The Money Supply & Monetary Policy

1. The Money Supply & Monetary Policy Monetary Policy Monetary Policy Flowchart

2. The Money Supply • The money supply is the total amount of cash in circulation – outside banks, plus bank deposits • Near Money is other types of deposits that can act as a store of value and can be converted into a medium of exchange but which are not, themselves, a medium of exchange

3. Canadian Money Supply Definitions • cash plus demand deposits in chequing and current accounts inbanks • M1 plus personal savings accounts, term deposits and non-personal notice deposits • M2 plus deposits in near banks, money market mutual funds and individual annuities at insurance companies • M2++ plus business term deposits and foreign currencies held by Canadians Hard currency M1 M2 M2++ M3 Narrow (smaller money supply) (larger money supply)Broad M1 M2 M2++ M3

4. The Creation of Money The Money Supply is expanded when: • The banks have excess reserves (Reserves > legal requirement for reserves) – AND – • The banks loan money to borrowers

5. What keeps the money supply from collapsing? • Confidence in the banking system • Branch banking: nationwide banks provide funds to any branch in trouble • Collateral: Banks require security for the repayment of significant loans. Therefore a default is less likely when a loan is called-in • Central bank (Bank of Canada) short-term funding • Government deposit insurance (CDIC) protects $100K per depositor per institution

6. i Dm0 Sm $ Dm0 Sm The Money Market (almost like any other market) • Borrowers are Demand • The higher the interest rate, the less they want Dm1 • Savers are Supply • The higher the interest rate, the more they save i1 ie Suppose people become more comfortable with debt Dm1 MS0 MS1 Greater Money Supply at higher interest rates

7. Monetary Policy The Money Supply & Monetary Policy - top Monetary Policy Flowchart

8. The Role of the Bank of Canada • Government’s bank • Deposit accounts • Debt and borrowing – Canada Savings Bonds, T-bills • Bankers’ bank • Short-term funding … lender of last resort • Overnight rate • Manage monetary policy and money supply • Inflation • Exchange rates • Interest rates • Currency • Royal Canadian Mint • Bank notes Issue: Independence?

9. Monetary Policy Tools Monetary policy is the attempt to adjust aggregate demand through the availability of money and credit. Overnight rate Government bonds Move government deposits … Moral Suasion Reserve requirements Interest rates • Administered by the Bank of Canada • Crown corporation – answers to government • "Independent" Tight Money Policy Tool Easy Money Raise Sell BofC “Lend Less!” Raise Therefore … Higher Lower Buy Chartered banks “Lend More!” Lower Lower

10. Monetary Policy Issues • “Big hammer”: • C I X M all impacted • i: C + I + G + (X – M) = AD • Exchange rates can force gov’t hand • Inflation and unemployment – not always tied • “Credit trap”: • Poor economy but … • i already extremely low • No way to go lower

11. Exchange rates • Decrease in Canadian interest rates: • Reduces appeal of Canadian returns for Canadians • Canadian savers take money abroad • Need to buy foreign currencies (sell CDN … SS) • Reduces appeal of Canadian returns for foreigners • Foreign savers reduce inflows into Canada in favour of saving elsewhere • Less need to buy CDN (DD) • Currency depreciation • Canadian eXports become cheaper (X) • iMports into Canada become more expensive (M) • Increase in net exports (X-M) • (AD) Rightward shift in AD curve

12. i Sm Sm Dm0 Dm0 Sm Sm $ Monetary Policy Flowchart “Easy money” policy: Increase in supply of money Excess supply of money ie i1 Fall in interest rates MS1 MS0 Increase in capital outflow Decrease in capital inflow Increase in consumption & investment expenditure S CDN / USD Currency depreciation D AD=C + I + G + (X– M) $CDN