Functions of money
- Medium of exchange: Pay for goods and services.
- Unit of account: Used to measure value in an economy.
- Store of value: Repository of purchasing power available over time.
Components of the Canadian money supply
- Currency in circulation
- Banker’s deposits with the NBI
- Other deposits with the RBI
- Demand deposits of banks
ROA, ROE, EM and leverage ratio
ROA: Return On Assets, net profit after taxes per dollar of assets.
ROE: Return On Equity, net profit after taxes per dollar of equity capital.
EM: Equity multiplier, the amount of assets per dollar of equity capital.
Leverage ratio: A bank’s capital divided by its assets.
Bank of Canada independence
- Central bank
- Responsible for monetary policy
- 100% owned by the federal government
- Semi-autonomous institution
- Goal dependent
- Instrument dependent
Formal structure of the Bank of Canada
The overall responsibility for the operation of the Bank of Canada rests with a Board of Directors, which consists of 15 members—the governor, the senior deputy governor, the deputy minister of finance, and 12 outside directors. The Board appoints the governor and senior deputy governor, with the government’s approval, for a renewable term of seven years. The outside directors are appointed by the minister of finance, with Cabinet approval, for a three-year term, and they are required to come from all regions of Canada, representing a variety of occupations with the exception of banking. The governor of the Bank is the chief executive officer and chair of the Board of Directors. Currently, the governor of the Bank of Canada is Tiff Macklem.
Functions of the Bank of Canada
- Currency: Unlimited power to issue legal tender.
- Funds management: Provides debt-management services for the federal government, such as advising on borrowings, managing new debt offerings, and servicing outstanding debt.
- Financial system: Serves as the lender of last resort if a deposit-taking financial institution faces a liquidity crisis.
- Monetary policy: Employs such tools as open market buyback operations (the purchase and sale of government securities that affect both interest rates and the amount of reserves in the banking system) and, to a lesser extent, the shifting of government balances between it and the directly clearing members of Payments Canada to implement changes in the money supply.
Monetary base
The sum of the Bank of Canada’s monetary liabilities (notes outstanding and bank settlement balances) and coins outstanding.
Money multiplier
A ratio that relates the change in the money supply to a given change in the monetary base.
Overnight lending rate and bank rate
Overnight rate: The interest rate on overnight (one-day) securities.
Bank rate: The interest rate the Bank of Canada charges to members of the Canadian Payments Association.
Goals of monetary policy
- High employment and output stability.
- Economic growth.
- Stability of financial markets.
- Interest-rate stability.
- Stability in foreign exchange markets.
Taylor rule
Economist John Taylor’s monetary policy rule that explains how the overnight interest rate target is set.
Determinants of consumption expenditure
Income, savings, expectations, changes in fiscal policies, debt, and availability of goods and services.
Relation between the price of a coupon bond and the yield to maturity
A bond’s price moves inversely to its yield to maturity rate. As interest rates rise, investors will demand greater returns. Therefore, the price of bonds will fall, naturally resulting in a rise in the yield to maturity rate.
Determinants of the demand and supply of bonds
- Wealth, the total resources owned by the individual, including all assets.
- Expected return (the return expected over the next period) on one asset relative to alternative assets.
- Risk (the degree of uncertainty associated with the return) on one asset relative to alternative assets.
- Liquidity (the ease and speed with which an asset can be turned into cash) relative to alternative assets
Three motives for holding money
- Transactions motive, hold money because it is a medium of exchange that can be used to carry out everyday transactions.
- Precautionary motive, hold money as a cushion against unexpected opportunities.
- Speculative motive, hold money as a store of wealth.
Crowding-out effect of fiscal policy
Crowding out is a phenomenon that occurs when increased government involvement in a sector of the market economy substantially affects the remainder of the market, either on the supply or demand side of the market.
Lags in monetary policy
The data lag is the time it takes for policymakers to obtain the data that describe what is happening in the economy. Accurate data on GDP, for example, are not available until several months after a given quarter is over.The recognition lag is the time it takes for policymakers to feel confident about the signals the data are sending about the future course of the economy. For example, to minimize errors, the government will not declare the economy to be in recession until at least six months after it has determined that a recession has begun.The legislative lag represents the time it takes to get legislation passed to implement a particular policy. The legislative lag does not apply to most monetary policy actions, such as the lowering of interest rates. It is, however, important in the implementation of fiscal policy, because it can sometimes take six months to a year to get legislation passed to change taxes or government purchases.The implementation lag is the time it takes for policymakers to change policy instruments once they have decided on a new policy. Again, this lag is less important for the conduct of monetary policy, because the Bank of Canada can immediately change its policy interest rate, whereas it is more important for the implementation of fiscal policy. The implementation of new fiscal policy can take substantial time; for example, getting government agencies to change their spending habits takes time, as does changing tax tables.The effectiveness lag is the time it takes for the policy to have a real impact on the economy. The effectiveness lag is both long (often a year longer) and variable (that is, substantial uncertainty exists about the length of this lag).
Cost-push inflation and demand pull inflation
Cost-push inflation results from either a negative supply shock or a push by workers for wage hikes that are beyond those justified by productivity gains. Demand-pull inflation results when policymakers pursue policies that increase aggregate demand.
