Macroeconomics Chapter 10 Notes

What is money and why it's important?

• How would youe effect transactions without money?

• The alternative is barter, the exchange of one good or service for another

• With barter, every trade requires a double coincidence of wants

• Unlikely that the trade will happen because of time and place

• Most people will have to spend time searcing for others to tarade with a high waste of resources

Store of value

• One item that people can use to transfer purchasing power from the present to the future

• The seller who accepts money in a trae can use it at a later date for a purchase

• But there are other stores of value(assets) in an economy

Medium of exchange

• An item used to purchase goods and services

• Sellers are willing to accept this item in a transaction

• You are confident that sellers qwill be willing to accept it in exchnage for something

• Legal tender consists of

• Banks notes

• Coins

Unit of account

• The standard people use to post prices and record debts

• A vendor sells hot dogs for 4 50 and cans of pop for 1 50

• The vendor could post the price of a hot dog as 3 cans of pop

What makes for good money

• There are 2 basic considerations that make one thing better than another as money

• Stability of value

• Early versions of oney gernerally took the form of physical material that was durable and had intritic value

• However money dose not need intrsic value to maintain sustainability

• Convenience

• Techonology has allowed for the development of more convenient forms of money

2 types of money

• Commodity money

• A physical commodity or something that can be exchanged for one

• The commodity has value even if not being used as money

• It has intrisic value

• Fiat money

• Money not back by physical commodity

• No intritic value

• Created and used as money because of government decree/order

• Backed only by the trust that the government will keep its value constant

Money in the Canadian economy

• The money supply is the quantity of money available in the economy

• The money supply is managed by the bankof canada

• Decisions by the BOC concerning the money supply constitute monetary policy

• What assets should be consiered part of the money supply?

• Currency in circulation: the paper bills and coins in th eahnds of the public

• Demand deposiits: fundsheld in bank accounts that depositiors can withdraw at any time without advance notice in person or by cheque, debit card, or online banking

Measures of the money supply

• There are many monetary aggregates which differ based on liquidity

• Monetary base- most liquid

• Currency in circulation plus bank reserves

• M1

• Currency in circulation plus cheuqeable deposists

• M2

• M1 plus saving accounts plus notice deposits

• Notice deposits- dunds that require advance notice prior to withdrawal

• M3

• Least liquid

• M2 plus term deposits plus forex deposits of residents

• Term deposits- funds that can be withdrawn only after the term has ended

• The bank of Canada has found that

• The growth of M1 provides useful info about the future level of production in the economy

• Th growth of broader monetary aggregates is leading indicator of the rate of inflation

Bank of Canada

• Acentral bank: an institution designed to regulate the money supply in the economy.

• Canada's central bank

• Not a commerical bank-does not offer banking services to the public

• Mandate is to regulate credit and currency control and protect the external values of the dollar mitigatees fluxs in the general level of production, trade, prices ,and employment

Banks reserves

• Reserves fefers to the mony that banks keep on hand to meet daily requests for cahs

• They are held as currency in the bank or as balances in banks' accounts at the central bank

• The reserve ratio is the fraction/percentage of demange deposits that banks hold as cash reserves

• Reserve ratios= Reserves/demand/deposits

• Required reserves- the amount of currency a bank is legally required to keep on hand

• Excess reserves- ant additional amount of currency a bank chooses to keep in excess of required reserves

• Reserves typically increase in times of recession- people draw on their savings and more.

• Equations

• Reserves = demand deposit - loans

• Required reserves = amount/government law

• Excess reserve = reserve - required reserve

 

Money acts as a sote of value of providing a means of transferring purchasing power from the present to the future. By saving some of this pay, Eric stores values so that he can purchase the blue ray player later.

 

Money acts as a medium of exchange by providing an accepted method of payment.

 

Money acts as a unit of account by providing buyers and sellers a common point for valuing goods and services.

 

To increase the money supply, the Bank of Canada must buy government bonds. In order to pay for the bonds, the Bank of Canada creates money. Its purchase of bonds puts the new money in the hands of the public. Assuming that households do not hold cash, the new money will be placed in demand deposits with banks.

At a reserve requirement of 10%, the money multiplier is 10. Therefore, the money supply will grow by 10 times the initial increase in demand deposits from the Bank of Canada's open-market purchase. If the Bank of Canada buys $20 worth of government bonds, demand deposits and bank reserves will rise by $20. The $20 increase in reserves will support an increase in the money supply of 10×$20=$20010×$20=$200 as banks lend out the excess reserves generated by the Bank of Canada's purchase.

 

Uncertain economic conditions cause banks to hold some excess reserves, increasing the percentage of deposits held as reserves from 10% to 25% and increasing the reserve ratio from 1/10 to 1/4. The money multiplier falls from 10 to 4—the reciprocal of the new reserve ratio (1/4).

When banks hold additional reserves, the Bank of Canada will have to buy more bonds in order to increase the money supply by a given amount. Specifically, an open-market purchase of $50 worth of bonds (rather than $20) is now required to increase the money supply by $200. When the Bank of Canada buys $50 in government bonds, demand deposits and bank reserves rise by $50. With the smaller multiplier, the $50 increase in reserves will support an increase in the money supply of 4×$50=$2004×$50=$200.

 

For most of this problem, you should have assumed that households hold money only in demand deposits and that banks do not hold excess reserves. A more realistic model of the banking system would relax both of these assumptions. In practice, banks can hold any level of excess reserves that they choose, much as households can hold as much currency as they like. Since the Bank of Canada cannot precisely control the level of excess reserves or the fraction of money households wish to hold as currency, it cannot precisely increase or decrease the money supply. It can get pretty close, however, by monitoring the behaviour of banks and households and adjusting monetary policy to reflect changes in banks' preferences for excess reserves or households' preferences for currency.

 

 

The amount of money the banking system genereates with each dollar of resres is called money multiplier

• Money multiplier

• Increase in Deposits= money multiplier * deposits

• Because deposits increased by 1,000 but currency decreased by 100, money supply is 900

• To compute the smallest increase in money supply, assume that entire 10 million is held by banks as reserves therefore the smallest is 10million.