Economics Unit 3

Money and Banking

Money :

Functions of Money

Characteristics of Money

Definition of money

A measure of value

A store of value

A medium of exchange

Easily divided into units

Readily recognizable by shape + colour

Durable

Difficult to duplicate

portable and easy to use

MUST retain value over time

Anything to purchase goods + purchases

Oppose counterfeiting

Must be accepted in economy

Monetary Policy

Bank of Canada

Interest rates

price charged for borrowing money

Functions

Director of Monetary policy

Monetary Policy

Banker to the chartered bank

Chartered Bank

established by charter from government

Influencing money and credit

Banker to the federal government

Issuer of currency

Role of Interest rates

Monetary Policy at Work

Affects consumer to save/borrow money

Tools of Monetary Policy

Overnight Rate target

Bank's Balance Sheet

Different Types of Interest Rates

Prime Rate

Bank Rate

Inflation Premium

Nominal Interest rate

Real rate of interest

financial institution's lowest interest rate

Given to its best customers

Bank of Canada's interest rate

to chartered banks

Determines rate to customers

Allowance for inflation

built into all interest rates

Interest rate that includes:

allowance for risk

credit worthiness

inflation premium

Nominal interest rate minus

expected rate of inflation

Easy Money Policy

Tight Money Policy

Stage 1

The Bank shifts government deposits

To accounts of chartered banks

Stage 2

Stage 3

Stage 4

Stage 2

Stage 3

Stage 1

Stage 4

Lend more with increased reserves

lowering interest rates attracts potential borrowers

Lower interest rates encourage large purchases

Consumers borrow for houses, car, appliances

Businesses borrow more for stocks, plants

New borrowings increase money supply growth

From increased bank deposits and reserves

The economy purchases increased output

Increased consumer / business spending

Increases Aggregate Demand and GDP

Ends recession, leads to full employment

The Bank shifts government accounts back

From chartered banks to Bank of Canada

Decreased reserves = less money lend out

Raise interest rate with decreased supply

Higher interest rates discourage borrowing

Consumers borrow for large purchases

Businesses cut investment in stocks, plants

Less borrowing decreases money supply growth

Decreased reserves = Chartered banks can't lend

Contributes to fall in spending

Decreased consumer / business spending

Decreases aggregate demand and prices

Ends the period of high inflation

Affects business' decision to borrow/expand

Affects Demand for Canadian money

Value of the dollar

Supply+ Demand for Loanable Funds

Changes in Interest Rates

Interest Rate affects Supply and Demand

Demand

Supply

Consumers borrow money for large purchases

Businesses borrow , calculating rate of return

Rate of Return

Estimated extra revenue from investment

Government

Not affected by interest rate

Interest costs paid by taxpayers

Business , money in deposit accounts

Chartered Banks, by regulating money supply

Individuals, money in deposit accounts

Demand

Fund demand increases (curve shifts right

Increase rate during "good times"

Supply

Fund demand decreases (curve shifts left)

Decrease rate during "uncertain times"

During good times, people save more

Curve shifts right, decrease rate

During recession, people reduce savings

Curve shifts left, increase rate

shift deposits buy/sell bonds

The Bank's tool to control inflation rate

Bank pays 0.5% less than Bank rate

This 0.5% range is called operating band

Overnight rate target: operation band's midpoint

Banks trade with each other

At the overnight rate

increase / decrease chartered banks' interest rate

influence short-term interest rates

speed / slow down money supply growth

The Bank states overnight rate target

Assets

Foreign Exchange

Advances to the chartered banks

Government of Canada Bonds

Liabilities

Currency Outstanding

Deposits of the chartered banks

Deposits of the federal government

Government sells bonds to the Bank

Canadian government receives money from Bank

Government promises to pay back

stock of foreign currencies

defend Canadian dollar on international markets

The Bank lends money to chartered banks

Charges interest (the Bank rate)

all bank notes issued by Bank

Asset to people, liability to Bank

Balances held by chartered banks

to settle debts + act as reserves

central bank pays interest

"chequing account" of the federal government

government deposits revenues + pays expenses