Transcript The Bank of Canada Act

PowerPoint Presentations for
Principles of Macroeconomics
Sixth Canadian Edition
by Mankiw/Kneebone/McKenzie
Adapted for the
Sixth Canadian Edition by
Marc Prud’homme
University of Ottawa
THE
MONETARY
SYSTEM
Chapter 10
Copyright © 2014 by Nelson Education Ltd.
10-2
THE MONETARY SYSTEM
 In this chapter, we begin to examine the role of
money in the economy.
 We discuss what money is, the various forms that
money takes, how the banking system helps
create money, and how the government
controls the quantity of money in circulation.
Copyright © 2014 by Nelson Education Ltd.
10-3
THE MEANING OF MONEY
Money: the set of assets in the economy
that people regularly use to buy goods and
services from other people
Copyright © 2014 by Nelson Education Ltd.
10-4
The Functions of Money
Medium of exchange: an item that buyers
give to sellers when they want to purchase
goods or services
Copyright © 2014 by Nelson Education Ltd.
10-5
The Functions of Money
Unit of account: the yardstick people
use to post prices and record debts
Copyright © 2014 by Nelson Education Ltd.
10-6
The Functions of Money
Store of value: an item that people can use
to transfer purchasing power from the
present to the future
Wealth: is the total of all stores of value,
including both monetary and nonmonetary assets
Copyright © 2014 by Nelson Education Ltd.
10-7
The Functions of Money
Liquidity: describes the ease with which an
asset can be converted into a medium of
exchange
Money is the most liquid of assets.
Copyright © 2014 by Nelson Education Ltd.
10-8
The Kinds of Money
Commodity money: money that takes the
form of a commodity with intrinsic value
Fiat money: money without intrinsic value
that is accepted as money because of
government decree
Copyright © 2014 by Nelson Education Ltd.
10-9
Money in the Canadian Economy
The quantity of money circulating in the
economy, called the money stock, has a
powerful influence on many economic
variables.
Currency: These are the paper bills and
coins in the hands of the public.
Copyright © 2014 by Nelson Education Ltd.
10-10
Money in the Canadian Economy
Demand deposits: These are the balances
in bank accounts that the depositors can
access on demand by writing a cheque or
using a debit card.
Copyright © 2014 by Nelson Education Ltd.
10-11
FIGURE 10.1:
Two Measures of the Money Stock for the Canadian Economy
Copyright © 2014 by Nelson Education Ltd.
10-12
QuickQuiz
List and describe the three functions of
money.
Copyright © 2014 by Nelson Education Ltd.
10-13
THE BANK OF CANADA
The Bank of Canada (BoC): the central
bank of Canada
Central bank: an institution designed to
regulate the quantity of money in the
economy
Copyright © 2014 by Nelson Education Ltd.
10-14
The Bank of Canada Act
Prior to the 1930s:
Bank notes were issued by the Department
of Finance and the commercial banks.
Canada was on the gold standard.
With the collapse of the gold standard as a
result of the Great Depression, a need arose to
control the quantity of fiat money in the
economy.
Copyright © 2014 by Nelson Education Ltd.
10-15
The Bank of Canada Act
 The government enacted the Bank of Canada Act in
1934.
 The BoC was established in 1935 and nationalized in
1938.
 The BoC is managed by a board of directors,
including:
 the governor, the senior deputy governor, and 12
directors, including the deputy minister of finance.
 The current governor of the BoC is Stephen Poloz.
Copyright © 2014 by Nelson Education Ltd.
10-16
The Bank of Canada Act
 In practice, the BoC is independent of the government.
 The primary responsibility of the BoC is to act in the national
interest.
 The preamble to the BoC Act: http://lawslois.justice.gc.ca/eng/acts/B-2/page-1.html
 To this end, the BoC has four main functions:
1. Issue currency
2. Banker to the commercial banks
3. Banker to the Canadian government
4. Control the money supply
Copyright © 2014 by Nelson Education Ltd.
10-17
The Bank of Canada Act
Money supply: the quantity of money
available in the economy
Monetary policy: the setting of the money
supply by policy makers in the central bank
Copyright © 2014 by Nelson Education Ltd.
10-18
Monetary Policy
The Bank of Canada has the power to
increase or decrease the number of dollars
in the economy.
The Bank of Canada is an important
institution because changes in the money
supply can profoundly affect the economy.
Copyright © 2014 by Nelson Education Ltd.
10-19
QuickQuiz
What is the difference between a central
bank like the Bank of Canada and a
commercial bank like the Bank of
Montreal?
Copyright © 2014 by Nelson Education Ltd.
10-20
COMMERCIAL BANKS AND
THE MONEY SUPPLY
 Although the Bank of Canada alone is
responsible for Canadian monetary
policy, the central bank can control the
supply of money only through its
influence on the entire banking system.
Copyright © 2014 by Nelson Education Ltd.
Thinkstock
 What is the role played by commercial
banks (which include credit unions,
caisses populaires, and trust companies)
in the monetary system?
10-21
The Simple Case of
100 Percent-Reserve Banking
Assumptions:
An economy with no banks
Currency is the only form of money.
The initial supply of money is $100.
Copyright © 2014 by Nelson Education Ltd.
10-22
The Simple Case of
100 Percent-Reserve Banking
 Now suppose someone opens a bank: First National
Bank.
 All deposits are held as reserves: 100 percentreserve banking.
 Reserves: deposits that banks have received but
have not loaned out
 Using a T-account to show changes in the bank’s
assets and liabilities …
Copyright © 2014 by Nelson Education Ltd.
10-23
The Simple Case of
100 Percent-Reserve Banking
FIRST NATIONAL BANK
Assets
Reserves
Liabilities
$100
Deposits
Copyright © 2014 by Nelson Education Ltd.
$100
10-24
Money Creation with
Fractional-Reserve Banking
 Fractional-reserve banking: a banking system in
which banks hold only a fraction of deposits as
reserves
 Reserve ratio: the fraction of deposits that banks
hold as reserves
 Assuming a reserve ratio of 10 percent …
Copyright © 2014 by Nelson Education Ltd.
10-25
Money Creation with
Fractional-Reserve Banking
FIRST NATIONAL BANK
Assets
Liabilities
Reserves
$10
Loans
90
Deposits
$100
* The money supply (currency + deposits) = $190
Copyright © 2014 by Nelson Education Ltd.
10-26
The Money Multiplier
SECOND NATIONAL BANK
Assets
Liabilities
Reserves
$9
Loans
81
Deposits
$90
* The money supply = $100 + $90 + $81 = $271
Copyright © 2014 by Nelson Education Ltd.
10-27
The Money Multiplier
THIRD NATIONAL BANK
Assets
Liabilities
Reserves
$8.10
Loans
72.90
Deposits
$81
* The money supply = $100 + $90 + $81 + $72.90 = $343.90
Copyright © 2014 by Nelson Education Ltd.
10-28
The Money Multiplier
Original deposit
First National lending
Second National lending
= $100.00
= $90.00 (= 0.9 x $100.00)
= $81.00 (= 0.9 x $90.00)
Third National lending
= $72.90
.
.
.
Total money supply
(= 0.9 x $81.00)
.
.
.
= $1000
Copyright © 2014 by Nelson Education Ltd.
10-29
The Money Multiplier
 Money multiplier: the amount of money the banking
system generates with each dollar it receives
 The money multiplier is the reciprocal of the reserve
ratio.
Copyright © 2014 by Nelson Education Ltd.
10-30
Bank Capital, Leverage, and
the Financial Crisis of 2007-09
 Bank capital: the resources the bank owners put
into an institution from issuing equity (e.g., stock)
 To increase the money supply, the BoC buys
bonds (or/and Treasury bills) from the public.
 To reduce the money supply, the BoC sells
bonds (or/and Treasury bills) to the public.
Copyright © 2014 by Nelson Education Ltd.
10-31
Bank Capital, Leverage, and
the Financial Crisis of 2007-09
MORE REALSITIC NATIONAL BANK
Assets
Liabilities
Reserves
$200
Deposits
$800
Loans
700
Debt
150
Securities
100
Capital
50
Copyright © 2014 by Nelson Education Ltd.
10-32
Active Learning
Banks and the Money Supply
While cleaning your apartment, you look under the sofa
cushion and find a $50 bill (and a half-eaten taco). You
deposit the bill in your chequing account.
The bank’s reserve requirement is 20 percent of deposits.
A. What is the maximum amount that the money
supply could increase?
B. What is the minimum amount that the money
supply could increase?
Copyright © 2014 by Nelson Education Ltd.
10-33
Active Learning
Answers
You deposit $50 in your chequing account.
A. What is the maximum amount that the money supply
could increase?
If banks hold no excess reserves, then
money multiplier = 1/R = 1/0.2 = 5
The maximum possible increase in deposits is
5 x $50 = $250
But money supply also includes currency,
which falls by $50.
Hence, max increase in money supply = $200.
Copyright © 2014 by Nelson Education Ltd.
10-34
Active Learning
Answers
You deposit $50 in your chequing account.
A. What is the maximum amount that the money supply
could increase?
Answer: $200
B. What is the minimum amount that the money supply
could increase?
Answer: $0
If your bank makes no loans from your deposit, currency
falls by $50, deposits increase by $50, money supply does
not change.
Copyright © 2014 by Nelson Education Ltd.
10-35
Bank Capital, Leverage, and
the Financial Crisis of 2007-09
 Leverage: the use of borrowed money to
supplement existing funds for purposes of
investment
 Leverage ratio: the ratio of assets to bank capital
 Capital requirement: a government regulation
specifying a minimum amount of bank capital
Copyright © 2014 by Nelson Education Ltd.
10-36
The Bank of Canada’s
Tools of Monetary Control
 Central banks have three main tools for
monetary control:
1. Open-market operations
2. Changes in reserve requirements
3. Changes in the overnight rate
 The BoC uses changes in the overnight rate to
control the money supply.
Copyright © 2014 by Nelson Education Ltd.
10-37
The BoC’s Tools of Monetary Control:
Changing the Overnight Rate
 Bank rate: the interest rate charged by the Bank
of Canada on loans to the commercial banks
 Overnight rate: the interest rate on very shortterm loans between commercial banks
Copyright © 2014 by Nelson Education Ltd.
10-38
The BoC’s Tools of Monetary Control:
Changing the Overnight Rate
 The BoC can alter the money supply by changing the bank
rate.
 This causes an equal change in the overnight rate.
 A higher overnight rate discourages banks from borrowing
reserves from the BoC; thus reducing reserves in the banking
system.
 The money supply contracts.
 Changes to the overnight rate are posted eight times a year.
Copyright © 2014 by Nelson Education Ltd.
10-39
The BoC’s Tools of Monetary Control:
Open-Market Operations
 Open-market operations: the purchase or sale of
Government of Canada bonds by the Bank of
Canada
 To increase the money supply, the BoC buys
bonds (or/and Treasury bills) from the public.
 To reduce the money supply, the BoC sells
bonds (or/and Treasury bills) to the public.
Copyright © 2014 by Nelson Education Ltd.
10-40
The BoC’s Tools of Monetary Control:
Open-Market Operations
Quantitative easing: the purchase and sale
by the central bank of nongovernment
securities or government securities with long
maturity terms
Copyright © 2014 by Nelson Education Ltd.
10-41
The BoC’s Tools of Monetary Control:
Open-Market Operations
 Foreign exchange market operations: the purchase or
sale of foreign money by the Bank of Canada
 If the Bank of Canada buys $100 M US dollars in the
foreign exchange market for $150 M Canadian, the
Canadian money supply increases immediately by
$150 M.
 If the Bank of Canada sells foreign currency from its
foreign exchange reserves, it receives in exchange
Canadian dollars and the Canadian money supply
is reduced.
Copyright © 2014 by Nelson Education Ltd.
10-42
The BoC’s Tools of Monetary Control:
Open-Market Operations
Sterilization: the process of offsetting foreign
exchange market operations with openmarket operations, so that the effect on the
money supply is cancelled out
Copyright © 2014 by Nelson Education Ltd.
10-43
The BoC’s Tools of Monetary Control:
Changing Reserve Requirements
 Reserve requirements: regulations on the
minimum amount of reserves that banks must
hold against deposits
 An increase in reserve requirements means that
banks must hold more reserves.
 It raises the reserve ratio.
 This lowers the money multiplier.
 The money supply decreases.
Copyright © 2014 by Nelson Education Ltd.
10-44
Problems in Controlling the Money Supply
1. The BoC does not control the amount of
money households choose to hold as
deposits in banks.
2. The BoC does not control the amount of
money banks choose to lend.
Copyright © 2014 by Nelson Education Ltd.
10-45
QuickQuiz
Describe how banks create money.
If the BoC wanted to use all three of its
policy tools to decrease the money supply,
what would it do?
Copyright © 2014 by Nelson Education Ltd.
10-46
Classroom Activity
What Can Be Learned from a Dollar?
Take a $5, $10, or $20 bill from wallets. Students without
any currency can share with someone who does. Please
read the bill.
What have you learned?
Copyright © 2014 by Nelson Education Ltd.
10-47
THE END
Chapter 10
Copyright © 2014 by Nelson Education Ltd.
10-48