The money supply monetary policy
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The Money Supply & Monetary Policy. Monetary Policy. Monetary Policy Flowchart. The Money Supply. The money supply is the total amount of cash in circulation – outside banks, plus bank deposits

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The Money Supply & Monetary Policy

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The money supply monetary policy

The Money Supply & Monetary Policy

Monetary Policy

Monetary Policy Flowchart


The money supply

The Money Supply

  • The money supply is the total amount of cash in circulation – outside banks, plus bank deposits

  • Near Money is other types of deposits that can act as a store of value and can be converted into a medium of exchange but which are not, themselves, a medium of exchange


Canadian money supply definitions

Canadian Money Supply Definitions

  • cash plus demand deposits in chequing and current accounts inbanks

  • M1 plus personal savings accounts, term deposits and non-personal notice deposits

  • M2 plus deposits in near banks, money market mutual funds and individual annuities at insurance companies

  • M2++ plus business term deposits and foreign currencies held by Canadians

Hard currency M1 M2 M2++ M3

Narrow (smaller money supply) (larger money supply)Broad

M1

M2

M2++

M3


The creation of money

The Creation of Money

The Money Supply is expanded when:

  • The banks have excess reserves

    (Reserves > legal requirement for reserves)

    – AND –

  • The banks loan money to borrowers


What keeps the money supply from collapsing

What keeps the money supply from collapsing?

  • Confidence in the banking system

  • Branch banking: nationwide banks provide funds to any branch in trouble

  • Collateral: Banks require security for the repayment of significant loans. Therefore a default is less likely when a loan is called-in

  • Central bank (Bank of Canada) short-term funding

  • Government deposit insurance (CDIC) protects $100K per depositor per institution


The money market almost like any other market

i

Dm0

Sm

$

Dm0

Sm

The Money Market (almost like any other market)

  • Borrowers are Demand

  • The higher the interest rate, the less they want

Dm1

  • Savers are Supply

  • The higher the interest rate, the more they save

i1

ie

Suppose people become more comfortable with debt

Dm1

MS0

MS1

Greater Money Supply at higher interest rates


Monetary policy

Monetary Policy

The Money Supply & Monetary Policy - top

Monetary Policy Flowchart


The role of the bank of canada

The Role of the Bank of Canada

  • Government’s bank

    • Deposit accounts

    • Debt and borrowing – Canada Savings Bonds, T-bills

  • Bankers’ bank

    • Short-term funding … lender of last resort

    • Overnight rate

  • Manage monetary policy and money supply

    • Inflation

    • Exchange rates

    • Interest rates

  • Currency

    • Royal Canadian Mint

    • Bank notes

Issue:Independence?


Monetary policy tools

Monetary Policy Tools

Monetary policy is the attempt to adjust aggregate demand through the availability of money and credit.

Overnight rate

Government bonds

Move government deposits …

Moral Suasion

Reserve requirements

Interest rates

  • Administered by the Bank of Canada

    • Crown corporation – answers to government

    • "Independent"

Tight MoneyPolicy ToolEasy Money

Raise

Sell

BofC

“Lend Less!”

Raise

Therefore …

Higher

Lower

Buy

Chartered banks

“Lend More!”

Lower

Lower


Monetary policy issues

Monetary Policy Issues

  • “Big hammer”:

    • C I X M all impacted

      • i: C + I + G + (X – M) = AD

  • Exchange rates can force gov’t hand

  • Inflation and unemployment – not always tied

  • “Credit trap”:

    • Poor economy but …

    • i already extremely low

    • No way to go lower


Exchange rates

Exchange rates

  • Decrease in Canadian interest rates:

    • Reduces appeal of Canadian returns for Canadians

      • Canadian savers take money abroad

      • Need to buy foreign currencies (sell CDN … SS)

    • Reduces appeal of Canadian returns for foreigners

      • Foreign savers reduce inflows into Canada in favour of saving elsewhere

      • Less need to buy CDN (DD)

    • Currency depreciation

      • Canadian eXports become cheaper (X)

      • iMports into Canada become more expensive (M)

    • Increase in net exports (X-M)

    • (AD) Rightward shift in AD curve


Monetary policy flowchart

i

Sm

Sm

Dm0

Dm0

Sm

Sm

$

Monetary Policy Flowchart

“Easy money” policy:

Increase in supply of money

Excess supply of money

ie

i1

Fall in interest rates

MS1

MS0

Increase in capital outflow

Decrease in capital inflow

Increase in consumption & investment expenditure

S

CDN / USD

Currency depreciation

D

AD=C + I + G + (X– M)

$CDN


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