Chapter 13- Money Handout Functions of Money There are three main functions of money: 1. _____________________________________ Most important is how money is used as payment for items that are bought and sold Without money, market participants must ___________, meaning that they trade one product for another If a trade is to happen, there must be a _____________ ___ ________, where someone who wants to purchase an item must find a seller who wants the item that the purchaser is offering 2. ____________________________________ Money’s major advantage is its _______________ which provides a safe and accessible store of wealth as it can be converted into a mean of payment People tend to think wealth is in terms of money even though the benefits of liquidity outweigh the income that could be earned by holding it in another form (such as bonds). 3. ____________________________________ Money provides buyers and sellers with a pricing standard, called ______ ___ ________. It allows all products to be compared against one another for example; a sweater costs $30 while a pair of socks costs $5. sweater costs more than socks Canadian Financial System ____________-____________ are institutions or businesses that accept funds provided by savers and lend these funds to borrowers Not all funds that flow into this institute flow out; therefore, they need to keep an amount on hand, known as _________ ______________ Deposit –takers are categorized into two types which are: 1. _________________________ ____________ They form most of the Canadian financial system in which they are allowed to sell a wide range of financial services Out of 50 Canadian charted banks, there are the Big Six banks which dominate 1. RBC (Royal Bank of Canada) 2. The Canadian Imperial Bank of Commerce 3._______________________ 4._______________________ 5. TD (Toronto-Dominion) 6. The National Bank 2. _________ ____________ These banks are not chartered but have more specialized services as they include trust companies, __________ __________ companies and _________ unions. If a certain deposit-taker does not fall into chartered banks or near banks, they are considered as other financial institutions. There are two specific types of other financial institutions called: 1. _____________ companies: which offer insurance policies to their clients and use the funds to buy income-producing financial assets 2. _____________ dealers: which buy and sell financial securities for customers Chartered banks, trust companies, insurance companies and investment dealers form the four main pillars of the financial system. In today’s society, financial deregulation allowed each institution to perform a wider range of functions. Because of this, critics fear that the more dominating companies are going to control most of the Canadian financial system. Supply of Money made up of ________________and some deposits Currency include paper notes issued by Canada’s central bank, the Bank of Canada, and coinage produced by the Royal Mint Deposits are given to deposit-takers (Banks) and lent out to borrowers who pay interest. Interest rates on loans are usually _________ than interest rates on deposits. This is how chartered banks and near banks make their profits. The ______________ a deposit taker can make use of funds and the ______________ the services the deposit-taker provides, the higher the interest rate will be. Four types of deposits: 1. ________________ Deposits: When a depositor can gain _______________access to their money, which can take the form of current and personal chequing accounts. Furthermore, depositors receive ________interests or no interest rates on their money. 2. ________________Deposits: Funds which deposit-takers need a notice before a withdrawal is made by the depositor. 3. ________________ Deposits: This type of deposits has depositors guaranteeing that withdrawals will not be made for a ___________period amount of time allowing depositors to gain a higher interest rate. Term deposits made by households are called personal term deposits, and those made by businesses are known as non-personal term deposits. 4. ____________ _______________Deposits: These deposits, which are held by Canadian residents, are treated as a _______________class of deposits because they are valued in terms of foreign currency. Money Defined Money is defined in many ways, the four most common definitions used by economists: M1, M2, M3, and M2+. 1. M1: the ____________definition of money, consisting of currency outside chartered banks and publicly held deposits at chartered banks. 2. M2: a ___________ definition of money, consisting of M1 plus ________ deposits and personal ________ deposits at chartered banks M3: the definition of money consisting of M2 plus _____-________ term deposits and ______________ ______________ deposits at chartered banks. 3. M2+: the definition of money consisting of M2 plus ______________ deposits at near banks and some other liquid assets. Choosing a Definition Many economists view _______ as the most accurate money supply since currency and demand deposits are used solely as means of payment Other economists believe M1 is too __________ and prefer __________ definitions, M2, M2+ because of recent innovation and payment methods that have made them more liquid. The Role of Credit Cards Credit cards are not money; they are an easier way for buyers to ___________ funds When a credit is used for a purchase, the lending institution makes a loan or “credit” to the user equal to the amount of the sale. If the borrower of the funds does not pay back the loan on time, the borrower must pay ____________ in addition to the initial amount Used effectively because as long as the borrower pays the money back ____ _______, interest will not be charged. Therefore, money would not have to be withdrawn from their back accounts allowing more interest to accumulate The Introduction of Debit Cards Debit cards allow a payment to be made through an instantaneous transfer of funds Different from credit cards as debit cards represent a different type of transaction since the buyer’s account is instantly reduced or “_________” by the amount of the purchase Can be employed by virtually any depositor. Short term: debit cards lead to higher prices for consumers. Long term: a downward pressure on prices for the consumers The Demand for Money In the economy, money is demanded for reasons related to transactions demand and asset demand. Transactions Demand: If there is a rise in an economy’s real output or price level, the total value of transactions ____________, increasing the demand for money. If there is a fall in real output or price level, the total value of transactions and demand for money decreases. Asset Demand: Associated with money’s function as a store of ____________ __________. The main cost of holding money is the added income that could have been earned by investing in higher-paying assets such as ____________. Bonds Formal contracts bought and sold on the open market. There is a set amount borrowed, to whom it is lent to, for what period of time and at what interest rate Bondholder is the person who is ___________ out the money and the bond issuer is the person who is ____________ it. When a bond ___________ or reaches the end of their term, the bond issuer pays the principal along with the interest accumulated to the bondholder. Prices of bonds and prevailing interest rates are _____________ related, meaning that as prices of bonds increase, prevailing interest rates ____________, and vice versa. Bonds are very attractive assets and the most popular way of funds, because they offer _____________, relatively _________ rates of return and can be sold before their term has ended. The only downside is the potential risk that bond issuer goes ____________ and is unable to repay the bondholder. Therefore asset demand for money is ____________ related to the nominal interest rate on bonds. Slope of money demand curve: Money demand represents the amount of money demanded, unadjusted for inflation, at all possible interest rates. When it is expressed in a table it becomes the money demand schedule, and when it is expressed in a graph, it gives the money _______________ ___________. The slope is negative because of the asset demand of money which is inversely related to interest rates on bonds. Shift in the money demand curve: A change in transaction demand changes the amount of money demanded at all interest rates, causing the curve to _______. Change in _________ ___________ and ___________ raises the transaction demand for money at every possible level. The Supply of Money The money ___________ is a set amount of money that exists in the economy, determined by the government decision-makers. Money supply can be expressed to forms of a table (money ________ __________) or in forms of a graph (money ________ _______). Equilibrium in the Money Market Supply and demand for money interact in the market creating a state of equilibrium Nominal _________ ________ is found at the intersection of money demand and money supply curves. Needless to say, _____________ and ___________ create equilibrium in the money market. When interest rates are above its equilibrium level there is a surplus of money meaning there is more money being supplied than demanded. In this case people will start to _________ themselves of money by buying ____________ that will in the future earn them high profits, the demand for these assets will rises. As a result, the nominal interest rate will ________ relieving the economy of the discrepancy between the demand and supply of money When the interest rate falls below the equilibrium level creating a shortage of money (where money is demanded more than is supplied) then people will start to ______ their assets, in order to _________ money. Ultimately, this price of these assets will fall, causing the nominal interest rate to ________ until equilibrium point is retained Desired Reserves Since 1994, both chartered banks and near banks have kept only ___________ ____________, the minimum amount of cash necessary to satisfy anticipated withdrawal demands. The Reserve Ratio The more money a deposit taker holds in deposits, the greater the anticipated withdrawal deposit takers can expect Best way is for the deposit takers to hold a certain portion of deposits in the form of __________ ____________. This portion expressed in a percentage, or in decimal terms, is the ___________ _________. Equation: RESERVE RATIO = DERSIRED RESERVES / DESPOSITS Excess Reserves Deposit takers find that their cash reserves exceed __________ levels giving excess reserves. Deposit takers will try to transform any excess reserves into ___________ _____________ assets such as loans. Equation: EXCESS RESERVES = CASH RESERVES – DESIRED RESERVES The Money Creation Process The Multiplier Formula Value of the money multiplier is determined by the _____________ of the deposit taker’s reserve ratio The Money Multiplier Equation: MONEY MULTIPLIER = 1 / RESERVE RATIO Equation: CHANGE IN MONEY SUPPLY = CHANGE IN EXCESS RESERVES X MONEY MUTIPLIER Adjustments to the Money Multiplier In order to see how money is “________”, we have to assume that all money is in the form of _________ and all deposits are made to one sort of deposit taker offering one type of deposit. However, in the real world money is only in forms of deposits. Publicly Held Currency In reality, not all money is in the form of _________, as the public does not deposit all their money in banks. Only some money is deposited and lent out, while some circulates in the economy. Therefore, the money supply does not increase by the _________ amount calculated by the money multiplier. Difference in Deposits Because not all deposits are the ________, not all are represented by M1.