Week 12, Day 3 - Chapter 13 Overheads (revised)

Week 12 Day 3- - Chapter 13 Money Banking and the Bank of Canada Roles of Money Money Supply Monetary Role of Banks Money Creation by Banks Role of

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Chapter 13 – Money, Banking, and the Bank of Canada Roles of Money Money Supply Monetary Role of Banks Money Creation by Banks Role of the Central Bank Monetary Tools of the Bank of Canada In this chapter, we examine the money and the banking system to understand the underpinnings of monetary policy. Roles of Money Money is an asset that serves three roles. 1) Medium of exchange – Money is used to make purchases. Without money, society would need to rely on barter. However, barter is inefficient because it requires the double coincidence of wants. Due to the difficulty of finding beneficial exchanges, there is less specialization in a barter system. Money encourages more specialization by making exchanges easier and results in greater gains through trade. 2) Store of value – Money is used as a store of wealth. Indeed, any asset that maintains its purchasing power can act as a store of value. As long as inflation is low, money can maintain its purchasing power over time. 3) Unit of account – Money is used to establish a set of common prices. In a barter system, every good has a multitude of prices (in terms of every other good). At one time, money was commodity money; its value was derived from both its use as a medium of exchange and its intrinsic value as a consumer good (eg gold and silver coins). Today, most money is fiat money; its value is derived entirely from its status as a medium of exchange. Q: Are credit cards money? A: No, credit cards allow for a short-term loan. Eventually the borrower must pay off the loan with cash or a cheque.
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Money Supply Coins and paper notes (ie currency) are money. However, the money supply is much larger than just the amount of currency. Deposits, which are liabilities for the financial institutions that hold them, are also part of the money supply because they can be used to make purchases either directly when cheques are written against the accounts or indirectly when funds are readily converted into cash or chequable deposits. However, not all deposits are equally liquid (ie convertible into cash with little loss of value). Deposits that are not chequable or require notice for withdrawals are less liquid. For example, term deposits are not chequable and require that the funds be held in the account for a set time period; early withdrawal is subject to interest penalties. Due to the different degrees of liquidity of the different types of deposits, there are several measures of the money supply. M1 = currency in circulation + demand deposits (personal chequing accounts and current accounts, which are chequable accounts of businesses) held by chartered banks M2 = M1 + personal savings deposits and non-personal notice deposits (which may require depositors to give notice before making withdrawals) held by chartered banks M2+ = M2 + deposits at non-bank institutions (such as credit unions and trust companies) + money market mutual funds M3 = M2 + term deposits held by chartered banks M1 is the most liquid and most narrow measure of the money
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This note was uploaded on 10/13/2009 for the course ECON 1221 taught by Professor Whitaker during the Winter '09 term at Langara.

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Week 12 Day 3- - Chapter 13 Money Banking and the Bank of Canada Roles of Money Money Supply Monetary Role of Banks Money Creation by Banks Role of

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