Copyright (c) 2006 McGraw-Hill Ryerson Limited

Chapter 2: Learning Objectives Functions and Efficiency of Money: from Barter to Monetary Exchange How should we Define Money? Canadian measures Monetary Standards & Systems: Types and Historical Experiences Consequence of Fiat Money: The Costs of Inflation Copyright (c) 2006 McGraw-Hill Ryerson Limited

Barter A method of exchange by which goods or services are directly exchanged for other goods or services without using a medium of exchange, such as money Double coincidence Equal values of goods and services Copyright (c) 2006 McGraw-Hill Ryerson Limited

Store of value and a standard of deferred payment The Functions of Money Medium of Exchange How transactions are conducted Medium of account How the value of goods & services are denominated Store of value and a standard of deferred payment How the value of goods & services are maintained in monetary terms Copyright (c) 2006 McGraw-Hill Ryerson Limited

Monetary Standards Commodity money Fiat money Gold, Silver, and Bimetallic standards Gresham’s Law Fiat money Paper money standard Canada’s early paper money history The introduction of central banking Copyright (c) 2006 McGraw-Hill Ryerson Limited

The Measurement of Money Taking an Empirical approach Institutional aspects: chartered vs. other types of financial institutions types of deposits and their evolution: the growth of electronic transactions (Table 2.1) Copyright (c) 2006 McGraw-Hill Ryerson Limited

Chartered Institutions A financial institution whose primary roles are to accept and safeguard monetary deposits from individuals and organizations, and to lend money out.  A chartered bank in operation has obtained government permission on some level to do business in the banking sector Copyright (c) 2006 McGraw-Hill Ryerson Read more: Limited

Chartered banks provide the core financial intermediary services: individuals can easily deposit their funds into various types of accounts within a chartered bank, earning interest on their temporary savings Chartered banks maintain a float of currency so they can process customers' daily transactions, but they lend out the majority of their deposits to individuals and commercial borrowers in an effort to stimulate economic growth Copyright (c) 2006 McGraw-Hill Ryerson Limited

The five largest banks in Canada Royal Bank of Canada Toronto Dominion Bank Bank of Nova Scotia Bank of Montreal Canadian Imperial Bank of Commerce Copyright (c) 2006 McGraw-Hill Ryerson Limited

Transactions Data Copyright (c) 2006 McGraw-Hill Ryerson Limited

The Measurement of Money Taking an Empirical approach Institutional aspects: chartered vs. other types of financial institutions types of deposits and their evolution: the growth of electronic transactions (Table 2.1) monetary aggregates: definitions and data Table 2.2 & Figure 2.1 Copyright (c) 2006 McGraw-Hill Ryerson Limited

The Canadian Money Supply: Key Measures, August 2004 TABLE 2.2 M1: Cash and demand deposits $162,368 M2: M1& savings deposits $623,318 M3: M2 & term deposits $868,017 M2+: M2 & deposits @ other deposit-taking institutions $872,466 M2++: M2+ & MMMF and CSBs $1,262,935 Copyright (c) 2006 McGraw-Hill Ryerson Limited

Major Canadian Money Supply Aggregates Copyright (c) 2006 McGraw-Hill Ryerson Limited

Problem 1 Page 30 What are M1, M2, M2+, and M3 ? Copyright (c) 2006 McGraw-Hill Ryerson Limited

Currency in Circulation: Seasonally adjusted or unadjusted Copyright (c) 2006 McGraw-Hill Ryerson Limited

The Measurement of Money Taking an Empirical approach Institutional aspects: chartered vs. other types of financial institutions types of deposits and their evolution: the growth of electronic transactions (Table 2.1) types of financial assets seasonal adjustment (Figure 2.2) Other refinements Copyright (c) 2006 McGraw-Hill Ryerson Limited

Asset class Instrument type Securities Other cash Debt (Long-term) Bonds Loans Debt (Short-term) Bills (T-bills, Commercial Paper….) Certificate of Deposits (CDs) Equity Stock Foreign Exchange Spot Foreign Exchange Copyright (c) 2006 McGraw-Hill Ryerson Limited

Bonds A certificate of long-term debt issued by a public entity or a corporation Issued at par value Coupon rate Copyright (c) 2006 McGraw-Hill Ryerson Limited

Underwriter An investment dealer who helps governments and corporations to raise capital by buying new shares and resell them to investors Copyright (c) 2006 McGraw-Hill Ryerson Limited

Stock States of ownership The stock of a business is divided into multiple shares A share has a certain declared face value, commonly known as the par value of a share Common stock and preferred stock. Copyright (c) 2006 McGraw-Hill Ryerson Limited

Inflation Versus Deflation There are 2 types of inflation/deflation: Anticipated: there are NO surprise changes in prices Unanticipated: SOME price changes are NOT expected Most inflations/deflations are NOT FULLY anticipated Copyright (c) 2006 McGraw-Hill Ryerson Limited

Creditor vs. lenders: real interest rate effect The Costs of Inflation Creditor vs. lenders: real interest rate effect Seigniorage: the profit from printing money “Shoe-leather” costs: frequent need for more cash Tax implications: paying tax on inflation “Menu” costs: cost of frequent price changes Accounting problems: historical vs current costs Inflation level and volatility: positively related Inflation and Economic growth: negatively related Copyright (c) 2006 McGraw-Hill Ryerson Limited

What’s Special About Deflation? When prices fall the REAL value of debt rises Debtors are penalized; borrowers benefit When prices fall EXPECTATIONS of additional reductions are possible Consumers postpone purchases with further negative economic implications If monetary policy responds by lowering interest rates they could fall to zero At zero (nominal) interest rates cannot become negative This is called the “zero lower bound” Copyright (c) 2006 McGraw-Hill Ryerson Limited

Summary Monetary systems are more efficient than barter systems Money has 3 functions medium of exchange medium of account store of value Canadian definitions of the money supply include M1, M2, M2+, M3 Excessive monetary expansion leads to inflation which is socially costly Deflation is the opposite of inflation and can produce serious negative economic consequences Copyright (c) 2006 McGraw-Hill Ryerson Limited