest • Economic benefits of depository institution: o Create liquidity: Create liquidity by borrowing short and lending long o Pool risk: The default risk is distributed to hundreds of people you’re lending to o Lower cost of borrowing: The cost of searching for a lender is lowered o Lower cost of monitoring borrower: Depository institutions can monitor borrowers at lower cost • Bank of Canada: o Central bank, acts as the supervisory authority to financial institutions, markets and payment system o Banker to banks and government  Restricted list of customer: other financial institutions  Accepts deposits and keeps reserves for financial institutions o Lender of last resort  It stands ready to make loans when the banking system as a whole is short of reserves  If some banks are short while others are at a surplus, the overnight loan market moves resources from one bank to another o Sole issuer of bank notes  Only bank permitted to issue notes and have a monopoly in this activity o Balance sheet:  BofC influences the economy by changing interest rate  Bank of Canada’s Assets: • Government securities • Loans to depository institutions (usually small or zero)  Bank of Canada’s liabilities: • Bank of Canada notes • Depository institution deposits  Monetary Base: BofC’s liabilities together with coins issued by the Mint make up the monetary base. The monetary base is the sum of notes, coins and deposits at the Bank of Canada  Open Market Operation: To change the monetary base; the Bank of Canada conducts an open market purchase or sale of securities • Open Market Purchase: The bank of Canada buys securities from a bank, and creates money by increasing the balance of that bank’s reserves (assets and liabilities increase) • Open market sale: The bank of Canada passes ownership of securities to another bank and the Bank creates more money by using its reserve to pay for it (BofC assets and liabilities decrease) • How Banks Create Money o Banks create deposits not actual money o Ammi Creating Deposits by Making Loans:  When a person uses a credit card to pay for a thing, they obligate themselves to repay that loan  When the slip is taken to a bank, the bank transfers the money to the receivers account thus creating a loan and a deposit  Bank’s ability to create money is limited by: • Monetary base o The size of the monetary base limits the total quantity of money that banks can create • Desired reserves o Determined by the desired reserve ration, reserves to deposits that banks plan to hold • Desired currency holding o Proportion of money held as a currency to bank deposits o Choices about how to make payments change slowly, therefore the ratio changes slowly o The leakage of bank reserves into currency is called the currency drain and the raio of currency to deposits the currency drain ratio • Money Creation Process o Begins with an increase in the monetary base which occurs if an open market operation - purchase has been conducted by the Bank of Canada (the opposite occurs with a Bank of Canada sale) o When the Bank of Canada buys securities from a bank, it’s reserves increase but deposits don’t change o When the bank’s reserves exceed its desired reserves, it has excess reserves o When excess reserves occur, a bank makes loans and creates deposits; if this applies to the entire banking system the quantity of money increases o Extra loans lower excess reserves by creating a higher threshold of desired reserves and a currency drain drains total reserves o Process:  Banks have excess reserves  Banks lend excess reserves  Quantity of money increases  New money is used to make payments  Some money remains on deposit  Some money is a currency drain  Desired reserves increase because deposits have been increased  Excess reserves decrease o Money multiplier: determines the change in the quantity of money that results from a chance in the monetary base  Ratio of change in the quantity of money to the change in mon
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