Chapter 27 Essay

Submitted By AnnieQueens
Words: 1698
Pages: 7

Chapter 27
Money and Banking


Two Perspectives on Money
The Classical View of Money
• Relative prices and real GDP determined only by real things
• technology and preferences
•Money is neutral
• change in the money supply causes no change in real variables
• change in the money supply does lead to a proportionate change in the price level


The Modern View
Short run:
• changes in money do generate changes in output and other real variables
Long run:
• money is neutral
•changes in money and the price level are closely linked countries with high inflation rates often have higher rates of growth of the money supply

The Nature of Money
Money is a medium of exchange
• acceptable as payment for goods and services.
• without money, would need a system of barter
•barter is inefficient
•requires double coincidence of wants
Not a problem when a general medium of exchange is used. 4

Money is a store of value
• without high inflation, money retains its value
Alternative media of exchange -- ice cream?
-- do not necessarily hold their value well.
Money is a unit of account
• the unit of measure we use to keep our financial accounts


The Origins of Money
Metallic money
• Coin worth market value of metal
• Led to debasing
Gresham’s Law:
• “bad money drives out good” when two types of money used
• one with greater intrinsic value will be driven out of circulation

Paper money
• backed by precious metal
• convertible on demand
• referred to as bank notes because it was issued by private banks


Fractionally backed paper money
• goldsmiths (banks) found they didn’t need to keep 1 oz. of gold in vaults for every receipt for 1 oz.
• issued more “receipts” than the gold in their vaults
Fiat money
• paper money or coinage
• neither backed by nor convertible into anything else
• decreed by the government to be acceptable as legal tender Today most currency is fiat money.

Modern Money
Deposit Money:
• money held by the public in form of deposits with commercial banks and other financial institutions
• bank deposits are money

Money Creation:
• banks create money by issuing more promises to pay
(deposits) than they have available in their cash reserves


The Canadian Banking System
Consists of:
• commercial banks
• a central bank
Central bank:
• acts as a bank to commercial banking system
• usually government-owned
• sole money-issuing authority
Bank of Canada [ BOC ] is central bank in Canada

• operates under system of joint responsibility - 1967
• operates monetary policy on a day-to-day basis
• free of political influence
• ultimately answerable to Parliament


Basic functions of BOC:
1) banker to commercial banks
2) banker to federal government
3) regulate money supply
4) regulate, support, and monitor financial markets


1) Banker to commercial banks:
• Accepts deposits (commercial bank reserves)
• Transfers funds to other commercial banks to settle debts
• Lends to commercial banks (lender of last resort)
Assets (March, 1999)
Government of Canada
Advances to banks
Foreign-currency assets
Other assets

Total ($millions)

Liabilities (March,1999)
30,042 Notes in circulation
737 Government deposits
323 Deposits of banks
1,696 Foreign-currency liabilities and capital
Other liabilities and capital 32,798 Total ($ millions)


2) Banker to Federal Government
• Holds some government deposits
• May lend to federal government by buying treasury bills
(short term bonds) or regular bonds

Important for conduct of monetary policy


3) Regulator of Money Supply
• Controls money supply
• Two main liabilities of BOC are:
• Currency in circulation
• Chartered bank reserves

• Controlling liabilities, controls money supply


4) Regulate and Support Money Markets
• Financial institutions
• banks, borrow short and lend long
• unexpected interest rate rise
• banks must pay higher interest rates to keep deposits • funds loaned out a lower rates