Overview-10
The
functions and measurement of
money
The Bank of Canada and its functions
Fractional reserve banking - how does
it work?
The money multiplier
Monetary control-how does B of C
control money supply?
Principles of Macroeconomics:
Canadian Edition
tutorials
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DEPARTMENT OF ECONOMICS
CARLETON UNIVERSITY
ECON 1000B
TUTORIAL GROUPS
WINTER TERM 2011
Professor Douglas Smith
1. WHEN
Tutorial groups will begin in the week of January 24. Groups will meet EVERY OTHER WEEK. The last group will meet in the week of March 21. Each group
will meet FOUR (4) times in the Winter term. The 8 week time period does NOT include reading week. Time, location and start dates for each group are shown
below.
2. WHERE
You are in the same group as in the Fall. Locations are shown below. DISCUSSSION GROUP GRADES ARE PROVIDED TO ME BY THE TAs. YOU MUST
ENSURE THAT YOU ARE ON THE GRADE LIST MAINTAINED BY YOUR TA FOR THIS TERM.
NOTE ROOM CHANGES!
3. TUTORIAL GRADES
There will be THREE (3) assignments per term. Assignments will be provided on my web page and must be handed in to your discussion group leader on
THE ASSIGNED DATE. Assignments will be accepted by TAs at the end of the tutorial session, ONLY from students who attended that session. The best
TWO (2) will count as your discussion group grade. In each term, tutorial group assignments will count for 20% of the final grade. [That is, 10 out of 50 in
each term].
Some tutorial assignments will require you to work ahead of the material being covered in class.
OPTION: It is in your interest to attend groups and do the assignments. If you do not hand in assignments, however, the assignment grade weight will be
transferred to the April exam.
GROUP SCHEDULE
Group
Number Day
Time
Start Date
Location
B01
TUES
1:35
JAN 25
Southam 309
B02
TUES
1:35
FEB 1
313 Southam
B03
TUES
1:35
JAN 25
311 Southam
B04
THURS
12:35
FEB 3
313 Southam
B05
THURS
12:35
JAN 27
311 Southam
B06
THURS
12:35
FEB 3
TB431
B07
THURS
4:35
JAN 27
309 Southam
B08
THURS
4:35
FEB 3
313 Southam
B09
THURS
1:35
JAN 27
TB210
B10
THURS
1:35
FEB 3
TB447
B11
MON
9:35
JAN 25
ME3190
WHY MONEY?
 Without
money, trade would require barter,
the exchange of one good or service for another.
 Every transaction would require a double
coincidence of wants – the unlikely occurrence that
two people each have a good the other wants.
 Most people would have to spend time searching
for others to trade with – a huge waste of
resources.
 This searching is unnecessary with money,
the set of assets that people regularly use to buy
g&s from other people.
The Meaning of Money
Money
is the set of
assets in the economy
that people regularly use
to buy goods and
services from other
people.
Principles of Macroeconomics: Ch 10
Canadian Edition
Three Functions of Money
 Medium of Exchange: anything that
is readily acceptable as payment.
 Unit of Account: serves as a unit of
account to help us compare the
relative values of goods.
 Store of Value: a way to keep some of
our wealth in a readily spendable form
for future needs.
Principles of Macroeconomics: Ch 10
Canadian Edition
The Two Types of Money
Commodity
Money: something that
performs the function of money and
has alternative, non-monetary uses.
– Examples: Gold, silver, cigarettes
Fiat
Money: something that serves
as money but has no other important
uses.
– Examples: Coins, currency, debit
cards
Principles of Macroeconomics: Ch 10
Canadian Edition
Money in the Canadian Economy
Money
Stock is the quantity of money
circulating in the economy.
Different ways of measuring the money
stock in the economy:
– M1
– M2
Principles of Macroeconomics: Ch 10 Canadian Edition
Measurement of Money
The
most familiar
forms of money
used include:
– Currency
– Demand
Deposits:balances in
banks that depositors can
access on demand by
writing a check or using a
debit card.
Principles of Macroeconomics: Ch 10
M1
Canadian Edition
Measurement of Money
A
broader measure of
money than M1, includes:
– M1 +Savings Deposits
+Personal Term Deposits
Principles of Macroeconomics: Ch 10
M2
Canadian Edition
M1 and M2
Where is All The Currency?
In
2006 there was about $46 billion of
Canadian currency outstanding ($1,797
in currency per adult).
Banks and companies hold some.
The outstanding currency may be in
the hands of tax evaders, drug dealers
and other criminals.
Principles of Macroeconomics: Ch 10
Canadian Edition
Tutorials
http://http-server.carleton.ca/~dosmith/
Rooms
have changed.
Check my webpage.
See Schedule and Agenda
All assignments are now up.
Also chapters 5-9.
groups
Money
Debit
cards are money. Like cheques,
they allow direct access to money.
Credit
cards are NOT money. They
provided for deferred payment.
Cheques or transfers used to pay card
balances are money.
Money: Medium of exchange
Allows
you to pay for things.
C$1,000 cash in you wallet.
8 PM, system failure-all ATMs down
Visiting Toronto, Buffalo, Atlanta,
Istanbul
What if you had $US1,000??
Medium of exchange is what is
accepted.
The Bank of Canada
Bank Of Canada (“B of C”) serves as
the nation’s central bank, which is designed
to control the quantity of money in the
economy.
 The “B of C” is owned by the Canadian
government.
 Interacts with chartered banks.
 The
 US
counterpart is the Fed-Federal Reserve
System
Principles of Macroeconomics: Ch 10 Canadian Edition
The B of C’s Organization
The
B of C is run by its Board of
Governors which is composed of:
– The Governor. Mark Carney
– The Senior Deputy Governor.
– Twelve directors including the Deputy
Minister of Finance.
– All members are appointed by the
Finance Minister.
Principles of Macroeconomics: Ch 10
Canadian Edition
The B of C’s Organization
The
Bank of Canada is controlled by
the Canadian government which
appoints the Board of Directors.
As a last resort the government can
issue a written directive to the
Governor who must comply.
In practice the Bank of Canada is
largely independent of the
government.
Principles of Macroeconomics: Ch 10
Canadian Edition
Four Primary Functions of the B of C
 Issue currency.
 Act as a banker’s bank, making
loans to chartered banks and as a
lender of last resort.
 Act as banker to the Canadian
government.
 Control the money supply with
monetary policy.
Principles of Macroeconomics: Ch 10 Canadian Edition
Money Supply Changes by the B of C
Open-Market
Operations: The primary
way in which the B of C changes the
money supply is done through the
purchase and sale of Canadian
government bonds. “OMO”
- To increase the money supply, the B of C
buys government bonds from the public.
-To decrease the money supply, the B of C
sells government bonds to the public.
Principles of Macroeconomics: Ch 10
Canadian Edition
OMO
 Think
of a cashier’s window
 Only Money and Bonds are transacted
 1. Bonds flow out and dollars flow in: SELLS
 2. Dollars flow out and bonds flow in: BUYS
– 1 is OMO to contract MS
– 2 is OMO to expand MS
What BofC changes is liquidity
2 Replaces unspendable bonds with money
OMO 2 increases liquidity –OMO1 decreases it
Banks and The Money Supply
The
behaviour of banks can influence
the quantity of demand deposits in the
economy and therefore, the money
supply.
Fractional Reserve Banking System:
The practice of holding a fraction
(RR)of money deposited as reserves
and lending out the rest.
Principles of Macroeconomics: Ch 10
Canadian Edition
Fractional Reserve Banking
Deposits
into a bank are recorded as
both assets and liabilities. Deposits
that have been received but not lent
out are called reserves.
The supply of money in the economy
is affected by the amount of deposits
that are kept in the bank as reserves
and the amount that is lent out. Loans
become an asset to the bank.
Principles of Macroeconomics: Ch 10
Canadian Edition
Bank “T-Account” Example
First Canadian Bank
Assets
Reserves
$10.00
Liabilities
Deposits
$100.00
Loans
$90.00
Total Assets
$100.00
Total Liabilities
$100.00
Principles of Macroeconomics: Ch 10
A “T-Account”
illustrates the
financial position
of a bank that
accepts deposits,
keeps a portion as
reserves and lends
out the rest.
Canadian Edition
Bank T-account
T-account:
a simplified accounting
statement
that shows a bank’s assets &
liabilities.
 Banks’
liabilities include deposits,
assets include loans & reserves.
 In
this example, notice that R/D = $10/$100
= 10%.
Money Creation with
Fractional-Reserve Banking
When
a bank makes a loan (from its
reserves) the money supply increases.
When banks hold only a fraction of
deposits in reserve, banks create
money.
The creation of money through loans
does not create any wealth, but the
economy has more liquidity-more of
the medium of exchange.
Principles of Macroeconomics: Ch 10 Canadian Edition
The Money Multiplier
When
one bank lends money, that
money is generally deposited into
another or the same bank thus
creating more deposits and more
reserves to be lent out.
The Money Multiplier is the amount of
money that the banking system
generates with each dollar of reserves.
Principles of Macroeconomics: Ch 10
Canadian Edition
The Money Multiplier
First Canadian Bank
Assets
Reserves
$10.00
Liabilities
Deposits
$100.00
Loans
$90.00
Total Assets
$100.00
Total Liabilities
$100.00
Principles of Macroeconomics: Ch 10
Canadian Edition
The Money Multiplier
First National Bank
Second Canadian Bank
Assets
Assets
Liabilities
Reserves
$9.00
Deposits
$90.00
Reserves
$10.00
Liabilities
Deposits
$100.00
Loans
Loans
$90.00
Total Assets
$100.00
$81.00
Total Liabilities
$100.00
Principles of Macroeconomics: Ch 10
Total Assets
$90.00
Total Liabilities
$90.00
Canadian Edition
The Money Multiplier
First Canadian Bank
Second Canadian Bank
Assets
Assets
Liabilities
Reserves
$9.00
Deposits
$90.00
Reserves
$10.00
Liabilities
Deposits
$100.00
Loans
Loans
$90.00
Total Assets
$100.00
$81.00
Total Liabilities
$100.00
Principles of Macroeconomics: Ch 10
Total Assets
$90.00
Total Liabilities
$90.00
First Canadian Edition
The Money Multiplier
First Canadian Bank
Second Canadian Bank
Assets
Assets
Liabilities
Reserves
$9.00
Deposits
$90.00
Reserves
$10.00
Liabilities
Deposits
$100.00
Total Money Supply = $190.00!
Loans
Loans
$90.00
Total Assets
$100.00
$81.00
Total Liabilities
$100.00
Principles of Macroeconomics: Ch 10
Total Assets
$90.00
Total Liabilities
$90.00
First Canadian Edition
What determines the size of the
money multiplier?
The
money multiplier
is the reciprocal of the
reserve ratio.
M=
– With a reserve
requirement (RR) of
10% or 1/10 . . .
1
RR
– The multiplier will be 10.
– Traces through n
banks
Principles of Macroeconomics: Ch 10
First Canadian Edition
Money multiplier
Money
 $100
 $90
 $81
 $72.90
 Etc
Assumptions
 In example,
R/D=10%
 Initial R=$100
 MS=R*(1/RR)
 =100*10
 Total
 Do
$1,000
Study Guide
Tools of Monetary Control
The B of C has three instruments of
monetary control:
1.Open-Market Operations:
– Buying and selling bonds.
2.Changing
the Reserve Ratio:
– Increasing or decreasing the ratio.
3.Changing the overnight rate
-The interest rate the B of C charges
other banks for loans.

OMO
 Open-Market
Operations --OMO
– The Bank of Canada conducts openmarket operations when it buys
government bonds from or sells
government bonds to the public:
Buying bonds causes the money
supply to increase.
Selling bonds causes the money
supply to decrease.
Bank of Canada’s Tools of Monetary
Control
 Foreign
Exchange Market Operations
– The Bank of Canada conducts foreign
exchange market operations when it buys or
sells foreign currencies
The money supply increases when the Bank
of Canada buys foreign currency with
Canadian currency.
The money supply decreases when the Bank
of Canada sells foreign currency.
FX
 Foreign
Exchange Market Operations
– If the Bank of Canada wants to sell foreign
currency to support the Canadian exchange
rate, but does not want the money supply to
fall, it uses the Canadian currency obtained in
the exchange to buy government bonds.
– This process of offsetting a foreign exchange
market operation with an open-market
operation is called sterilization.
Overnight rate
Bank
rate is the rate that BofC charges
chartered banks for loans.
Overnight rate is the rate on very short
term loans.
If BofC raises bank rate and overnight
rate, banks borrow less reducing
reserves and MS.
Raising rates reduces MS and VV
Problems in Controlling the Money
Supply
Two
problems that the B of C must
deal with that arise due to fractionalreserve banking:
The B of C does not control the
amount of money that households
choose to hold as deposits in banks.
The B of C does not control the
amount of money that bankers choose
to lend. ???excess reserves
Principles of Macroeconomics: Ch 10
Canadian Edition
CHAPTER SUMMARY
 The
term money refers to assets that people
regularly use to buy goods and services.
 Money serves three functions in an
economy: as a medium of exchange, a unit
of account, and a store of value.
 Commodity money is money that has
intrinsic value.
 Fiat money is money without intrinsic value.
 The Bank of Canada, the central bank of
Canada, controls the Canadian money
supply through open-market operations.