Week 6

Principles of Macroeconomics (with Xtra!)

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Ch4: MONEY & INFLATION in the LR Money Refers to all assets, generally with a high degree of liquidity, that can easily be used to settle transactions. Three Main Functions of Money 1) Store of Value - provides a way to transfer purchasing power to the future 2) Unit of Account - provides the terms in which prices and debts are recorded 3) Medium of Exchange - what is used to buy goods and services Types of Money Demand ( M d ) 1) Speculative - demand/hold asset mix with some money to speculate on return 2) Precautionary - hold some money for just in case or emergency uses 3) Transactions - demand/hold some money to pay for day to day transactions 4) Liquidity - might hold some money to provide more liquidity to your asset mix Types of Transactions (Monetary) Systems 1) No Money - Barter Economy - trades based on double coincidence of wants 2) Commodity Money - money based on (either made from or backed by) a commodity 3) Fiat Money - money based 100 percent on trust (i.e. worthless money with no other use - backed by the taxing powers of the issuing government)
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Page 2 of 8 The Main Measures of Money Supply (M S ) Symbol Assets Included Amount in Aug 2000 (billions of dollars) B Currency outside of banks (i.e. in circulation) ( Monetary base is currency plus chartered bank deposits at BOC) $ 33.9 M1 Sum of currency in circulation + Personal chequing accounts at chartered banks + Current accounts at chartered banks (i.e. demand deposits) $ 104.9 M2 Sum of M1 plus Personal saving deposits at chartered banks + Nonpersonal notice deposits at chartered banks $ 487.6 M3 Sum of M2 plus Non-personal Fixed-term deposits of firms at chartered banks + foreign currency deposits (booked in Canada) at chartered banks $ 670.4 M2+ Sum of M2 plus All deposits and shares at trusts companies, mortgage loan companies, credit unions, and Caisses Populaires (includes personal deposits at government financial institutions, individual annuities at life insurance companies, and money market mutual funds) $ 687.5 (July est) Source: Bank of Canada ( ) and Statistics Canada
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Page 3 of 8 Monetary Policy Tools (ordered from least likely to most likely to be used) 1) Reserve ratios of chartered banks (% of deposits held in reserve); 2) Government deposits in banking system (move them around to affect size of M S ); 3) Official transactions in foreign assets (buying/selling of the bonds or currency (foreign exchange) of a foreign gov’t or agency - has same effect on money supply as case 3); 4) Open market operations (buying/selling of domestic gov’t bonds in the open market); or 5) Bank rate (overnight rate) adjustments. Why Might the Bank of Canada (BOC) Change the Money Supply ( M S ) ? Answer to influence one of the following key variables: S Interest rates (nominal only in the LR); S Exchange rates (nominal only in the LR); S Inflation rates ( B ); S Real GDP (Y) in the SR (Can M S affect this in the LR too? Most theories say no); or S Unemployment (U) in the SR (like GDP most theories say M S can not affect this in the LR).
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