Chapter 12 Money.notebook. February 03, 2017

Transcription

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" 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. 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 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 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. 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 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. The Demand for Money: Reasons why there is a demand for money: Transaction Demand the demand for money related to its use as a means of exchange. An increase in output or price level requires more money for transaction purposes. Asset Demand the demand for money which is related to its use as a store of purchasing power (holding money in its liquid form). If a higher paying asset is available (Ex: bond), people will convert their liquid form to asset form. Bonds are the most popular way for 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. 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 and vice versa. 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. 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 page 339 Equilibrium > intersection of the demand for money curve and the money supply curve. 6

7 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. excess reserves cash reserves that are in excess of desired reserves. These are converted to income producing assets such as loans. reserve ratio = desired reserves deposits 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%. Transaction #1: Saver A deposits $1000 at the Cabot Bank Cabot Bank Cash Reserves $1000 Saver A's Deposit $1000 7

8 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) Cash Reserves $1000 Loan to Borrower X 900 Cabot Bank Saver A's Deposit $1000 Deposit of Borrower X 900 Transaction #3: Borrower X buys something worth $900 from Saver B. Cabot Bank Cash Reserves $100 Loan to Borrower X Saver A's Deposit 900 $1000 Transaction #4: Saver B deposits $900 at the Fraser Bank. Fraser Bank Cash Reserves $900 Saver B's Deposit $900 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) Cash Reserves $900 Saver B's Deposit $900 Borrower Y Loan 810 Borrower Y's Deposit 810 8

9 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 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 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. 9