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Chapter 15
The Monetary System
Outline
o Role of money in the economy
o Creation of money
o Control of supply of money by the Bank of
Canada
Money
o 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
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
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.
The Kinds of Money
o Commodity money- money that takes the form
of a commodity with intrinsic value
o 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commercial banks that can be withdrawn on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
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
Monetary Base, 1955-2003
M1 Supply, 1967-2003
M2 Supply, 1968-2003
The Bank of Canada
o Basic Functions of the Bank:
o
o
o
o
Banker to the Commercial banks
Banker to the Government
Controller and regulator of money supply
Regulator and supporter of money markets
91- Day Treasury Bill yields, 1946- 2003
Bank Rate- Monthly, 1935-2003
Bond (1-3 year) yields , 1949-2003
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)