May 18, Chapter 12 Money.notebook. Dec 2 8:03 PM. Dec 2 8:10 PM. Dec 2 8:33 PM. Dec 2 8:23 PM

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1 Chapter 12: Money Pages Functions of Money: 1) medium of exchange acts as a means of payment when goods are bought and sold. More efficient than the barter system which involves trading one product for another which requires a double coincidence of wants. 2) Store of purchasing power Provides a safe and accessible means of storing wealth. Money is the most liquid asset, so its major advantage is the ease with which it can be used to pay for items. People hold wealth as money when the benefits of liquidity outweigh the income that would have been earned by holding it in another form (Ex: TFSA). "As Good As Gold" Dec 2 8:03 PM Dec 2 8:10 PM 3) Measure of Value Provides buyers and sellers with a pricing standard (unit of account) so all products can be valued using a consistent unit of measurement. Contrast this with the barter system which requires many units of account. The Canadian Financial System: deposit takers institutions which accept money provided by savers and lend these funds to borrowers. liabilities the funds accepted from and owed to the savers. assets loans granted to the borrowers. Make money by paying lower interest rates on deposits than they charge on loans. Keep a minimum amount of cash on hand (cash reserves) to meet the demands of the depositors. Dec 2 8:23 PM Dec 2 8:33 PM 1

2 Two types of deposit-takers: 1) chartered banks deposit takers which are allowed to sell a wide range of financial services through a charter they receive from the federal gov't. 77 chartered banks. "Big Six" control 90%: RBC, TD, Canada Trust Bank, Scotiabank, BMO, CIBC. Considered an oligopoly. 2) near banks deposit takers that are not chartered and have more specialized services. Examples: trust companies, credit unions Dec 2 8:43 PM Dec 2 8:47 PM Additional Information: Financial institutions other than deposit takers include insurance companies and investment dealers. Due to financial deregulation in the 1980s, all financial institutions have been allowed to perform a wider variety of functions. Page 330 Dec 2 8:50 PM Dec 2 8:54 PM 2

3 The Supply of Money: money supply = currency + some deposits currency includes paper money issued by the bank of Canada and coinage issued by the Canadian Mint. deposits funds accepted by deposit takers and lent to borrowers. The longer the deposit taker can use the funds and the fewer the services the higher the interest rate. Types of Deposits: demand deposits deposits in which depositors can demand immediate access to their money (Ex: chequing accounts). Receive very low interest rates due to ease of access to deposits and expense of producing cheques. Dec 2 8:57 PM Dec 2 9:01 PM notice deposits deposits in which notice is required to withdraw funds (Ex: savings accounts). term deposits deposits in which the depositors guarantee that they will not withdraw their funds for a fixed period of time (Ex: TFSA). foreign currency deposits deposits held by Canadians that are valued in foreign currency, usually the American dollar. Definitions of Money: M1: narrowest definition of money which includes currency and demand deposits (cash reserves not included). M1+: M1 + notice deposits M2 M3 M2+ narrow broad Dec 2 9:08 PM Dec 2 9:16 PM 3

4 M1+ is viewed as the most accurate definition of the money supply. Role of Credit Cards: NOT MONEY. An easy way for buyers to buy funds for a short period of time. Role of Debit Cards: NOT MONEY. A convenient way for holders to access money just like cheques except electronically. Dec 2 9:18 PM Dec 2 9:35 PM The Demand for Money: Reasons why there is a demand for money: Transaction Demand money kept for purchases. Varies directly with GDP. As output rises, more morey demanded for purchases. Asset Demand money held in its liquid form for later use. Biggest cost to asset demand is the interest that could be earned from other investments. Asset demand is inversely related to interest rates; the higher the interest rate the lower the asset demand and vice versa. Bonds are a popular investment issued by gov't or businesses to raise funds. People are more likely to purchase bonds as an alternative to holding money. Bond prices are inversely related to interest rates. Dec 2 9:41 PM Dec 2 9:48 PM 4

5 Example: Bond purchases. Purchase: $1000 bond at 6%/a => guaranteed an annual interest payment of $60. Sell: Interest is 12%/a => since $60 interest is guaranteed, the bond falls in price to $500. or Sell: Interest is 3%/a=> since $60 interest is guaranteed, the bond increases in price to $2000. THEREFORE: People will buy bonds at low prices (high interest rate), in the hopes of making a profit when prices rise (low interest rate), decreasing their asset demand for money. OR People will sell bonds at high prices (low interest) and will wait until bond prices fall (high interest rates) to invest their money, increasing the asset demand for money. Dec 2 9:52 PM Dec 2 10:00 PM Page 337 money demand represents the amounts of money demanded at all possible interest rates at a given real output and price level. NOTES: Changes in interest rate, which affects the asset demand for money, causes movement along the curve. Changes in transaction demand causes changes in amounts of money demanded at all interest rates causing the whole curve to shift. Dec 2 10:08 PM Dec 2 10:10 PM 5

6 money supply a set amount determined by government decision makers. Supply curve will shift only when government decisionmakers decide to change it. Page 338 Dec 2 10:12 PM Dec 2 10:18 PM page 339 Equilibrium > intersection of the demand for money curve and the money supply curve. Dec 2 10:17 PM Dec 2 10:19 PM 6

7 Chapter Exercises Page 347: 1, 3, 4 Money Creation: desired reserves minimum amount of cash necessary to satisfy anticipated withdrawal demands. reserve ratio the proportion of deposits in the form of cash reserves the deposit taker holds to deal with anticipated withdrawals. reserve ratio = desired reserves deposits May 9 9:24 AM Dec 2 10:20 PM excess reserves cash reserves that are in excess of desired reserves. These are converted to income producing assets such as loans. The Process: Two assumptions: 1) The public holds money in deposits and only uses cheques. 2) All deposits are demand deposits, are made with banks, and their reserve ratio is 10%. excess reserves = cash reserves desired reserves Dec 2 10:25 PM Dec 3 9:48 PM 7

8 Transaction #1: Saver A deposits $1000 at the Cabot Bank Assets Cabot Bank Liabilities Cash Reserves $1000 Saver A's Deposit $1000 Note: No change in the amount of money held in the economy, only who holds it, therefore, no change in the money supply. Transaction #2: Cabot Bank loans $900 to Borrower X. (Bank only has to keep 10% ($100) of the $1000 and can loan out the remaining $900) Assets Cash Reserves $1000 Loan to Borrower X 900 Cabot Bank Liabilities Saver A's Deposit $1000 Deposit of Borrower X 900 Note: $900 has been created, therefore, the money supply increases by $9000. Dec 3 9:53 PM Dec 3 9:56 PM Transaction #3: Borrower X buys something worth $900 from Saver B. Assets Cabot Bank Liabilities Cash Reserves $100 Loan to Borrower X Saver A's Deposit 900 $1000 Transaction #4: Saver B deposits $900 at the Fraser Bank. Assets Fraser Bank Liabilities Cash Reserves $900 Saver B's Deposit $900 Note: $900 that was created does not disappear. It is now in the bank account of the person who was given the money, say Saver B. Dec 3 10:03 PM Dec 3 10:06 PM 8

9 Transaction #5: Fraser Bank loans $810 to Borrower Y. (Fraser Bank only has to keep 10%($90) of the $900 and can loan out the remaining $810) Assets Cash Reserves $900 Borrower Y Loan 810 Liabilities Saver B's Deposit $900 Borrower Y's Deposit 810 Loan generation continues a long as there are excess cash reserves to lend out. Question: How much money can be created? Note: $810 has been created, therefore the money supply increases by $810. Dec 3 10:10 PM May 10 11:01 AM The Money Multiplier: The previous example caused the money supply to increase by $1710 ($900 + $810). The initial deposit has a magnified effect on the money supply. The amount by which it is magnified is calculated using the money multiplier. money multiplier the value by which the initial change (the initial loan amount) is multiplied to give the maximum total change in the money supply. the reciprocal of the reserve ratio. Example: Reserve ratio = 10% money multiplier = 1 reserve ratio money multiplier = 1 = Therefore, increase in money supply = 10 x $900 = $9000 Dec 3 10:15 PM Dec 3 10:23 PM 9

10 Other Considerations: publicly held currency some money is held as currency which decreases the effect of the multiplier. differences in deposits there are various kinds of deposits which reduces the effect of the multiplier. Dec 3 10:26 PM 10