Chapter 2:
Learning Objectives
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Functions and Efficiency of Money: from Barter
to Monetary Exchange
How should we Define Money? Canadian
measures
Monetary Standards & Systems: Types and
Historical Experiences
Consequence of Fiat Money: The Costs of
Inflation
The Functions of Money

Medium of Exchange
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Medium of account
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How transactions are conducted
How the value of goods & services are denominated
Store of value and a standard of deferred
payment
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How the value of goods & services are maintained
in monetary terms
Monetary Standards
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Commodity money
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Gold, Silver, and Bimetallic standards
Gresham’s Law
Fiat money
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Paper money standard
Canada’s early paper money history
The introduction of central banking
The Measurement of Money


Taking an Empirical approach
Institutional aspects:
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
chartered vs. other types of financial
institutions
types of deposits and their evolution: the
growth of electronic transactions (Table
2.1)
Transactions Data
The Measurement of Money


Taking an Empirical approach
Institutional aspects:



chartered vs. other types of financial
institutions
types of deposits and their evolution: the
growth of electronic transactions (Table
2.1)
monetary aggregates: definitions and data

Table 2.2 & Figure 2.1
The Canadian Money Supply:
Key Measures, August 2004
TABLE 2.2
M1: Cash and
$162,368
M2:
M1& savings
deposits
$623,318
M3:
M2 & term
deposits
$868,017
M2+:
$872,466
demand deposits
M2 &
deposits @ other
deposit-taking
institutions
M2++:
M2+ &
MMMF and CSBs
$1,262,935
Major Canadian Money Supply Aggregates
1400000
Millions of dollars
1200000
M2++
1000000
M2+
800000
600000
M1++
400000
M1+
200000
M1
0
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
Year
Currency in Circulation: Seasonally adjusted
or unadjusted
44000
40000
Million of dollars
36000
Seasonally Adjusted
Seasonally Unadjusted
32000
28000
24000
20000
16000
12000
8000
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
Year
The Measurement of Money


Taking an Empirical approach
Institutional aspects:





chartered vs. other types of financial institutions
types of deposits and their evolution: the growth of
electronic transactions (Table 2.1)
types of financial assets
seasonal adjustment (Figure 2.2)
Other refinements
Inflation Versus Deflation

There are 2 types of inflation/deflation:
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
Anticipated: there are NO surprise changes in
prices
Unanticipated: SOME price changes are NOT
expected

Most inflations/deflations are NOT FULLY anticipated
The Costs of Inflation
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Creditor vs. lenders: real interest rate effect
Seigniorage: the profit from printing money
“Shoe-leather” costs: frequent need for more
cash
Tax implications: paying tax on inflation
“Menu” costs: cost of frequent price changes
Accounting problems: historical vs current
costs
inflation level and volatility: positively related
Inflation and Economic growth: negatively
related
What’s Special About Deflation?
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When prices fall the REAL value of debt rises
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When prices fall EXPECTATIONS of additional
reductions are possible
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Debtors are penalized; borrowers benefit
Consumers postpone purchases with further negative
economic implications
If monetary policy responds by lowering interest
rates they could fall to zero
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At zero (nominal) interest rates cannot become negative
This is called the “zero lower bound”
Summary
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Monetary systems are more efficient than barter systems
Money has 3 functions
 medium of exchange
 medium of account
 store of value
Canadian definitions of the money supply include M1, M2,
M2+, M3
Excessive monetary expansion leads to inflation which is
socially costly
Deflation is the opposite of inflation and can produce
serious negative economic consequences