© 2005 mcgraw-hill ryerson ltd. macroeconomics, chapter 11 1 money and banking slides prepared by...

© 2005 McGraw-Hill Ryerson Ltd.© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter 11Macroeconomics, Chapter 11 11

Money and BankingMoney and BankingMoney and BankingMoney and Banking

SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGESLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE


In this chapter you will learnIn this chapter you will learnIn this chapter you will learnIn this chapter you will learn

11.111.1 The definition and functions of money The definition and functions of money11.211.2 What constitutes the supply of money What constitutes the supply of money11.311.3 What backs Canada’s money supply What backs Canada’s money supply11.411.4 The components of money demand The components of money demand11.511.5 How the equilibrium interest rate is How the equilibrium interest rate is

determined in the money marketdetermined in the money market11.611.6 About the structure of the Canadian About the structure of the Canadian

financial systemfinancial system11.711.7 About recent developments in money and About recent developments in money and

bankingbanking


Chapter 11 TopicsChapter 11 TopicsChapter 11 TopicsChapter 11 Topics

11.111.1 The Definition & Functions of Money The Definition & Functions of Money

11.211.2 The Supply of Money The Supply of Money

11.311.3 What “Backs” the Money Supply? What “Backs” the Money Supply?

11.411.4 The Demand for Money The Demand for Money

11.511.5 Equilibrium in the Money Market Equilibrium in the Money Market

11.611.6 The Canadian Financial System The Canadian Financial System

11.711.7 Recent Developments in Money & Banking Recent Developments in Money & Banking


The Definition & Functions of The Definition & Functions of MoneyMoney


Money is what money doesMoney is what money does




Medium of exchangeMedium of exchange


Medium of exchangeMedium of exchange Measure of valueMeasure of value




Medium of exchangeMedium of exchange Measure of valueMeasure of value Store of valueStore of value




Currency (coins & paper money)

plus Demand depositsequals M1M1

(billions of dollars)December, 2002December, 2002

The Supply of MoneyThe Supply of MoneyThe Supply of MoneyThe Supply of MoneyTable 11-1Table 11-1

M1M1137.3


The Supply of MoneyThe Supply of MoneyThe Supply of MoneyThe Supply of Money

Currency: Coins + Paper MoneyCurrency: Coins + Paper Money• token moneytoken money• Bank of Canada notesBank of Canada notes

Demand DepositsDemand Deposits• about about ⅔ of M1 ⅔ of M1

Institutions That Offer Demand DepositsInstitutions That Offer Demand Deposits• chartered banks are the primary depository chartered banks are the primary depository

institutionsinstitutions



Near-moniesNear-monies• nonchequable savings depositsnonchequable savings deposits• term depositsterm deposits



plus Demand depositsequals M1M1 plus Personal savings deposits,

plus Non-personal notice depositsequals M2M2



M1M1137.3

M2M2

559.8



M2+ is M2 plusM2+ is M2 plus• deposits at trust & mortgage loan deposits at trust & mortgage loan

companiescompanies• deposits at caisses populaires & credit deposits at caisses populaires & credit

unions & other non-bank deposit-taking unions & other non-bank deposit-taking institutionsinstitutions

• money market mutual fundsmoney market mutual funds



plus Demand depositsequals M1M1 plus Personal savings deposits,

plus Nonpersonal notice depositsequals M2M2 plus Deposits: Other intermediaries

equals M2+M2+

M1M1 M2+M2+

801.8

M2M2



559.8

137.3



we will use the narrow M1 definition of we will use the narrow M1 definition of money, unless stated otherwisemoney, unless stated otherwise


What “Backs” the Money Supply?What “Backs” the Money Supply?What “Backs” the Money Supply?What “Backs” the Money Supply?

Money as DebtMoney as Debt Value of MoneyValue of Money

• AcceptabilityAcceptability• Legal TenderLegal Tender• Relative ScarcityRelative Scarcity



Money & PricesMoney & Prices• The Purchasing Power of the DollarThe Purchasing Power of the Dollar

NOTES:ReciprocalReciprocal relationshipbetween the price leveland the value of thedollar

D =1

P



Money & PricesMoney & Prices• The Purchasing Power of the DollarThe Purchasing Power of the Dollar• Inflation & AcceptabilityInflation & Acceptability


The Demand for MoneyThe Demand for MoneyThe Demand for MoneyThe Demand for Money

Transactions Demand, DTransactions Demand, Dtt

• demand for money as a medium of demand for money as a medium of exchangeexchange

• varies directly with GDPvaries directly with GDP

Asset Demand, DAsset Demand, Daa

• demand for money as a store of valuedemand for money as a store of value• varies inversely with the interest ratevaries inversely with the interest rate


The Demand For MoneyThe Demand For MoneyTransactionsDemand, Dt +

Inte

rest

Rat

e

Amount of moneydemanded (billions

of dollars)

Dt

10

7.5

5

2.5

00 50 100 150 200 250 300

i%

Figure 11-1Figure 11-1


TransactionsDemand, Dt

AssetDemand, Da+ =


of dollars)

10

7.5

5

2.5

0Da

0 50 100 150 200 250 300


of dollars)

Dt

10

7.5

5

2.5

00 50 100 150 200 250 300

i% i%

Inte

rest

Rat

e

The Demand For MoneyThe Demand For MoneyFigure 11-1Figure 11-1



AssetDemand, Da

Total demandfor money, Dm+ =

10

7.5

5

2.5

0


of dollars)

10

7.5

5

2.5

0Da

0 50 100 150 200 250 300


of dollars)

Dt

10

7.5

5

2.5

00 50 100 150 200 250 300


of dollars)

0 50 100 150 200 250 300

Dm

i% i% i%

100 + 100 = 200100 + 100 = 200

Inte

rest

Rat

e



Equilibrium in the Money Equilibrium in the Money MarketMarket

Equilibrium in the Money Equilibrium in the Money MarketMarket

demand for money combined with demand for money combined with supply of money portrays the money supply of money portrays the money marketmarket



AssetDemand, Da


10

7.5

5

2.5

0


of dollars)

10

7.5

5

2.5

0Da

0 50 100 150 200 250 300 Amount of money

demanded (billionsof dollars)

Dt

10

7.5

5

2.5

00 50 100 150 200 250 300


of dollars)

0 50 100 150 200 250 300

i% i% i%

ADD THEADD THEMONEY SUPPLYMONEY SUPPLY

TO FIND THETO FIND THEEQUILIBRIUM RATEEQUILIBRIUM RATE

OF INTERESTOF INTEREST

ADD THEADD THEMONEY SUPPLYMONEY SUPPLY

TO FIND THETO FIND THEEQUILIBRIUM RATEEQUILIBRIUM RATE

OF INTERESTOF INTEREST

Inte

rest

Rat

e


Dm



AssetDemand, Da


10

7.5

5

2.5

0


of dollars)

10

7.5

5

2.5

0Da

0 50 100 150 200 250 300


of dollars)

Dt

10

7.5

5

2.5

00 50 100 150 200 250 300


of dollars)

0 50 100 150 200 250 300

i% i% i%Sm

ie

EquilibriumEquilibriumInterest RateInterest Rate

Inte

rest

Rat

e


Dm


Adjustment to a Decline in the Adjustment to a Decline in the Money SupplyMoney Supply

Adjustment to a Decline in the Adjustment to a Decline in the Money SupplyMoney Supply

A decline in the supply of money will A decline in the supply of money will create a temporary shortage of money create a temporary shortage of money & increase the equilibrium interest rate& increase the equilibrium interest rate


The Money MarketThe Money Market

Ra

te o

f in

tere

st,

i (p

erce

nt)

Amount of money demanded(billions of dollars)

10

7.5

5

2.5

0

Sm

Dm

ie

Suppose the moneySuppose the moneysupply is decreasedsupply is decreasedfrom $200 billion, Sfrom $200 billion, Sm,m,

to $150 billion Sto $150 billion Sm1m1

0 50 100 150 200 250 300

Figure 11-2Figure 11-2



0 50 100 150 200 250 300

10

7.5

5

2.5

0

Dm

ie

Sm

A temporary A temporary shortageshortageof money will requireof money will requirethe sale of some assetsthe sale of some assetsto meet the needto meet the need

Sm1

Ra

te o

f in

tere

st,

i (p

erce

nt)

The Money MarketThe Money MarketFigure 11-2Figure 11-2



0 50 100 150 200 250 300

10

7.5

5

2.5

0

Dm

ie

Sm


Sm1

Ra

te o

f in

tere

st,

i (p

erce

nt)


Everyone sells bondsEveryone sells bonds bond prices fallbond prices fall

interest rates riseinterest rates riseillustrated…illustrated…

Everyone sells bondsEveryone sells bonds bond prices fallbond prices fall

interest rates riseinterest rates riseillustrated…illustrated…


BondsBondsBondsBonds

a $1,000 bond @ 5% pays $50 annuallya $1,000 bond @ 5% pays $50 annually if you buy this bond for $667, you still receive if you buy this bond for $667, you still receive

$50 annually$50 annually what is your effective interest rate?what is your effective interest rate? 50/667=7.5%50/667=7.5%

the lower the the lower the bond price,bond price,

the higher the the higher the interest rateinterest rate

the lower the the lower the bond price,bond price,

the higher the the higher the interest rateinterest rate



0 50 100 150 200 250 300

10

7.5

5

2.5

0

Dm

ie

Sm


Sm1

Ra

te o

f in

tere

st,

i (p

erce

nt)


Everyone sells bondsEveryone sells bondsbond prices fallbond prices fall

interest rates riseinterest rates riseuntil people are happyuntil people are happy

holding the lowerholding the lowerquantity of moneyquantity of money

Everyone sells bondsEveryone sells bondsbond prices fallbond prices fall

interest rates riseinterest rates riseuntil people are happyuntil people are happy

holding the lowerholding the lowerquantity of moneyquantity of money



10

7.5

5

2.5

0

Dm

ie

After adjustments toAfter adjustments toasset holdings, a newasset holdings, a newequilibrium will beequilibrium will beseen at a higher levelseen at a higher levelof interestof interest

Sm1

0 50 100 150 200 250 300

Ra

te o

f in

tere

st,

i (p

erce

nt) Sm



Adjustment to an Increase in Adjustment to an Increase in the Money Supplythe Money Supply

Adjustment to an Increase in Adjustment to an Increase in the Money Supplythe Money Supply

An increase in the supply of money will An increase in the supply of money will create a temporary surplus of money & create a temporary surplus of money & decrease the equilibrium interest ratedecrease the equilibrium interest rate



10

7.5

5

2.5

0

Dm

ie

Sm

0 50 100 150 200 250 300

Suppose the money Suppose the money supplysupply

is increased from is increased from

$200 billion, S$200 billion, Sm1m1,, to to

$250 billion S$250 billion Sm2m2

Ra

te o

f in

tere

st,

i (p

erce

nt)




10

7.5

5

2.5

0

Dm

Sm

0 50 100 150 200 250 300

Sm2 A temporary A temporary surplus surplus of money of money

will requirewill requirethe purchase of the purchase of some assets to some assets to

meet the desired meet the desired level of liquiditylevel of liquidity

Ra

te o

f in

tere

st,

i (p

erce

nt)



BondsBondsBondsBonds

a $1,000 bond @ 5% pays $50 annuallya $1,000 bond @ 5% pays $50 annually if you buy this bond for $2000, you still if you buy this bond for $2000, you still

receive $50 annuallyreceive $50 annually what is your effective interest rate?what is your effective interest rate? 50/2000=2.5%50/2000=2.5%

the higher the the higher the bond price,bond price,

the lower the the lower the interest rateinterest rate

the higher the the higher the bond price,bond price,

the lower the the lower the interest rateinterest rate



10

7.5

5

2.5

0

Dm

Sm

0 50 100 150 200 250 300

Sm2 A temporary A temporary surplus surplus of money of money

will requirewill requirethe purchase of the purchase of some assets to some assets to

meet the desired meet the desired level of liquiditylevel of liquidity

Ra

te o

f in

tere

st,

i (p

erce

nt)


Everyone buys bondsEveryone buys bondsbond prices risebond prices riseinterest rates fallinterest rates fall

until people are happyuntil people are happyholding the higherholding the higherquantity of moneyquantity of money

Everyone buys bondsEveryone buys bondsbond prices risebond prices riseinterest rates fallinterest rates fall

until people are happyuntil people are happyholding the higherholding the higherquantity of moneyquantity of money



10

7.5

5

2.5

0Dm

ie

Sm2

0 50 100 150 200 250 300

After After adjustments toadjustments to

asset holdings, a asset holdings, a newnew

equilibrium will equilibrium will bebe

seen at a lower seen at a lower levellevel

of interestof interest

Ra

te o

f in

tere

st,

i (p

erce

nt) Sm



The Canadian Financial The Canadian Financial SystemSystem


The Evolution of the Canadian Banking The Evolution of the Canadian Banking SystemSystem• 20032003

– 16 domestically owned banks16 domestically owned banks– 33 foreign bank subsidiaries33 foreign bank subsidiaries– 20 foreign bank branches20 foreign bank branches

• big six banks have 90% of total banking big six banks have 90% of total banking assets & 75% of payments volumeassets & 75% of payments volume

• mergers may lead to more concentrationmergers may lead to more concentration


Table 11-2Table 11-2The Balance Sheet of Canadian Chartered BanksThe Balance Sheet of Canadian Chartered Banks

December 2002 ($ Billions)December 2002 ($ Billions)

AssetsAssets LiabilitiesLiabilities

ReservesReserves 0.50.5 Demand depositsDemand deposits 97.297.2

LoansLoans 688.8688.8 Savings depositsSavings deposits 131.1131.1

Gov’t. of Canada Gov’t. of Canada securitiessecurities

76.776.7 Term depositsTerm deposits 240.9240.9

Foreign-currency Foreign-currency assetsassets

40.040.0 Foreign-currency Foreign-currency liabilitiesliabilities

76.976.9

Gov’t of CanadaGov’t of Canada 2.02.0

Other Other 235.1235.1 OtherOther 493.0493.0

TotalTotal 1,041.11,041.1 TotalTotal 1.041.11.041.1


Assets (Canadian $ billions, 2002)Assets (Canadian $ billions, 2002)

Mizuho Holdings (Japan)Mizuho Holdings (Japan) $1,876,772$1,876,772

Citigroup (U.S.)Citigroup (U.S.) 1,674,7501,674,750

Sumitomo Mitsui (Japan)Sumitomo Mitsui (Japan) 1,338,4001,338,400

Deutsche Bank (Germany)Deutsche Bank (Germany) 1,288,9261,288,926

Mitsubishi Tokyo (Japan)Mitsubishi Tokyo (Japan) 1,196,9571,196,957

Royal Bank of CanadaRoyal Bank of Canada 351,042351,042

Canadian Imperial Bank of CommerceCanadian Imperial Bank of Commerce 280,447280,447

TD Canada TrustTD Canada Trust 279,788279,788

ScotiabankScotiabank 276,162276,162

Bank of MontrealBank of Montreal 232,362232,362

National Bank of CanadaNational Bank of Canada 72,44772,447

GLOBAL PERSPECTIVE 11.1GLOBAL PERSPECTIVE 11.1




Canada’s Chartered BanksCanada’s Chartered Banks• fractional reserve systemfractional reserve system

Making LoansMaking Loans Other Financial IntermediariesOther Financial Intermediaries Cheque ClearingCheque Clearing


Recent Developments in Recent Developments in Money & BankingMoney & Banking


Expansion of ServicesExpansion of Services• new productsnew products• minibanksminibanks• ABMsABMs• debit cards, phone banking, Internet debit cards, phone banking, Internet

bankingbanking




Expansion of ServicesExpansion of Services Globalization of Financial MarketsGlobalization of Financial Markets




Expansion of ServicesExpansion of Services Globalization of Financial MarketsGlobalization of Financial Markets Electronic TransactionsElectronic Transactions

© 2005 mcgraw-hill ryerson ltd. macroeconomics, chapter 11 1 money and banking slides prepared by...

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