Macro CH10

Liquidity (def)

the ease with which an asset can be converted into the economy's medium of exchange.

The Bank of Canada must wrestle with two problems that arise due to fractional-reserve banking. The Bank of Canada does not control the amount of money that...

-households choose to hold as deposits in banks. -commercial bankers choose to lend. (required/excess reserve).

Four Primary Functions of the Bank of Canada

1) Issue currency 2) Act as banker to the commercial banks 3)Act as banker to the Canadian government 4)Control the money supply

Reserve of a commercial bank (2)

1) Vault cash 2) Deposit at central bank (Bank of Canada)

Central Bank's Tools of Monetary Control (3)

1)Open market operations -Domestic market -Foreign exchange market 2)Changing overnight rates 3)Changing reserve requirement

The reserve ratio, R

= fraction of deposits that banks hold as reserves = total reserves as a percentage of total deposits

A bank run occurs when... It reverses the money creation process --> ... Policies (1):

A bank run occurs when depositors suspect that a bank may go bankrupt and "run" to the bank to withdraw. It reverses the money creation process --> disruptive impact on any economy. Policies: Deposit insurance

Bank of Canada can also buy or sell... This will affect...

Bank of Canada can also buy or sell foreign currency in the foreign exchange market. this will affect the money supply in the economy.

What assets should be considered part of the money supply? (2)

Currency: the paper bills and coins in the hands of the (non-bank) public. Demand deposits: balances in bank accounts that depositors can access on demand by writing a check or using a debit card.

(Fractional Reserve System )Balancing act of commercial banks. In order to make money, commercial banks need to _________________ In order to reduce the risk, commercial banks need to ________.

In order to make money, commercial banks need to lend money out --> loan In order to reduce the risk, commercial banks need to keep some deposit.

Example of 2007-2008 financial crisis:

Insolvency

Leverage ratio =

Total Assets/ Capital (owner's equity)

Illiquidity:

a bank does not have enough resources to satisfy its current liability.

Insolvency:

a bank is insolvent when it is unable to pay off its debt holders and depositor in full. -Capital requirement

In a fractional reserve banking system, banks keep

a fraction of deposits as reserves, and use the rest to make loans.

Central bank:

an institution designed to regulate the money supply in the economy. The Bank of Canada: the central bank of Canada.

Medium of exchange:

an item buyers give to sellers when they want to purchase goods and services.

Store of value:

an item people can use to transfer purchasing power from the present to the future.

Change in reserve ratio will

change money multiplier. It also has strong impact on liquidity issues.

Commercial banks include

credit unions, trust companies and others. Big 5 in Canada

Money is the most...

liquid asset available, because it is the medium of exchange.

Bank of Canada has 8 scheduled interest rate announcement in a year (change of overnight rate) Impact: example-

lower interest rate -cheaper for a commercial bank to borrow --> less reserve/liquid assets and more loans -->increase money supply. Most interest rates inside the economy moves with key policy interest rate as well.

3 functions of money:

medium exchange, unit of account, store of value

Fiat money:

money without intrinsic value, used as money because of government decree. Example: the Canadian dollar.

Most developed country choose

not to use required reserve ratio as a policy tool; it is a very strong instrument

Function of Commercial banks:

profit maximization but with risk management.

When Bank of Canada sells, it charges the commercial bank's deposit account at Bank of Canada -->

reserve of the commercial bank decreases.

When Bank of Canada purchases, it credits the commercial bank's deposit account at Bank of Canada -->

reserve of the commercial bank increases.

Key interest rate:

set by Bank of Canada, target rate for the overnight rate -Major policy tool -Operating band ----Bank rate: key interest rate +0.25% ----Deposit rate: key interest rate -0.25%

Commodity money:

takes the form of a commodity with intrinsic value Examples: gold coins, other precious metals, rocks.

The money multiplier is Equals

the amount of money the banking system generates with each dollar of reserves. The money multiplier equals 1/R Example: with $100 cash bill and 10% multiplier = 1/0.1 = 10 and M1 = 10 x $100 = $1000 Assumptions: general public will not hold any currency

Leverage: (Risk):

the borrowed resources to supplement existing funds for purposes of investment Risk: the impact from default on leverage ratio

Overnight rate:

the interest rate at which major financial institutions borrow and lend one-day funds among themselves.

Open market operation:

the purchase or sale of securities (Government of Canada Bond) by the Bank of Canada.

Commercial banks can influence

the quantity of demand deposits in the economy and the money supply.

The money supply (M+) (or money stock):

the quantity of money available in the economy

Money is

the set of assets in an economy that people regularly use to buy goods and services from other people.

Unit of account:

the yardstick people use to post prices and record debts .