Economics 1022A/B Chapter Notes - Chapter 24: Credit Union, Cheque Clearing, Bank Reserves
1 Sep 2018
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Chapter 24 – Money, the Price level, and Inflation
What is Money?
Money – any commodity or token that is generally acceptable as a means of payment
Means of payment – method of settling a debt
Money serves 3 other functions:
1. Medium of exchange
• Any object that is generally accepted in exchange for g+s
• Barter – g+s exchanged directly for other g+s
• Double coincidence of wants – (rarely occurs) ex; if you want a hamburger, you might offer a CD but
you must find someone who is selling hamburgers and wants your CD
2. Unit of account
• An agreed measure for stating the prices of g+s
• Simple if all prices are expressed in dollars + cents (not in terms of g+s)
3. Store of value
• It can be held and exchanged later for g+s
• Other items can be a store of value also
• No store of value has a stable value
Money in Canada Today
In Canada today, money consists of:
1. Currency – the notes and coins held by individuals and businesses
a. Notes are money b/c gov’t declares them so with the words
b. Notes + coins in banks not considered currency b/c they’re not held by individuals/businesses
c. Convenient for settling small debts + buying low-priced items
2. Deposits at banks and other depository institutions
a. Ex; deposits at trust and mortgage companies, credit unions, caisses populaires (also counted as
money)
b. Deposits money b/c owners use them to make payments
c. Depostis owned by gov’t of Canada not money b/c not held by individuals/businesses
Official measures of money:
M1 – consists of currency held by individuals + business plus chequable deposits owned by individuals + businesses
M2 – consists of M1 + all other deposits (non-chequable deposits (personal/non-personal) + fixed term deposits)
held by individuals + businesses
M1
M2
• Currency held by individuals + businesses
• Personal chequable deposits
• Non-personal chequable deposits
• M1
• Personal non-chequable deposist
• Non-personal non-chequable deposits
• Fixed term deposits
Are M1 and M2 really money?
• Chequable deposits = money b/c they can transferred from one person to another by writing a cheque or
using a debit card
o Similar to handing over currency
• M1 = currency + chequable despots = MONEY
• M2 = MONEY
o Some savings despots in M2 are just as much payment as deposits in M1
o Use ATM to get funds from savings
o BUT some savings deposits are not a means of payment (liquid assets)
• Liquidity – the property of being easily convertible into a means of payment without loss in value
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o Deposits in M2 are not means of payment are quickly converted into means of payment
(currency/chequable deposits)
Deposits are Money but Cheques are not:
• Cheques people write are not counted as money
• Deposits are money…but cheques are not…
o Cheque instructs the bank to transfer money from one account to another
o If they use diff. banks: cheque goes to a cheque-clearing center (take a few days)
Credit Cards are not money:
• Credit card = ID card (one that lets you take out a loan at the instant you buy something)
• Swipe credit card → “I agree to pay for these goods when the credit company bills me” → then must pay
minimum payment due → use money (you need to have currency or a chequable deposit to pay)
o Not means of payment – not MONEY
Depository Institutions
Depository institution – financial firm that takes deposits from households and firm (components of M1 and M2)
Types of Depository Institutions
3 types of depository institutions: (all similar economic functions – mostly call all of them banks)
1. Chartered banks – private firm chartered under the Bank Act of 1991 to receive deposits and make loans
• Largest institutions in banking system
• Conduct all types of banking/financial business
2. Credit unions and caisses populaires
• Credit union – cooperative organization that operates under the Cooperative Credit Associations Act
of 1991
• Receives deposits from + makes loan to its members
• Caisses populaire – similar type that operates in Quebec
3. Trust and mortgage loan companies
• Privately owned depository institution that operates under the Trust and Loan Companies Act of 1991
• Receive deposits, make loans, act as trustee for pension funds and estates
What Depository Institutions Do
• Provide services such as cheque clearing, account management, credit cards, and Internet banking
(all provide an income from service fees)
• Earn most of their income: using the funds they receive from depositors to make loans + buy
securities that earn a higher interest rate than that paid to depositors
o Must perform a balancing act weighing return against risk
Chartered bank puts funds it receives from depositors + other funds it borrow into 4 types of assets:
1. Reserves – notes + coins in its vault or its deposit account at the Bank of Canada
a. Used to meet depositors currency withdrawals + make payments to other banks
b. Half of 1% of deposits as reserves
2. Liquid assets – gov’t of Canada Treasury bills + commercial bills
a. Bank’s first line of defence if they need reserves
b. Can be sold + instantly converted into reserves with virtually no risk of loss
c. Low risk = earn a low interest rate
3. Securities – gov’t of Canada bonds + other bonds (mortgage-backed securities)
a. Can be converted into reserves but at prices that fluctuate (assets are then riskier than liquid
assets)
b. Have higher interest rate
4. Loans – commitments of funds for an agreed-upon period of time (riskiest assets of a bank)
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a. Give to corporations to finance the purchase of capital
b. Mortgage loans – to finance the purchase of homes, personal to finance consumer goods
c. Outstanding balances on credit card accounts = bank loans
d. Cannot be converted into reserves until they’re due to be repaid
e. Earn highest interest rate
Economic Benefits Provided by Depository Institutions
• Earns part of profit: pays a lower interest rate on deposits than what it receives on loans
Provide 4 benefits:
1. Create liquidity
a. By borrowing short and lending long (taking deposits and standing ready to repay them on short
notice or on demand + making loan commitments that run for terms for many years)
2. Pool risk
a. Loan might not be repaid – default
b. If you lend to one (they default) you lose the entire amount → but if you lend to 1,000 people (in
bank) and one person defaults then you lose almost nothing
c. They pool risk
3. Lower the cost of borrowing
a. They lower the cost of this search to borrow when no one is able to lend
b. Firm gets it from single institution that gets deposits from a large # of ppl but spreads the cost of
this activity over many borrowers
4. Lower the cost of monitoring borrowers
a. Costly – imagine how costly it would be if each household that lent money to a firm incurred the
costs of monitoring the firm directly – depository institutions can perform this task at a much
lower cost
How Depository Institutions are Regulated
• Financial regulation in Canada:
o Shared by the Department of Finance, the Bank of Canada, the Office of the Superintendent of
Financial Institutions, the Canada Deposit Insurance Corporation, and provincial agencies
• GOAL: to identify, evaluate, and lessen the consequences of financial risk
• Department of Finance:
o Ultimate responsibility – but delegates the day-to-day details to the other agencies
• Bank of Canada:
o Ensures banks + depository institutions have adequate liquidity + provides general guidance +
advice to government
• Office of the Superintendent of Financial Institutions:
o Supervises the banks + other depository intuitions + ensures that their balance sheets have a
high enough capital ratio + assets are sufficiently liquid to withstand stress
• Canada Deposit Insurance Corporation:
o Operates a system of deposit insurance that insures deposits held at Canadian banks up to
$100,000 in case of bank failure
• Provincial gov’t agencies:
o Regulate credit unions + caisses populaire
Financial Innovation
• Depository institutions are always seeking ways to improve their products through financial innovation
• During 1970s – high inflation sent interest rate on home-purchase loans to 15%/year
o Traditional fixed interest rate mortgages were unprofitable
o Variable interest rate mortgages were introduced
• During 2000s – interest rates were low + DI were flush with funds
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ECON 1022A/B Full Course Notes
Verified Note
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Document Summary
Chapter 24 money, the price level, and inflation. Money any commodity or token that is generally acceptable as a means of payment. Means of payment method of settling a debt. Simple if all prices are expressed in dollars + cents (not in terms of g+s: store of value. It can be held and exchanged later for g+s: other items can be a store of value also, no store of value has a stable value. M1 consists of currency held by individuals + business plus chequable deposits owned by individuals + businesses. M2 consists of m1 + all other deposits (non-chequable deposits (personal/non-personal) + fixed term deposits) held by individuals + businesses. Chequable deposits = money b/c they can transferred from one person to another by writing a cheque or using a debit card. Similar to handing over currency: m1 = currency + chequable despots = money, m2 = money.
