Chapter 2: Learning Objectives

2. 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

3. 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

4. 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

5. 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

6. 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)

7. 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

8. 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

9. 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

10. Transactions Data

11. 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) • monetary aggregates: definitions and data • Table 2.2 & Figure 2.1

12. The Canadian Money Supply: Key Measures, August 2004TABLE 2.2

13. Major Canadian Money Supply Aggregates

14. 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

15. Currency in Circulation: Seasonally adjusted or unadjusted

16. 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) • types of financial assets • seasonal adjustment (Figure 2.2) • Other refinements

18. Bonds • A certificate of long-term debt issued by a public entity or a corporation • Issued at par value • Coupon rate

19. Underwriter • An investment dealer who helps governments and corporations to raise capital by buying new shares and resell them to investors

20. 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.

21. 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

22. 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

23. 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”

24. 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