© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter 11 1 Money and Banking SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter 11 2 In this chapter you will learn 11.1 The definition and functions of money 11.2 What constitutes the supply of money 11.3 What backs Canada’s money supply 11.4 The components of money demand 11.5 How the equilibrium interest rate is determined in the money market 11.6 About the structure of the Canadian financial system 11.7 About recent developments in money and banking

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter 11 3 Chapter 11 Topics 11.1 The Definition & Functions of Money 11.2 The Supply of Money 11.3 What “Backs” the Money Supply? 11.4 The Demand for Money 11.5 Equilibrium in the Money Market 11.6 The Canadian Financial System 11.7 Recent Developments in Money & Banking

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter 11 4 The Definition & Functions of Money u Money is what money does

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter 11 5 The Definition & Functions of Money u Medium of exchange

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter 11 6 u Medium of exchange u Measure of value The Definition & Functions of Money

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter 11 7 u Medium of exchange u Measure of value u Store of value The Definition & Functions of Money

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter 11 8 Chapter 11 Topics 11.1 The Definition & Functions of Money 11.2 The Supply of Money 11.3 What “Backs” the Money Supply? 11.4 The Demand for Money 11.5 Equilibrium in the Money Market 11.6 The Canadian Financial System 11.7 Recent Developments in Money & Banking

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter 11 9 Currency (coins & paper money) plus Demand deposits M1 equals M1 (billions of dollars) December, 2002 The Supply of Money Table 11-1 M

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter The Supply of Money u Currency: Coins + Paper Money token moneytoken money Bank of Canada notesBank of Canada notes u Demand Deposits about ⅔ of M1about ⅔ of M1 u Institutions That Offer Demand Deposits chartered banks are the primary depository institutionschartered banks are the primary depository institutions

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter The Supply of Money u Near-monies nonchequable savings depositsnonchequable savings deposits term depositsterm deposits

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Currency (coins & paper money) plus Demand deposits M1 equals M1 plus Personal savings deposits, plus Non-personal notice deposits M2 equals M2 The Supply of Money Table 11-1 (billions of dollars) December, 2002 M M

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter The Supply of Money u M2+ is M2 plus deposits at trust & mortgage loan companiesdeposits at trust & mortgage loan companies deposits at caisses populaires & credit unions & other non-bank deposit-taking institutionsdeposits at caisses populaires & credit unions & other non-bank deposit-taking institutions money market mutual fundsmoney market mutual funds

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Currency (coins & paper money) plus Demand deposits M1 equals M1 plus Personal savings deposits, plus Nonpersonal notice deposits M2 equals M2 plus Deposits: Other intermediaries M2+ equals M2+ M1 M M2 The Supply of Money Table 11-1 (billions of dollars) December,

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter The Supply of Money u we will use the narrow M1 definition of money, unless stated otherwise

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Chapter 11 Topics 11.1 The Definition & Functions of Money 11.2 The Supply of Money 11.3 What “Backs” the Money Supply? 11.4 The Demand for Money 11.5 Equilibrium in the Money Market 11.6 The Canadian Financial System 11.7 Recent Developments in Money & Banking

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter What “Backs” the Money Supply? u Money as Debt u Value of Money AcceptabilityAcceptability Legal TenderLegal Tender Relative ScarcityRelative Scarcity

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter What “Backs” the Money Supply? u Money & Prices The Purchasing Power of the DollarThe Purchasing Power of the Dollar NOTES: Reciprocal Reciprocal relationship between the price level and the value of the dollar D = 1 P

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter What “Backs” the Money Supply? u Money & Prices The Purchasing Power of the DollarThe Purchasing Power of the Dollar Inflation & AcceptabilityInflation & Acceptability

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Chapter 11 Topics 11.1 The Definition & Functions of Money 11.2 The Supply of Money 11.3 What “Backs” the Money Supply? 11.4 The Demand for Money 11.5 Equilibrium in the Money Market 11.6 The Canadian Financial System 11.7 Recent Developments in Money & Banking

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter The Demand for Money u Transactions Demand, D t demand for money as a medium of exchangedemand for money as a medium of exchange varies directly with GDPvaries directly with GDP u Asset Demand, D a demand for money as a store of valuedemand for money as a store of value varies inversely with the interest ratevaries inversely with the interest rate

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter The Demand For Money Transactions Demand, D t + Interest Rate Amount of money demanded (billions of dollars) DtDt i% Figure 11-1

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Transactions Demand, D t Asset Demand, D a += Amount of money demanded (billions of dollars) DaDa Amount of money demanded (billions of dollars) DtDt i% Interest Rate The Demand For Money Figure 11-1

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Transactions Demand, D t Asset Demand, D a Total demand for money, D m += Amount of money demanded (billions of dollars) DaDa Amount of money demanded (billions of dollars) DtDt Amount of money demanded (billions of dollars) DmDm i% = 200 Interest Rate The Demand For Money Figure 11-1

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Chapter 11 Topics 11.1 The Definition & Functions of Money 11.2 The Supply of Money 11.3 What “Backs” the Money Supply? 11.4 The Demand for Money 11.5 Equilibrium in the Money Market 11.6 The Canadian Financial System 11.7 Recent Developments in Money & Banking

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Equilibrium in the Money Market u demand for money combined with supply of money portrays the money market

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Transactions Demand, D t Asset Demand, D a Total demand for money, D m += Amount of money demanded (billions of dollars) DaDa Amount of money demanded (billions of dollars) DtDt Amount of money demanded (billions of dollars) i% ADD THE MONEY SUPPLY TO FIND THE EQUILIBRIUM RATE OF INTEREST ADD THE MONEY SUPPLY TO FIND THE EQUILIBRIUM RATE OF INTEREST Interest Rate The Demand For Money Figure 11-1 DmDm

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Transactions Demand, D t Asset Demand, D a Total demand for money, D m += Amount of money demanded (billions of dollars) DaDa Amount of money demanded (billions of dollars) DtDt Amount of money demanded (billions of dollars) i% SmSm ieie Equilibrium Interest Rate The Demand For Money Figure 11-1 DmDm

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Adjustment to a Decline in the Money Supply u A decline in the supply of money will create a temporary shortage of money & increase the equilibrium interest rate

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter The Money Market Rate of interest, i (percent) Amount of money demanded (billions of dollars) SmSm DmDm ieie Suppose the money supply is decreased from $200 billion, S m, to $150 billion S m Figure 11-2

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Amount of money demanded (billions of dollars) DmDm ieie SmSm A temporary shortage of money will require the sale of some assets to meet the need S m1 Rate of interest, i (percent) The Money Market Figure 11-2

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Amount of money demanded (billions of dollars) DmDm ieie SmSm A temporary shortage of money will require the sale of some assets to meet the need S m1 Rate of interest, i (percent) The Money Market Figure 11-2 Everyone sells bonds  bond prices fall  interest rates rise illustrated… Everyone sells bonds  bond prices fall  interest rates rise illustrated…

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter BondsBonds u a $1,000 5% pays $50 annually u if you buy this bond for $667, you still receive $50 annually u what is your effective interest rate? u 50/667=7.5% the lower the bond price, the higher the interest rate the lower the bond price, the higher the interest rate

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Amount of money demanded (billions of dollars) DmDm ieie SmSm A temporary shortage of money will require the sale of some assets to meet the need S m1 Rate of interest, i (percent) The Money Market Figure 11-2 Everyone sells bonds  bond prices fall  interest rates rise until people are happy holding the lower quantity of money Everyone sells bonds  bond prices fall  interest rates rise until people are happy holding the lower quantity of money

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Amount of money demanded (billions of dollars) DmDm ieie After adjustments to asset holdings, a new equilibrium will be seen at a higher level of interest S m Rate of interest, i (percent) SmSm The Money Market Figure 11-2

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Adjustment to an Increase in the Money Supply u An increase in the supply of money will create a temporary surplus of money & decrease the equilibrium interest rate

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Amount of money demanded (billions of dollars) DmDm ieie SmSm Suppose the money supply is increased from $200 billion, S m1, to $250 billion S m2 Rate of interest, i (percent) The Money Market Figure 11-2

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Amount of money demanded (billions of dollars) DmDm SmSm S m2 A temporary surplus of money will require the purchase of some assets to meet the desired level of liquidity Rate of interest, i (percent) The Money Market Figure 11-2

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter BondsBonds u a $1,000 5% pays $50 annually u if you buy this bond for $2000, you still receive $50 annually u what is your effective interest rate? u 50/2000=2.5% the higher the bond price, the lower the interest rate the higher the bond price, the lower the interest rate

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Amount of money demanded (billions of dollars) DmDm SmSm S m2 A temporary surplus of money will require the purchase of some assets to meet the desired level of liquidity Rate of interest, i (percent) The Money Market Figure 11-2 Everyone buys bonds  bond prices rise  interest rates fall until people are happy holding the higher quantity of money Everyone buys bonds  bond prices rise  interest rates fall until people are happy holding the higher quantity of money

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Amount of money demanded (billions of dollars) DmDm ieie S m After adjustments to asset holdings, a new equilibrium will be seen at a lower level of interest Rate of interest, i (percent) SmSm The Money Market Figure 11-2

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Chapter 11 Topics 11.1 The Definition & Functions of Money 11.2 The Supply of Money 11.3 What “Backs” the Money Supply? 11.4 The Demand for Money 11.5 Equilibrium in the Money Market 11.6 The Canadian Financial System 11.7 Recent Developments in Money & Banking

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter The Canadian Financial System u The Evolution of the Canadian Banking System –16 domestically owned banks –33 foreign bank subsidiaries –20 foreign bank branches big six banks have 90% of total banking assets & 75% of payments volumebig six banks have 90% of total banking assets & 75% of payments volume mergers may lead to more concentrationmergers may lead to more concentration

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Table 11-2 The Balance Sheet of Canadian Chartered Banks December 2002 ($ Billions) AssetsLiabilities Reserves0.5 Demand deposits 97.2 Loans688.8 Savings deposits Gov’t. of Canada securities 76.7 Term deposits Foreign-currency assets 40.0 Foreign-currency liabilities 76.9 Gov’t of Canada 2.0 Other235.1Other493.0 Total1,041.1Total

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Assets (Canadian $ billions, 2002) Mizuho Holdings (Japan) $1,876,772 Citigroup (U.S.) 1,674,750 Sumitomo Mitsui (Japan) 1,338,400 Deutsche Bank (Germany) 1,288,926 Mitsubishi Tokyo (Japan) 1,196,957 Royal Bank of Canada 351,042 Canadian Imperial Bank of Commerce 280,447 TD Canada Trust 279,788 Scotiabank276,162 Bank of Montreal 232,362 National Bank of Canada 72,447 GLOBAL PERSPECTIVE 11.1

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter The Canadian Financial System u Canada’s Chartered Banks fractional reserve systemfractional reserve system u Making Loans u Other Financial Intermediaries u Cheque Clearing

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Chapter 11 Topics 11.1 The Definition & Functions of Money 11.2 The Supply of Money 11.3 What “Backs” the Money Supply? 11.4 The Demand for Money 11.5 Equilibrium in the Money Market 11.6 The Canadian Financial System 11.7 Recent Developments in Money & Banking

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Recent Developments in Money & Banking u Expansion of Services new productsnew products minibanksminibanks ABMsABMs debit cards, phone banking, Internet bankingdebit cards, phone banking, Internet banking

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Recent Developments in Money & Banking u Expansion of Services u Globalization of Financial Markets

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Recent Developments in Money & Banking u Expansion of Services u Globalization of Financial Markets u Electronic Transactions

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter Chapter 11 Topics 11.1 The Definition & Functions of Money 11.2 The Supply of Money 11.3 What “Backs” the Money Supply? 11.4 The Demand for Money 11.5 Equilibrium in the Money Market 11.6 The Canadian Financial System 11.7 Recent Developments in Money & Banking