Chapter 11 Money & Banking - siast5

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2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter 11. 2. In this chapter you will learn. 11.1 The definition and functions of money. 11.2 What constitutes ...

Money and Banking

SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE © 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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In this chapter you will learn 11.1 The definition and functions of money 11.2 What constitutes the supply of money 11.3 What backs Canada’s money supply 11.4 The components of money demand 11.5 How the equilibrium interest rate is determined in the money market 11.6 About the structure of the Canadian financial system 11.7 About recent developments in money and banking © 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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Chapter 11 Topics 11.1 The Definition & Functions of Money 11.2 The Supply of Money 11.3 What “Backs” the Money Supply? 11.4 The Demand for Money 11.5 Equilibrium in the Money Market 11.6 The Canadian Financial System 11.7 Recent Developments in Money & Banking

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Definition & Functions of Money  Money

is what money does

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Definition & Functions of Money  Medium

of exchange

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Definition & Functions of Money  Medium

of exchange  Measure of value

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Definition & Functions of Money  Medium

of exchange  Measure of value  Store of value

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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Chapter 11 Topics 11.1 The Definition & Functions of Money 11.2 The Supply of Money 11.3 What “Backs” the Money Supply? 11.4 The Demand for Money 11.5 Equilibrium in the Money Market 11.6 The Canadian Financial System 11.7 Recent Developments in Money & Banking

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Supply of Money Table 11-1

Currency (coins & paper money) plus Demand deposits equals M1

December, 2002 © 2005 McGraw-Hill Ryerson Ltd.

M1 137.3

(billions of dollars) Macroeconomics, Chapter 11

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The Supply of Money  Currency:

Coins + Paper Money

• token money • Bank of Canada notes  Demand

Deposits

• about ⅔ of M1  Institutions

That Offer Demand Deposits

• chartered banks are the primary depository institutions © 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Supply of Money  Near-monies

• nonchequable savings deposits • term deposits

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Supply of Money Table 11-1

Currency (coins & paper money) M1 plus Demand deposits 137.3 equals M1 plus Personal savings deposits, plus Non-personal notice deposits equals M2

M2

559.8

December, 2002 © 2005 McGraw-Hill Ryerson Ltd.

(billions of dollars) Macroeconomics, Chapter 11

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The Supply of Money  M2+

is M2 plus

• deposits at trust & mortgage loan companies • deposits at caisses populaires & credit unions & other non-bank deposit-taking institutions • money market mutual funds

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Supply of Money Table 11-1

Currency (coins & paper money) M1 plus Demand deposits 137.3 equals M1 plus Personal savings deposits, plus Nonpersonal notice deposits equals M2 plus Deposits: Other intermediaries

M2 M2+

559.8

equals M2+

801.8 December, 2002 © 2005 McGraw-Hill Ryerson Ltd.

(billions of dollars) Macroeconomics, Chapter 11

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The Supply of Money  we

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

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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Chapter 11 Topics 11.1 The Definition & Functions of Money 11.2 The Supply of Money 11.3 What “Backs” the Money Supply? 11.4 The Demand for Money 11.5 Equilibrium in the Money Market 11.6 The Canadian Financial System 11.7 Recent Developments in Money & Banking

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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What “Backs” the Money Supply?  Money

as Debt  Value of Money • Acceptability • Legal Tender • Relative Scarcity

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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What “Backs” the Money Supply?  Money

& Prices

NOTES:

Reciprocal relationship • The Purchasing Power of the the Dollar between price level and the value of the dollar

D

© 2005 McGraw-Hill Ryerson Ltd.

=

1

P

Macroeconomics, Chapter 11

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What “Backs” the Money Supply?  Money

& Prices

• The Purchasing Power of the Dollar • Inflation & Acceptability

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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Chapter 11 Topics 11.1 The Definition & Functions of Money 11.2 The Supply of Money 11.3 What “Backs” the Money Supply? 11.4 The Demand for Money 11.5 Equilibrium in the Money Market 11.6 The Canadian Financial System 11.7 Recent Developments in Money & Banking

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Demand for Money  Transactions

Demand, Dt

• demand for money as a medium of exchange • varies directly with GDP  Asset

Demand, Da

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

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Demand For Money Figure 11-1

Transactions Demand, Dt Interest Rate

i%

+

10 7.5 5 2.5

Dt 0

0 50 100 150 200 250 300

Amount of money demanded (billions of dollars)

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Demand For Money Figure 11-1

Transactions Demand, Dt Interest Rate

i%

+

Asset Demand, Da

i%

10

10

7.5

7.5

5

5

2.5

2.5

Dt 0

=

0 50 100 150 200 250 300

0

Da 0 50 100 150 200 250 300

Amount of money demanded (billions of dollars)

© 2005 McGraw-Hill Ryerson Ltd.

Amount of money demanded (billions of dollars)

Macroeconomics, Chapter 11

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The Demand For Money Figure 11-1

Transactions Demand, Dt Interest Rate

i%

+

Asset Demand, Da

=

i%

Total demand for money, Dm

i%

10

10

10

7.5

7.5

7.5

5

5

5

2.5

2.5

2.5

Dt 0

0 50 100 150 200 250 300

0

Da 0 50 100 150 200 250 300

Amount of money demanded (billions of dollars)

Amount of money demanded (billions of dollars)

0

Dm 0 50 100 150 200 250 300

Amount of money demanded (billions of dollars)

100 + 100 = 200 © 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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Chapter 11 Topics 11.1 The Definition & Functions of Money 11.2 The Supply of Money 11.3 What “Backs” the Money Supply? 11.4 The Demand for Money 11.5 Equilibrium in the Money Market 11.6 The Canadian Financial System 11.7 Recent Developments in Money & Banking

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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Equilibrium in the Money Market  demand

for money combined with supply of money portrays the money market

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Demand For Money Figure 11-1

Transactions Demand, Dt Interest Rate

i%

=

i%

10

Total demand for money, Dm

i% 10

10

7.5

ADD THE 7.5 MONEY SUPPLY 5 5 TO FIND THE 2.5 2.5 EQUILIBRIUMDaRATE 0 0 OF INTEREST 0 50 100 150 200 250 300 7.5

5 2.5

Dt 0

+

Asset Demand, Da

0 50 100 150 200 250 300

0 50 100 150 200 250 300

Amount of money demanded (billions of dollars)

© 2005 McGraw-Hill Ryerson Ltd.

Dm

Amount of money demanded (billions of dollars)

Amount of money demanded (billions of dollars)

Macroeconomics, Chapter 11

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The Demand For Money Figure 11-1

Transactions Demand, Dt Interest Rate

i%

+

Asset Demand, Da

=

i%

Total demand for money, Dm

i%

10

10

10

7.5

7.5

7.5

5

5

5

2.5

2.5

2.5

Dt 0

0 50 100 150 200 250 300

Amount of money demanded (billions of dollars)

0

Da 0 50 100 150 200 250 300

Amount of money demanded (billions of dollars)

Equilibrium Interest Rate

© 2005 McGraw-Hill Ryerson Ltd.

0

Sm

ie Dm 0 50 100 150 200 250 300

Amount of money demanded (billions of dollars)

Macroeconomics, Chapter 11

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Adjustment to a Decline in the Money Supply A

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

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Money Market Rate of interest, i (percent)

Figure 11-2

Sm 10 7.5

ie

5

Suppose the money supply is decreased from $200 billion, Sm, to $150 billion Sm1

Dm

2.5

0 0

50

100

150

200

250

300

Amount of money demanded (billions of dollars) © 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Money Market Rate of interest, i (percent)

Figure 11-2

Sm1

Sm A temporary shortage of money will require the sale of some assets to meet the need

10 7.5

ie

5

Dm

2.5

0 0

50

100

150

200

250

300

Amount of money demanded (billions of dollars) © 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Money Market Rate of interest, i (percent)

Figure 11-2

Sm1

Sm

A temporary shortage of money will require the sale of some assets sellsto meet the need

10

Everyone bonds ie 5  bond prices fall 2.5interest rates riseDm illustrated… 7.5

0 0

50

100

150

200

250

300

Amount of money demanded (billions of dollars) © 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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Bonds a

$1,000 bond @ 5% pays $50 annually  if you buy this bond for $667, you still receive $50 annually the lower the  what is your effective bondinterest price,rate?  50/667=7.5% the higher the

interest rate

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Money Market Rate of interest, i (percent)

Figure 11-2

Sm1

Sm

A temporary shortage 10 of money will require Everyone sells bonds the sale of some assets 7.5 to meet the need bond prices fall

 ie 5 interest rates rise

until people are happy 2.5 holding the lower Dm quantity of money 0 0

50

100

150

200

250

300

Amount of money demanded (billions of dollars) © 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Money Market Rate of interest, i (percent)

Figure 11-2

Sm1

Sm After adjustments to asset holdings, a new equilibrium will be seen at a higher level of interest

10

ie

7.5 5

Dm

2.5

0 0

50

100

150

200

250

300

Amount of money demanded (billions of dollars) © 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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Adjustment to an Increase in the Money Supply  An

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

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

36

The Money Market Rate of interest, i (percent)

Figure 11-2

Sm Suppose the money supply is increased from $200 billion, Sm1, to ie $250 billion Sm2

10 7.5 5

Dm

2.5

0 0

50

100

150

200

250

300

Amount of money demanded (billions of dollars) © 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

37

The Money Market Rate of interest, i (percent)

Figure 11-2

SmSm2

A temporary surplus of money will require the purchase of some assets to meet the desired level of liquidity

10 7.5 5

Dm

2.5

0 0

50

100

150

200

250

300

Amount of money demanded (billions of dollars) © 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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Bonds a

$1,000 bond @ 5% pays $50 annually  if you buy this bond for $2000, you still receive $50 annually the higher the  what is your effective bondinterest price,rate?  50/2000=2.5% the lower the

interest rate

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Money Market Rate of interest, i (percent)

Figure 11-2

SmSm2

A temporary surplus of money 10 require Everyone buys bondsthewill purchase of 7.5 bond prices rise some assets to meet the desired 5 interest rates fall level of liquidity

 

until people are happy 2.5 holding the higher Dm quantity of money 0 0

50

100

150

200

250

300

Amount of money demanded (billions of dollars) © 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Money Market Rate of interest, i (percent)

Figure 11-2

After SmSm2 adjustments to asset holdings, a new equilibrium will be seen at a lower level of interest

10 7.5 5 2.5

ie

Dm

0 0

50

100

150

200

250

300

Amount of money demanded (billions of dollars) © 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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Chapter 11 Topics 11.1 The Definition & Functions of Money 11.2 The Supply of Money 11.3 What “Backs” the Money Supply? 11.4 The Demand for Money 11.5 Equilibrium in the Money Market 11.6 The Canadian Financial System 11.7 Recent Developments in Money & Banking

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

42

The Canadian Financial System  The

Evolution of the Canadian Banking System • 2003 – 16 domestically owned banks – 33 foreign bank subsidiaries – 20 foreign bank branches

• big six banks have 90% of total banking assets & 75% of payments volume • mergers may lead to more concentration © 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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Table 11-2 The Balance Sheet of Canadian Chartered Banks December 2002 ($ Billions) Assets Liabilities Reserves Loans

0.5 Demand deposits

97.2

688.8 Savings deposits

131.1

Gov’t. of Canada securities

76.7 Term deposits

Foreign-currency assets

40.0 Foreign-currency liabilities

Gov’t of Canada Other Total

235.1 Other 1,041.1 Total

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

240.9 76.9

2.0 493.0 1.041.1 44

GLOBAL PERSPECTIVE 11.1 Assets (Canadian $ billions, 2002) Mizuho Holdings (Japan) $1,876,772 Citigroup (U.S.) 1,674,750 Sumitomo Mitsui (Japan) Deutsche Bank (Germany)

1,338,400 1,288,926

Mitsubishi Tokyo (Japan) Royal Bank of Canada Canadian Imperial Bank of Commerce TD Canada Trust Scotiabank Bank of Montreal National Bank of Canada

1,196,957 351,042 280,447 279,788 276,162 232,362 72,447

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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The Canadian Financial System  Canada’s

Chartered Banks

• fractional reserve system  Making

Loans  Other Financial Intermediaries  Cheque Clearing

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

46

Chapter 11 Topics 11.1 The Definition & Functions of Money 11.2 The Supply of Money 11.3 What “Backs” the Money Supply? 11.4 The Demand for Money 11.5 Equilibrium in the Money Market 11.6 The Canadian Financial System 11.7 Recent Developments in Money & Banking

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

47

Recent Developments in Money & Banking  Expansion

• • • •

of Services

new products minibanks ABMs debit cards, phone banking, Internet banking

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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Recent Developments in Money & Banking  Expansion

of Services  Globalization of Financial Markets

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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Recent Developments in Money & Banking  Expansion

of Services  Globalization of Financial Markets  Electronic Transactions

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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Chapter 11 Topics 11.1 The Definition & Functions of Money 11.2 The Supply of Money 11.3 What “Backs” the Money Supply? 11.4 The Demand for Money 11.5 Equilibrium in the Money Market 11.6 The Canadian Financial System 11.7 Recent Developments in Money & Banking

© 2005 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 11

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