Money and Banking

Money and Banking Definitions

Money and the Functions of Money

1. It is a medium of exchange used to make payments for goods and services. Example: A $20 bill used to buy a t-shirt.
2. It serves as a unit of account (it can be used for accounting purposes). Example: Instead of a clothing store saying they sold 4 jeans, 12 hats, and 5 shirts they can just say they sold $400 worth of goods.
3. It is a store of value (you can sell a good for money today and the money can be stored for a future purchase). Example: Cash held in your wallet or precious metals like gold and silver are a store of value. A car is not a store of value because it starts losing value as soon as you buy it.
4. Is a standard of deferred payments in borrowing and lending. Example: If you buy a car today and pay for it in installments in the future that is a deferred payment.

Definitions

• Liquidity - the ease with which an asset can be converted into cash (medium of exchange). Example: Houses are generally less liquid than stocks because it can take longer to sell a house and convert it to cash.
• Barter Economy - an economy where goods trade directly for other goods. This is inconvenient because it requires a double coincidence of wants. Example: Let's say a farmer wants to trade 3 sheep for 1 cow. He will first have to find someone that wants 3 sheep and that has a cow to trade in exchange. This can take a long time to find.
• Commodity money - money that takes the form of a commodity with intrinsic value. Example: Gold and silver coins
• Fiat money - money without intrinsic value that is used as money because of government decree. It is accepted as legal tender (money that, by law, must be accepted for purchases of goods). Today, almost all currency is fiat money. Example: a $20 bill is fiat money.
• Currency - the paper bills and coins in the hands of the public. It is also called cash held by public.
• Demand deposits - balances in bank accounts that depositors can access on demand by writing a cheque or using a debit card.
• Term Deposit - a deposit that you earn interest on, but you have to give notice before withdrawing from it.
• Near Money - a liquid asset that is easily convertible into money. It can be used as a store of value but not as a medium of exchange Example: Term deposits

• Money Substitute - something that serves as a medium of exchange but is not a store of value. Example: Credit cards
• Bank Run - when people lose confidence in banks and rush to withdraw cash. It is also called a financial panic.
• Central Bank: In Canada it’s the Bank of Canada (BoC) and in the USA it is the Federal Reserve. It serves as banker to the commercial banks and are the only one that can print money. The central bank is different from commercial banks, in that it is not profit seeking. The central bank serves 4 main purposes:

1. Banker to commercial banks - it can lend money to commercial banks like Citibank and HSBC.
2. Banker to the government - it can lend money to the government.
3. Regulator of the money supply - it can print money.
4. Regulator and supporter of financial markets - it can influence the interest rate in the market.

Money Supply

3 Ways of Measuring Money Supply

• M1: Currency + chequing deposits
• M2: M1 + non-personal demand and notice (term) deposits at commercial banks.
• M2+ (M3): M2 + deposits at non-banks (like insurance companies, pension funds, mutual funds).