Money Ch.11

Money is used to pay for things How did this happen? Trading – currency Money is anything that is generally acceptable in purchasing goods or settling depts. Money is used as a medium of exchange - trade for wants and needs A measure of value – how much something costs A store of value – store purchasing power

Money Supply Money supply is how much money is circulating outside of the banks plus bank deposits. Components of money supply Demand deposits (ex. chequing and savings accounts) Term deposits (customer agrees to deposit a fixed amount of money for a fixed period in return for higher interest rates) Notice accounts (customer must give the bank notice before a withdrawal) Money market mutual funds (ex. short-term mutual funds, bonds etc.)

Definitions of the Money Supply M1 – money used as a medium of exchange to make payments (all currency outside of banks as well as demand deposits except savings accounts). M2 – includes all M1 plus personal savings accounts, including chequing and savings, term deposits, and non-personal notice deposits. M2++ - includes all M2 as well as deposits at non-bank deposit-taking institutions (ex. Credit unions, trust companies) money market mutual funds and individual annuities at life insurance companies. M3 – all M2++ as well as large term deposits held by businesses and foreign currencies held by Canadian’s.

How Banks Create Money Balance sheet Deposit is an asset and a liability People will usually only take out a portion of their deposits for savings so the bank can “bank” on this and use a portion of this money to invest to make more money. This is the reserve ratio. Excess reserves is the amount of money over and above what they will normally need (based on past withdrawals). Banks use the excess reserves to lend customers more money, then they use it to buy something which gets deposited back into that bank or another bank and the cycle continues.

How banks destroy money By contracting deposits. Let’s say a business or customer comes in and wants to withdraw more money than the bank has in reserve. It will make up this shortfall by cease lending money until new deposits of cash replenish its reserves. This would come from existing loans that continue to be repaid to the bank. The borrowers of this bank can make withdrawals from other banks in the system to make payments.