chapter 15 the monetary system. outline orole of money in the economy ocreation of money ocontrol of...
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Chapter 15
The Monetary System
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Outline
o Role of money in the economy o Creation of moneyo Control of supply of money by the
Bank of Canada
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Moneyo Money is the set of assets in the
economy that people regularly use to buy goods and services from other people
o Money acts as a medium of exchange and can also serve as a store of value and a unit of account
o Wealth is the sum of all valuable assets owned minus liabilities
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The Functions of Money
o Medium of exchange is an item that buyers give to sellers when they purchase goods & services
o A unit of account is the yardstick people use to post prices and record debts
o A store of value is an item that people can use to transfer purchasing power from the present to the future
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The Nature of Money
o Liquidity is the ease with which an asset can be converted into the economy’s medium of exchange
o Money is the most liquid asset but it is far from perfect as a store of value
o Trade off between liquidity and store of value determines the type of asset people wish to hold.
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The Kinds of Money o Commodity money- money that takes the
form of a commodity with intrinsic valueo Fiat money- money without intrinsic value
that is used as money because of government decree
o Currency- includes the paper bills and coins in the hands of the public
o Deposit money or demand deposits - money held by the public in the form of deposits in commercial banks that can be withdrawn on demand
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Measures of Money
o M1= currency+ demand deposits o M2= M1+ savings deposits+
personal term deposits o Term deposit is tied up for a period
of time and has a specified withdrawal time and pays a higher interest rate than demand deposits
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Monetary Base, 1955-2003
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M1 Supply, 1967-2003
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M2 Supply, 1968-2003
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The Bank of Canada
o Basic Functions of the Bank: o Banker to the Commercial banks o Banker to the Government o Controller and regulator of money
supplyo Regulator and supporter of money
markets
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91- Day Treasury Bill yields, 1946- 2003
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Bank Rate- Monthly, 1935-2003
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Bond (1-3 year) yields , 1949-2003
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Money creation by the banking system
o Assumptions:o Only one kind of asset- loans, and only
one kind of deposit- demand deposit o Fixed reserve ratio= 20% o No cash drain from the banking system
(public holds a fixed amount of currency in circulation)