What are the 4 primary functions of the Bank of Canada?
1. Issue currency
2. Act as banker to the commercial banks (a bank’s bank; the lender of last resort)
3. Act as banker to the Canadian government
4. Control the money supply
1. What is the money supply?
2. What is monetary policy?
1. The money supply is the quantity of money available in the economy.
2. Monetary policy are the decisions by policy makers concerning the money supply
Which can be changed more quickly: monetary policy or fiscal policy?
Monetary policy can be changed more quickly. The Bank of Canada can make changes at any of its monthly meetings or more frequently if need be.
Fiscal policy has to go through the legislative process of the parliament approving a fiscal policy action. Even once approved, it takes time to implement the fiscal policy change.
1. What is crowding out?
2. What is the difference between the crowding out effect in the short run and long run?
1. Crowding out is a decline in private expenditures as a result of increases in government purchases.
2. In the short run, an increase in government purchases may not fully crowd out private expenditures due to the stimulative effect of an increase in government purchases on aggregate demand. In the long run, most economists believe that a permanent increase in government purchases will result in complete crowding out of private expenditures.
What is meant by supply-side economics?
Supply-side economics refers to the use of taxes to increase incentives to work, save, invest, and start a business in order to increase long-run aggregate supply.
Are the following examples contractionary fiscal policy, expansionary fiscal policy or not fiscal policy at all?
1. The corporate income tax rate is increased.
2. The Bank of Canada lowers the target for the overnight interest rate.
3. Individual income tax rate is decreased.
4. The Quebec government invests in building a new highway in an attempt to expand employment in the province
1. Contractinaory fiscal polciy
2. This is a monetary, not a fiscal policy
3. Expansionary fiscal policy
4. Not a fiscal policy
What is the difference between commodity money and fiat money?
Fiat money has no value except as money, whereas commodity money has value independent of its use as money.
* Commodity money, such as silver and gold, has intrinsic values. That is, the commodity's value is not derived from the fact that it is used an accepted medium of exchange. Fiat money, on the other hand, derives its value entirely from the fact that it is a legal tender designated by the government. For example, if the United States introduces a new kind of currency that has a color pink, then the existing stock of green U.S. dollars will be worthless. But silver and gold will be worth as much whether the U.S. dollar is of color pink or color green.
Distinguish among money, income and wealth
A person's money is the currency held and the checking account balance, whereas income is their earning and their wealth is the value of all their assets minus their debts.
A central bank of a country controls the money supply, which equals the currency held by.....
the public plus their checking account balances
What are the largest asset and the largest liability of a typical bank?
Typically, loans are a banks largest asset and deposits (including your checking account) their largest liability
How do the banks create money?
When there is an increase in checking account deposits, banks gain reserves and make new loans, and the money supply expands
1. What is the formula for the simple deposit multiplier?
2. If the required reserve ratio is 0.10, the maximum increase in checking account deposits that will result from an increase in bank reserves of $10,000 is $________ (Enter your response as an integer.)
2. 1/0.10 x $10,000 = $100,000
1. How does the quantity theory provide an explanation about the cause of inflation?
2. What are very high rates of inflation called?
3. Why do governments sometimes allow hyperinflation to occur?
1. The quantity theory shows that if the money supply grows at a faster rate than real GDP, then there will be inflation.
3. When governments want to spend more than they collect in taxes, central banks increase the money supply at a rate higher than GDP growth, often resulting in hyperinflation
1. How is most of the money supply in Canada created?
2. Suppose that during one period, the velocity of money is constant and during another period, it undergoes large fluctuations. During which period will the quantity theory of money be more useful in explaining changes in the inflation rate?
1. When banks increase their reserves, they increase their loans, which creates new checking account deposits and expands the money supply.
2. The period where velocity is constant because when velocity is constant the changes in the money supply can be shown to be the main cause of inflation
1. What do economists mean by the demand for money?
2. What is the advantage of holding money?
3. What is the disadvantage of holding money?
1. It is the amount of money-currency and checking account deposits-that individuals hold
2. Money can be used to buy goods, services, or financial assets
3. Money, in the form of currency or checking account deposits, earns either no interest or a very low rate of interest
1. What is the formula for calculating the inflation rate using growth rate of money supply, velocity and real output?
2. If the money supply is growing at a rate of 66 percent per year, real GDP (real output) is growing at a rate of 66 percent per year, and velocity is constant, what will the inflation rate be?
1. Inflation rate = Growth of money supply + growth rate of velocity of money - growth rate of real output
- 2. 0%
What is the desired reserve ratio?
The minimum fraction of deposits banks are required by law to keep as reserves
1. Suppose that you are a bank manager, because of an increase in the level of uncertainty in financial markets you want to hold more reserves. You raise your desired reserve ratio from 10 percent to 12 percent.What actions would you need to take?
2. As your actions and those of other bank managers reduced the amount of loans made, what can we expect to happen to the money supply?
1. The desired reserve ratio tells banks the amount of deposits that they need to hold as reserves. If banks are holding 10% of their deposits and loaning out the other90%, then to match the 12% desired reserve ratio, banks would need to make less loans.
2. The money supply would end up decreasing.
Banks create additional money from the money they receive from deposits. If banks have to hold more funds as reserves, they cannot make the loans that create additional money. Therefore, the deposit creation process is reduced when banks hold more deposits as reserves.