Ch 24 - Money, Deposit Multiplier, Price Level, Inflation

Saturday, April 07, 2012

6:05 PM

 Functions of money

 

Medium of exchange	Replaces barter
Unit of account	Agreed measure for stating the prices of goods and services
Store of value

 

Currency	Notes and coins held by households
Deposits	At Bank
Fiat Money	Notes not backed by anything tangible (no intrinsic value)

 

 Official Measures of Money

 

M1	Chequable deposits (personal & non-personal) Currency outside banks
M2	M1 Fixed term deposits Non-chequable deposits (personal & non-personal)

 

Liquidity	The property of being instantly convertible into a means of payment with little loss of value
Deposits are money, but cheques are not	Cheque is an instruction to a bank to transfer money. Deposit is money, it cheque by itself
Credit cards are not money	Only enables loan. Must be repaid with money.

 

Banking System: Institutions

 

Depository institution	Firm that takes deposits from households and firms and makes loans to other households and firms.   Chartered banks Credit unions Trust/Mortgage loan companies   Goal: Maximize wealth of its owners Types of assets: Reserves - deposited in bank of Canada Liquid assets - Gov. Canada treasury bills and commercial bills Securities - Long-term bonds Loans   Benefits: Create liquidity Pool risk Lower cost of borrowing Lower cost of monitoring borrowers
Bank of Canada	Central Bank - public authority that regulates a nation's depository institutions and control the quantity of money.   Banker to banks and government Last resort lender Sole issuer of bank notes
Monetary Base	Includes Sum of Bank of Canada notes outside of the bank. Banks' deposits at the Bank of Canada Coins held by households, firms, and banks   Open market operation - purchase or sale of government of Canada securities (by Bank of Canada) in the open market
Payments System	Allows banks make payments to each other to settle transactions by their customers.

 

 

 Desired & Access Reserves

 

Reserve ratio	Fraction of total deposits held as reserves by banks
Desired reserve ratio	Ratio that banks wants to have
Excess reserves
Currency drain ratio	Ratio of currency held in cash by people to deposits

 

 Money creation process

 

1. Banks have excess reserves
2. Banks lend them out.
3. Quantity of money increases
4. New money is used to make payments
5. Some new money remain as deposits
6. Some new money is held as currency
7. Desired reserves increase (due to increase in deposits)
8. Excess reserves decrease but remain positive

 

Money multiplier

 



 

	Currency drain ratio
	Desired reserve ratio

 

 



 

	Quantity of money

 

 

 Determinants of amount of money people plans to hold

 

Price level	Changes the nominal, but not the real money. (Since change in price level is inflation)
Nominal interest rate	Indirect relationship on the quantity of real money people plans hold.
Real GDP	(Direct)
Financial innovation	Lowers the cost of switching between money. (Inverse)

 

Demand for money	X = quantity of real money demanded Y = nominal interest rate
Determinants	Real GDP (Direct) Financial innovation (Indirect)

 

Quantity theory of money	In the long run, an increase in the quantity of money brings an equal percentage increase in the price level.
Velocity of circulation	Average number of times per year a dollar is used to purchase goods/services

 



 

	Price level
	Real GDP
	Quantity of money
	Velocity of circulation

 



 



 

Long run: