Money and Banks Money Supply 1

 The Money  What is money?  What form can money take?  Why is money worth something?  What happens to the value of the money over time? 2

 The money  Medium of exchange  Barter may work but  Have to find the right partner  Have to have the double coincidence of wants  Medium of exchange solves these problems  Store of value  Not a perfect one  Inflation  Unit of Account  Also not a perfect one  Inflation 3

 Forms of the money  Commodities  Stones on island of Yap  Cigarettes of POW camps  Precious metals  Coins  Paper money  Promise to pay, IOU  Fully backed  Fractionally backed  Gold standard  Fiat money  Deposit money 4

 Bank of Canada  Central bank  Banker to the commercial banks  Reserves  Banker to the federal government  Regulator of the money supply  Regulator of financial markets  Commercial banks  Financial intermediaries  Crediting business  Cheque/debit card clearing and collection  Profit seeking 5

 Commercial banks  Reserves  Bank runs of Great Depression  Fractional reserve system  Reserve ratio (actually held)  Fractional reserve system means reserve ratio < 1  Target reserve ratio (would like to hold) 6

 Commercial bank system creates money Suppose a $100 bill is dug from your backyard and deposited into bank A. – Assume banks hold 10 percent of deposits as reserves. – Assume individuals hold no currency. Bank A: Assets Liabilities Bank B: Assets Liabilities Bank C: Assets Liabilities Banking system: Assets Liabilities This injection of $100 into the banking system will generate $1,000 of money!!! Money Multiplier = 1/reserve ratio = The amount of money the banking system generates with each $1 of reserves 7

 Commercial bank system creates money  Money Multiplier = 1/reserve ratio = The amount of money the banking system generates with each $1 of reserves  This is the most money the system could generate, recall the assumptions: Assume banks hold 10 percent of deposits as reserves. Assume individuals hold no currency.  Excess reserves  Money Multiplier = 1/(actual reserve ratio v)  Kind of, reserve ratios may differ for the banks  Cash drain  If c is the ratio of cash people hold to deposits,  Money Multiplier = 1/(v + c)  Excess reserves and cash drain reduce Money Multiplier 8

 The money supply = total stock of money in the economy  Currency  In circulation  Bank deposits  Differing liquidity of various deposits  Chequing deposits  Term deposits  Liquidity of assets  Near money = easily convertible into money  Money Supply Measures Money Supply Measures 9