ECON 209 Lecture Notes - Lecture 14: Reserve Requirement, Time Deposit, Excess Reserves
7 Jun 2018
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2018_02_26 ECON 209
Lecture 14: Chapter 26: Money and Banking
26.1 The Nature of Money
I. Money is any generally accepted medium of exchange
A. A medium of exchange is anything that is generally accepted in return for
goods/services sold
II. Money as a medium of exchange
A. If there was no money - goods would have to be exchanged by barter
1. A system in which goods and services are traded directly for other goods and
services
2. With barter, each transaction requires a double coincidence of wants
a) Unnecessary when a medium of exchange is used
B. With money, trade is easier
III. Money as a store of value
A. To be a satisfactory store of value, money must have a relatively stable value
B. Example: Same value as today in a month
C. When the price level is stable
1. Purchasing power of a given sum of money is also stable
D. When the price level is highly variable
1. So is the purchasing power of money
2. The usefulness of money as a store of value is undermined
IV. Money as a unit of account
A. Money is used for accounting
B. Its use for such purpose does not rely on its physical existence
V. The Origins of Money
A. Metallic money
1. Before the invention of coins, it was necessary to carry the metals in bulk
2. The invention of coinage eliminated the need to weigh the metal at each
transaction
3. HOWEVER: Coins often could not be taken at their face value because of the
practise of clipping a thin slice off the edge of the coin
4. Gresham's Law is the theory that “bad” or debased money (example: coins
mixed with other metal), drives “good” or undebased money out of circulation
a) The bad ones will be used for the transactions
B. Paper money
1. Goldsmiths required secure safes, and the public began to deposit gold with
these goldsmiths for safekeeping
2. Goldsmiths would give their depositors receipts promising to return the gold on
demand
3. Because people knew the goldsmith to be reliable
a) Buyers began to transfer the goldsmith’s receipt when making a
purchase
b) Essentially the origin of paper money
4. Such paper money (later issued by banks, called banknotes) was backed by
precious metal and convertible on demand into the metal
5. Early on, many goldsmiths and banks discovered that it was not necessary to
keep one ounce of gold in the vaults for every claim to one ounce circulating as
paper money
a) Such a currency is fractionally backed by the reserves
6. As time went on, currency (notes and coins) issued by private banks became
less common, and central banks took control of issuing currency
a) To control the supply of money in the economy
b) In time, only central banks were permitted by law to issue currency
C. Fiat money
1. Our money today
2. Paper money or coinage that is neither backed by nor convertible into anything
else but is decreed by the government to be legal tender
3. If fiat money is generally acceptable, it is a medium of exchange
4. If its purchasing power remains stable, it is a satisfactory store of value
5. If both of these things are true, it serves as a satisfactory unit of account
VI. Modern Money: Deposit Money
A. Deposit money: money held by the public in the form of deposits with commercial banks
B. Bank deposits are money
C. House, car - not money, but are assets
D. Today - banks create money by issuing more promises to pay (deposits) than they have
cash reserves available to pay out
1. Part of the process does depend on the commercial banks
a) Creating money in the economy
26.2 The Canadian Banking System
I. Several types of institutions make up a modern baking system
A. The central bank is a bank that acts as a banker to the commercial banking system and
often to the government as well
1. Usually the sole money-issuing authority
2. Has a machine to print more money
B. Financial intermediaries are privately owned institutions that serve the general public
1. They are the intermediaries between savers, from whom they accept deposits,
and borrowers, to whom they make loans
2. The term “commercial banks” refers to all financial intermediaries
II. The Bank of Canada
A. Commenced operations on March 11, 1935
B. Organization of the Bank of Canada is designed to keep the operation of monetary
policy free from day-to-day political influence
1. The Bank of Canada has considerable autonomy
2. The ultimate responsibility for the Bank’s actions rests with the government
3. System known as “joint responsibility”
C. Basic functions:
1. Act as a banker to the commercial banks
2. Acts as a banker to the federal government
3. Regulate the money supply
4. Support financial markets
Document Summary
Money is any generally accepted medium of exchange: a medium of exchange is anything that is generally accepted in return for goods/services sold. Money as a unit of account: money is used for accounting. Its use for such purpose does not rely on its physical existence. If fiat money is generally acceptable, it is a medium of exchange. If its purchasing power remains stable, it is a satisfactory store of value. If both of these things are true, it serves as a satisfactory unit of account. The creation of deposit money: example, the bank has a reserve ratio of 20% In the second table, has exceeded the reserves (not optimal: because of a new deposit of , the commercial bank will give more loans. If v is the target reserve ratio: a new deposit to the banking system will increase the total amount of deposits by.
