Chapter 2: Learning Objectives

Copyright (c) 2006 McGraw-Hill Ryerson Limited


Chapter 2: Learning Objectives 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

Barter A method of exchange by which goods

or services are directly exchanged for other goods or services without using a medium of exchange, such as money

Double coincidence Equal values of goods and services



The Functions of Money

Medium of Exchange How transactions are conducted

Medium of account How the value of goods & services are denominated

Store of value and a standard of deferred payment How the value of goods & services are maintained

in monetary terms


Monetary Standards

Commodity money Gold, Silver, and Bimetallic standards Gresham’s Law

Fiat money Paper money standard Canada’s early paper money history The introduction of central banking


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)

Chartered Institutions A financial institution whose primary

roles are to accept and safeguard monetary deposits from individuals and organizations, and to lend money out.

A chartered bank in operation has obtained government permission on some level to do business in the banking sector

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Chartered banks provide the core financial intermediary services: individuals can easily deposit their funds into various types of accounts within a chartered bank, earning interest on their temporary savings

Chartered banks maintain a float of currency so they can process customers' daily transactions, but they lend out the majority of their deposits to individuals and commercial borrowers in an effort to stimulate economic growth


The five largest banks in Canada Royal Bank of Canada Toronto Dominion Bank Bank of Nova Scotia Bank of Montreal Canadian Imperial Bank of Commerce



Transactions Data




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 demand deposits

$162,368

M2: M1& savings deposits

$623,318

M3: M2 & term deposits

$868,017

M2+: M2 & deposits @ other deposit-taking institutions

$872,466

M2++: M2+ & MMMF and CSBs

$1,262,935


Major Canadian Money Supply Aggregates

0

200000

400000

600000

800000

1000000

1200000

1400000

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

M2++

M2+

M1++

M1+M1

Year

Milli

ons

of d

olla

rs

Problem 1 Page 30

What are M1, M2, M2+, and M3 ? M1 = 1,000 + 13,000 = 14,000 M2 = 14,000 + 12,000 = 26,000 M2+ = 26,000 + 6,000 = 32,000 M3 = 26,000 + 9,000 = 35,000



Currency in Circulation: Seasonally adjusted or unadjusted

8000

12000

16000

20000

24000

28000

32000

36000

40000

44000

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

Seasonally AdjustedSeasonally Unadjusted

Milli

on o

f doll

ars

Year




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

Asset class Instrument typeSecurities Other cash

Debt (Long-term) Bonds LoansDebt (Short-term) Bills (T-bills,

Commercial Paper….)Certificate of Deposits (CDs)

Equity StockForeign Exchange Spot Foreign

Exchange


Bonds A certificate of long-term debt issued by

a public entity or a corporation Issued at par value Coupon rate


Underwriter An investment dealer who helps

governments and corporations to raise capital by buying new shares and resell them to investors


Stock States of ownership The stock of a business is divided into

multiple shares A share has a certain declared face

value, commonly known as the par value of a share

Common stock and preferred stock.



Inflation Versus Deflation

There are 2 types of inflation/deflation: 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

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? When prices fall the REAL value of debt rises

Debtors are penalized; borrowers benefit When prices fall EXPECTATIONS of additional

reductions are possible Consumers postpone purchases with further negative

economic implications If monetary policy responds by lowering interest

rates they could fall to zero At zero (nominal) interest rates cannot become negative This is called the “zero lower bound”


Summary

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

Chapter 2: Learning Objectives

Documents

services copyright c

economic growth copyright

m2 deposits

banking sector copyright

monetary deposits

m2 term deposits

value of goods services

demand deposits