PART 4: MONEY, BANKING, AND MONETARY POLICY
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1 PART 4: MONEY, BANKING, AND MONETARY POLICY CHAPTER 12 Money, Banking, and Money Creation Slides prepared by Bruno Fullone, George Brown College 2010 McGraw-Hill Ryerson Limited 1
2 In This Chapter You Will Learn: Learning Objective 12.1: The definition and functions of money Learning Objective 12.2: What constitutes the supply of money Learning Objective 12.3: What backs Canada s money supply Learning Objective 12.4: About the structure of the Canadian financial system Learning Objective 12.5: How a chartered bank can create (or destroy) money through loans to the public Learning Objective 12.6: About the multiple deposit expansion of the entire chartered banking system Learning Objective 12.7: What the monetary multiplier is and how to calculate it Chapter 12 2
3 12.1 The Definition and Functions of Money Money is what money does Medium of exchange Measure of value Store of value LO12.1 3
4 12.2 The Components of the Money Supply Money Definition M1 Currency: Coins + Paper Money token money Bank of Canada notes Demand Deposits about 3/4 of M1 Institutions That Offer Demand Deposits chartered banks are the primary depository institutions Two Qualifications: currency held by the Bank of Canada and chartered banks is excluded from M1 and other measures of the money supply also excluded from the money supply are any deposits of the federal government or the Bank of Canada that are held by chartered banks LO12.2 4
5 The Components of the Money Money Definition M2 M1 + near monies Supply Near monies are highly liquid financial assets that do not directly function as a medium of exchange but can be readily converted into currency LO12.2 5
6 The Components of the Money Supply Currency (coins & paper money) plus Demand deposits equals M1 plus Personal savings deposits, plus Non-personal notice deposits equals M2 M1 529 M2 939 December, 2005 Table 12-1 (billions of dollars) LO12.2 6
7 The Components of the Money Money Definition M2+ M2+ is M2 plus deposits at trust & mortgage loan companies deposits at caisses populaires & credit unions & other non-bank deposit-taking institutions money market mutual funds Money Definition M2++ Supply M2++ is M2 plus Canadian saving bonds and non-money market mutual funds LO12.2 7
8 The Components of the Money Supply Currency (coins & paper money) plus Demand deposits equals M1 plus Personal savings deposits, plus Nonpersonal notice deposits equals M2 plus Deposits: Other intermediaries equals M2+ plus Canadian saving bonds plus non-money market mutual funs equals M2++ December, 2005 Table 12-1 M1 M2 M (billions of dollars) LO M
9 What Backs the Money Supply? Money as Debt Value of Money Acceptability Legal Tender Relative Scarcity Money and Prices Purchasing Power of the Dollar Inflation and Acceptability Stabilizing the Purchasing power of money LO12.3 9
10 12.4 The Canadian Financial System The Evolution of the Canadian Banking System Canadian Chartered Banks Making Loans Other Financial Intermediaries Cheque Clearing LO
11 12.1 Global Perspective LO
12 12.5 Chartered Banks and the Creation of Money The creation of money is done with the help of Canada s chartered banks The Fractional Reserve System LO
13 Illustrating the Idea: the Goldsmiths Goldsmiths accepted gold deposits and issued paper receipts Paper receipts were used as a medium of exchange 100% reserve system ð eventually led to fractional reserve system LO
14 Significant Characteristics of Fractional Reserve Banking Fractional Reserve System Money creation & reserves Bank panics & regulation LO
15 Formation of a Chartered Bank ASSETS Vancouver Bank LIABILITIES AND NET WORTH TRANSACTION 1 Creating a bank $250,000 Cash for Capital Stock LO
16 ASSETS Formation of a Chartered Bank Vancouver Bank LIABILITIES AND NET WORTH Cash $250,000 Capital Stock $250,000 LO
17 Acquiring Property and Equipment ASSETS Vancouver Bank LIABILITIES AND NET WORTH Cash $250,000 Capital Stock $250,000 TRANSACTION 2 Acquiring property and equipment $240,000 buildings and equipment LO
18 ASSETS Acquiring Property and Equipment Cash $ 10,000 Property 240,000 Vancouver Bank LIABILITIES AND NET WORTH Capital Stock $250,000 LO
19 ASSETS Cash $ 10,000 Property 240,000 Accepting Deposits Vancouver Bank LIABILITIES AND NET WORTH Capital Stock $250,000 TRANSACTION 3 Accepting Deposits Demand $100,000 Deposits LO
20 ASSETS Cash $110,000 Property 240,000 Accepting Deposits Vancouver Bank LIABILITIES AND NET WORTH Demand Deposits $100,000 Capital Stock 250,000 LO
21 ASSETS Cash $110,000 Property 240,000 Accepting Deposits Vancouver Bank LIABILITIES AND NET WORTH Demand Deposits $100,000 Capital Stock 250,000 Note: demand deposits are LIABILITIES to the bank LO
22 ASSETS Reserves $ 110,000 Property 240,000 Reserves Vancouver Bank LIABILITIES AND NET WORTH Demand Deposits $100,000 Capital Stock 250,000 Note: cash is part of the bank s reserves - Desired Reserves LO
23 ASSETS Reserves $110,000 Property 240,000 Reserves Vancouver Bank LIABILITIES AND NET WORTH Demand Deposits $100,000 Capital Stock 250,000 Demand Deposits are subject to Desired Reserve Ratio Desired chartered bank' desired reserves reserve ratio chartered bank' s demand - deposit liabilities LO
24 ASSETS Excess Reserve Vancouver Bank LIABILITIES AND NET WORTH Reserves $110,000 Property 240,000 actual reserves Demand Deposits $100,000 Capital Stock 250,000 desired reserves = 20% X $100,000 =$20,000 Two Important Points Excess Reserves (E) = Actual Reserves - Desired Reserves Assume 20% Desired Reserve Requirement FIND THE EXCESS RESERVES LO
25 ASSETS Excess Reserve Vancouver Bank LIABILITIES AND NET WORTH Reserves $110,000 Property 240,000 Demand Deposits $100,000 Capital Stock 250,000 Two Important Points Excess Reserves (E) = Actual Reserves - Desired Reserves Assume 10% Desired Reserve Requirement E = $110,000-20,000 = $90,000 LO
26 ASSETS Excess Reserve Vancouver Bank LIABILITIES AND NET WORTH Reserves $110,000 Property 240,000 Demand Deposits $100,000 Capital Stock 250,000 Two Important Points Excess Reserves (E) = Actual Reserves - Desired Reserves Assume 10% Desired Reserve Requirement E = $110,000-10,000 = $100, Bank of Canada can influence the lending ability of banks through reserves LO
27 Clearing a Cheque ASSETS Vancouver Bank LIABILITIES AND NET WORTH Reserves $110,000 Demand Property 240,000 Deposits $100,000 Capital Stock 250,000 TRANSACTION 4 Clearing a cheque drawn against the bank = $50,000 LO
28 After Cheque Clearing ASSETS Vancouver Bank LIABILITIES AND NET WORTH Reserves $ 60,000 Property 240,000 TRANSACTION 4 This bank loses reserves and deposits to the Bank of Manitoba Demand Deposits $50,000 Capital Stock 250,000 LO
29 Money Creation: Single Bank The maximum amount of new money which can be created by a single bank is equal to its excess reserves The bank creates money when it creates new loans Money is destroyed when loans are repaid Banks create money when they buy government bonds from the public LO
30 Granting a New Loan ASSETS Vancouver Bank LIABILITIES AND NET WORTH Reserves $ 60,000 Property 240,000 Bank has excess reserves of how much? of HOW MUCH? Use a 20% reserve ratio Demand Deposits $ 50,000 Capital Stock 250,000 LO
31 Granting a New Loan ASSETS Vancouver Bank LIABILITIES AND NET WORTH Reserves $ 60,000 Property 240,000 Demand Deposits $ 50,000 Capital Stock 250,000 TRANSACTION 5 Bank makes a loan to Grisley Company equal to the excess reserves $50,000 LO
32 When a Loan is Negotiated ASSETS Vancouver Bank LIABILITIES AND NET WORTH Reserves $ 60,000 Loans 50,000 Property 240,000 Demand Deposits $100,000 Capital Stock 250,000 A new loan & a new deposit of $50,000 are created LO
33 Before a Cheque is Drawn on the Loan ASSETS Vancouver Bank LIABILITIES AND NET WORTH Reserves $ 60,000 Loans 50,000 Property 240,000 Demand Deposits $100,000 Capital Stock 250,000 Grisley Co. writes a cheque worth $50,000 payable to Quickbuck Co. which banks at the Manitoba Bank LO
34 After a Cheque is Drawn on the Loan ASSETS Vancouver Bank LIABILITIES AND NET WORTH Reserves $ 10,000 Loans 50,000 Property 240,000 Demand Deposits $50,000 Capital Stock 250,000 Note that after clearing, the Vancouver Bank has no more excess reserves! LO
35 New Loan After Cheque Clearing ASSETS Vancouver Bank LIABILITIES AND NET WORTH Reserves $ 10,000 Loans 50,000 Property 240,000 Demand Deposits $50,000 Capital Stock 250,000 A bank MUST have excess reserves to create loans 35 LO
36 Buying Government Securities ASSETS Vancouver Bank LIABILITIES AND NET WORTH Reserves $ 60,000 Property 240,000 Demand Deposits $ 50,000 Capital Stock 250,000 TRANSACTION 6 Bank buys securities from the public for an amount equal to the excess reserves LO
37 Buying Government Securities ASSETS Vancouver Bank LIABILITIES AND NET WORTH Reserves $ 60,000 Securities 50,000 Property 240,000 Demand Deposits $100,000 Capital Stock 250,000 Once again, the money supply has increased by $50,000 LO
38 Government Securities Bond purchases from the public by the chartered banks increases the money supply Bond sales to the public decreases the money supply LO
39 Bankers have two conflicting goals: Profit Profits, Liquidity, and the Liquidity Overnight Lending Rate Overnight loans rate paid on overnight loans to cover temporary shortages of reserves LO
40 12.6 The Banking System: Multiple- Deposit Expansion A single bank can lend one dollar for each dollar of excess reserves The banking system can lend (create money) by a multiple of its excess reserves LO
41 Bank Multiple-Deposit Expansion Process Acquired reserves and deposits Desired reserves A $ $ Excess reserves Amount bank can lend. New money created 1. A Junkyard owner deposit $ Bank adds the $100 in its reserves 3. 20% is the desired reserve ratio LO
42 Bank Multiple-Deposit Expansion Process Acquired reserves and deposits Desired reserves Excess reserves A $ $ $80.00 Amount bank can lend. New money created $80.00 Money is created once the loan is made LO
43 Bank Multiple-Deposit Expansion Process Acquired reserves and deposits Desired reserves Excess reserves Amount bank can lend. New money created A $ $ $80.00 $80.00 Loan recipient now spends the money. He/she buys something; Seller deposits proceeds in his/her bank. LO
44 Bank A B Multiple-Deposit Expansion Process Acquired reserves and deposits $ Desired reserves Excess reserves Amount bank can lend. New money created $ $80.00 $80.00 New deposit means excess reserves in seller s bank; process repeats LO
45 Bank A B C Multiple-Deposit Expansion Process Acquired reserves and deposits $ Desired reserves $ Excess reserves $ Amount bank can lend. New money created $ LO
46 Bank Multiple-Deposit Expansion Process Acquired reserves and deposits Desired reserves Excess reserves Amount bank can lend. New money created A B C D E F G H I J $ $ $ $ K Monetary destruction 2.15 works 8.59 the 8.59 L M same way 6.87 in reverse N Other banks Total amount of money created by the bank system = $ LO
47 12.7 The Money Multiplier Monetary multiplier = 1/desired reserve ratio Maximum demand-deposit creation 1 = R = 1.20 = 5 = Excess reserves x Monetary multiplier LO
48 Table 12-3 Expansion of the Money Supply by the Chartered Banking System LO
49 The Last Word: The U.S. Bank Panics of 1930 to 1933 Before deposit insurance Bank failure led to mass withdrawals Forced loan reduction 25-33% decline in money supply 1933 national bank holiday to evaluate all banks Contributed to the Great Depression Regulation protects the system today Slide prepared by Bruno Fullone, George Brown College 49
50 Chapter 12 Summary 12.1 The Definition and Functions of Money 12.2 The Components of the Money Supply 12.3 What Backs the Money Supply? 12.4 The Canadian Financial System 12.5 Chartered Banks and the Creation of Money 12.6 The Banking System: Multiple-Deposit Expansion 12.7 The Monetary Multiplier Chapter 12 50
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