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| Question | Answer |
| Money | any commodity or token that is generally acceptable as a means of payment |
| Means of Payment | a method of settling a debt |
| Money has three other functions | o Medium of exchange o Unit of account o Store of value |
| Medium of Exchange | an object that is generally accepted in exchange for goods and services |
| Unit of Account | an agreed measure for stating the prices of goods and services |
| Store of Value | money can be held for a time and later exchanged for goods and services |
| Currency | the notes and coins held by individuals and firms |
| Deposits | deposits of individuals and firms at banks and other depository institutions |
| Fiat Money | used in Canada; notes are not backed by anything tangible |
| M1 Measure of Money | consists of currency held by individuals and businesses. M1 does not include notes and coins held by banks, and it does not include chequable deposits owned by the Government of Canada |
| M2 Measure of Money | consists of M1 plus all other deposits – non-chequable deposits and fixed term deposits |
| Liquidity | the property of being instantly convertible into a means of payment with little loss of value |
| The banking system consists of private and public institutions that | o Create money o Manage the nation’s monetary and payment systems |
| The Banking System consists of two institutions that play a crucial role in financial markets | o Depository institutions o The Bank of Canada |
| Depository Institution | a firm that takes deposits from households and firms and makes loans to other households and firms |
| Reserves | notes and coins in a bank’s vault or in its deposit account at the Bank of Canada |
| Liquid Assets | government of Canada Treasury bills and commercial bills |
| Securities | long-term Government of Canada bonds and other bonds such as mortgage-backed securities |
| Loans | commitments of fixed amounts of money for agreed-upon periods of time |
| Economic benefits provided by Depository Institutions | make a profit from the spread between the interest rate paid on the deposits and the interest rate charged on loans |
| Create Money | depository institutions lend money when people/firms need it |
| Pool Risk | the loss of any one small loan to a bank is minimal |
| Lower the Cost of Borrowing | reduces search costs for firms in finding money |
| Lower the Cost of Monitoring Borrowers | depository institutions are set up to encourage good borrowing and repayment practices |
| The Bank of Canada | the central bank of Canada |
| Central Bank | the public authority that regulates a nation’s depository institutions and control the quantity of money |
| The Bank of Canada's Functions are | o Banker to the banks and government o Lender of last resort o Sole issuer of bank notes |
| Lender of Last Resort | means that it stands ready to make loans when the banking system as a whole is short of reserves |
| Sole Issuer of Bank Notes | The Bank of Canada is the only bank that is permitted to issue the bank notes |
| Changes to the Bank of Canada's balance sheet alter the ______, which is one step in the money creation process | Changes to the Bank of Canada's balance sheet alter the monetary base, which is one step in the money creation process |
| The Bank of Canada’s assets are | o Government securities o Loans to depository institutions |
| The Bank of Canada's liabilities are | o Bank of Canada notes o Deposits of banks and the government |
| Monetary Base | the sum of Bank of Canada notes, banks’ deposits at the Bank of Canada, and coins issued by the Mint |
| Open Market Operation | the purchase or sale of government of Canada securities by the Bank of Canada in the open market |
| Money is created by | the chartered banks when they convert reserves into loans |
| Desired Reserve Ratio | the ratio of reserves to depositions that banks want to hold |
| Excess Reserves | equal actual reserves minus desired reserves |
| Currency Drain Ratio | the ratio of currency to deposits |
| 8 steps in money creation | o Banks have excess reserves o Banks lend excess reserves o The quantity of money increases o New money is used to make payments o Some new money remains as deposits o Some new money is held as currency o Desired reserves increase due to increase in deposits o Excess reserves decrease but remain positive |
| Money Multiplier | the multiple increase in the money supply resulting from an initial loan (The ratio of the total change in the quantity of money to the initial change in the monetary base) |
| The quantity of money that people plan to hold depends on 4 factors | o The price level o The nominal interest rate o Real GDP o Financial innovation |
| The Price Level | A rise in the price level increases the quantity of nominal money but doesn’t change the quantity of real money that people plan to hold |
| Nominal Money | the amount of money measured in dollars |
| Real Money | the nominal money ÷ the price level |
| The Nominal Interest Rate | The nominal interest rate is the opportunity cost of holding wealth in the form of money rather than an interest-bearing asset |
| Real GDP | An increase in real GDP increases the volume of expenditure, which increases the quantity of real money that people plan to hold |
| Financial Innovation | Financial innovation that lowers the cost of switching between money and interest-bearing assets decreases the quantity of real money that people plan to hold |
| Demand for Money | the relationship between the quantity of real money demanded and the nominal interest rate, all else equal |
| A rise in the interest rate brings a _____ in the quantity of real money demanded | A rise in the interest rate brings a decrease in the quantity of real money demanded |
| A fall in the interest rate beings an ______ in the quantity of real money demanded | A fall in the interest rate beings an increase in the quantity of real money demanded |
| if there is a decrease in real GDP or a financial innovation, there is a _________ shift in the demand for money | if there is a decrease in real GDP or a financial innovation, there is a leftward shift in the demand for money |
| if there is an increase in real GDP, there is a _________ shift in the demand for money | if there is an increase in real GDP, there is a rightward shift in the demand for money |
| Supply of Money | the relationship between the quantity of real money supplied and the nominal interest rate, all else equal |
| Money Market Equilibrium | occurs when the quantity of money demanded equals the quantity of money supplied |
| Money Market Equilibrium determines | the nominal interest rate |
| Short-Run Equilibrium | Knowing the money demand curve, the Bank of Canada adjusts the quantity of money (MS) each day so that the quantity of real money is brought to equilibrium with the intended interest rate |
| Long-Run Equilibrium | In the long-run, real money supplied does not change |
| Quantity Theory of Money | the proposition that, in the long run, an increase in the quantity of money brings an equal percentage increase in the price level |
| Velocity of Circulation | the average number of times in a year a dollar is used to purchase goods and services in GDP |
| Quantity Theory of Money Equation | GDP = PY |
| Velocity of Circulation Equation | V=PY/M |
| Equation of Exchange | MV=PY |
| The equation of exchange becomes the quantity theory of money if M does not influence V or Y | P=M ( V/Y ) |
| the equation of exchange in growth rates | Inflation rate=money growth rate+rate of velocity change-real GDP growth |
| In the long run, velocity does not change, so | inflation rate=money growth rate-real GDP growth |
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