Lec 7
July 23, 2012
Quiz will be due this weekend!
Theory of money
How AG adjusts… look at connection AD and AS (Ch 26) and AG expenditure model.
-Key: Extinction ag exp and AD; and Related Ag exp and AD curve
-Agg exp curve: relationship between agg planned exp and real GDP (CP)
-Agg demand curve: relationship between agg quantity of Goods and services demanded and PRICE
LEVEL (CP)
When inventory falls… firms need to increase production = increase their prices as well
Business slows , AG exp drops…. Firm finds that theres a surplus inventory = reduce output of
production = prices then drop
-when firms change…. economy price level changes. TO understand this gdp and price level, we utilize
ad and as agg expenditure. Blending the two models together. When price level change, agg planned
exchanges and ____ (wealth effect and substitution effect)
Higher price level (CP) Lower planned agg expenditure
substitution effect: 2 levels—1)given future price level. Rise in price = goods and services more
expensive. Delay in purchases. Temporal substitution. 2) International substitution: Rise in cdn price
level (CP): makes cdn goods more expensive relative to foreign goods = CDN imports up, cdn exports
down.
-----Theory of money
-any commodity that is generally accepted for payment is money
Money serves helps facilitates 1) medium of exchange 2) unit of count 3)store value
Medium of exchange
-without it, goods and services would be directly exchanged (Barter system)
-can use credit card (Not considered money, lending or borrowing ticket; allows you to create debt),
cheque, debit (automatic withdrawal) to obtain products/services ---still represents the definition of
Money (except credit card b/c it’s a loan) because it represents your assets
Unit of count
-agreed measure for stating prices for goods and services
-dollars and cents in North America
Store value
-can hold and be exchanged later for goods and services
->100 pennies = Lonnie
-Assets (house), gold, art work, bonds (transferable ,exchangeable), securities, car (may depreciate but
has value attached to it) can be considered store value …. What’s critical? STABILITY OF that item to
store of value
Sweating and clipping –devaluing coins
2 types of money in Canada : Deposits (Different def of money) and Currencies (notes and coins)
Measuring money
M1(Narrow def) : chequable deposits, non personal level; chequable deposits, personal level ;currency
outside bank
M2 (Broader def which includes M1 and other deposits): All of M1, fixed term deposits, non-chequable
deposits, non personal; non-chequable deposits, personal
-M1 and M2 is considered money.
Near money (ex. term deposit – you know exactly how much purchasing power; has value of money and
can be converted)
money substitutes (things that act as a medium exchange not a store value) ex: credit card
The Banking system
consists of : Private and public institutions
Manage nations monetary and payment system
1) Depository institution
subgroups: Chartered banks, Credit Unions (Takes deposits and makes loans) and Trusted mortgage loan
companies (privately owned. Receives deposits, makes loans, and acts as trustees for pension funds)
-lots of lending institutions in Canada. Big 5: RBC, TD, Scotia, BMO and CIBC
-produce income from charging service fees and loans; buying securities at higher cost
-4 types of assets: Reserves, liquid assets, securities and loans.
->Reserve: used to meet depository currencies withdrawals and used to make payments at other banks.
0.5% must be held on hand
->liquid assets: Commercial bills. First line of defense. Low risk, interest cost is very low. Earn a low
interest rate.
->securities: bonds, mortgage back securities, can be converted to reserves. Prices that fluctuate – these
assets are more riskier than liquid asset. Interest rate is then higher.
Loans: commitment of funds. Corporation can finance. For individuals. Homes.
2) Payment system
Benefits of banks:
-Create liquidity
-Pool risk
-Lower cost of borrowing
-Low cost of monitoring
3)Bank of Canada
-cda’s central bank
-public authority that supervises other banks, financial markets, payment system and monetary policy.
-a bank’s bank. Holds investment securities. Sole organization that can issue bank notes.
Restrictive list of customers all banks , credit unions and trust companies--->>>accepts deposits which
then become reserves.
-has influence directly to economy to change or influence interest rate …. Q of money in system.
Depends on bank’s balance sheet (analysis of its assets and liabilities)
-“Overnight loan system”
-central bank has monopoly
-don’t be concern about the statistics of the bank’s balance sheet…but how do they create money?
Creation of money: a new deposit … 3 sources
1) immigrating to Cnaada and bringing cash –this is deposited and considered new money deposited
2) ppl bringing money from home (savings) as undeclared cash and depositing = new deposit in system
3) purchasing government securities from individual or companies in return for cheque … new deposit
Bank of cda goes to open market and buys bonds from individual. Bank issues cheque. This cheque is a
new deposit in the system. This begins process of balance sheet.
bank Ratio of reserve to deposits has increased …………
loan portfolio –increase in deposits
Open market operations
Why you hold money? Speculative demand , precautionary demand ,
Variables that effect amount of money being held (4): Price level, Nominal Interest rate, real gdp,
financial innovation
Q of real money demanded and Interest rate – to see changes in real money demanded.
Money supply shift to right (or go up) – only if central bank increase reserves OR if commercial banks
lend larger fractions of the reserve
-reserve ratio. 0.5%
Cambridge equation: M = 1/v * (P*Y)
North American equation” M*V = (P*Y)
(P*Y) is Nominal flow of spending
v being velocity.. measure of how fast money is moving through the economy…avg number of times a
dollar is used to buy a good/service throughout the year
Market demand for money|
quantity theory – theory only –circulation of funds
Money multiplier (DISREGARD)