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Macroeconomics: Money, Banks, and the Bank of Canada

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  • What are the three main functions of money?

    Medium of exchange, unit of account, and store of value.

  • What is the difference between commodity money and fiat money?

    Commodity money has intrinsic value (e.g., gold coins), while fiat money has no intrinsic value and is used because of government decree (e.g., Canadian dollar).

  • What does the money supply include?

    The quantity of money available in the economy, including currency and demand deposits accessible on demand.

  • What are M1+ and M2 in Canadian money supply measures?

    M1+ includes currency, demand deposits, and checkable deposits; M2 includes M1+ plus savings deposits, small time deposits, and money market mutual funds.

  • What is the role of the Bank of Canada?

    The central bank of Canada that oversees the banking system and regulates the money supply through monetary policy.

  • Are credit cards included in the money supply?

    No, because credit card purchases are loans from banks, not money itself. Only when the credit card bill is paid does money move.

  • How do banks create money in a fractional reserve banking system?

    Banks keep a fraction of deposits as reserves and loan out the rest, creating new deposits and increasing the money supply.

  • What is the reserve ratio (R)?

    The fraction of deposits that banks hold as reserves, expressed as total reserves divided by total deposits.

  • What happens to the money supply in a 100% reserve banking system?

    Banks hold all deposits as reserves and make no loans, so the money supply equals the currency held by the public.

  • What is the money multiplier formula?

    Money multiplier = \(\frac{1}{R}\), where R is the reserve ratio.

  • How does a reserve ratio of 10% affect the money supply?

    Each dollar of reserves can support \$10 of money supply, so \$100 of reserves can create \$1000 of money.

  • What is the quantity equation in macroeconomics?

    \(M \times V = P \times Y\), where M is money supply, V is velocity, P is price level, and Y is real output.

  • What does the velocity of money represent?

    The average number of times each dollar in the money supply is used to purchase goods and services included in GDP.

  • What assumption does the quantity theory of money make about velocity?

    It assumes the velocity of money is constant over time.

  • How is the inflation rate related to money supply growth in the quantity theory?

    Inflation rate = Growth rate of money supply + Growth rate of velocity − Growth rate of real output.

  • What happens if the money supply grows faster than real GDP?

    There will be inflation, meaning the price level rises.

  • What is hyperinflation and what causes it?

    Very high inflation (e.g., over 50% per month) caused by central banks increasing the money supply far beyond real GDP growth.

  • What are the economic effects of high inflation?

    Money loses value rapidly, people avoid holding it, and economies often experience slow growth or recession.

  • How did the German hyperinflation of the 1920s occur?

    The government financed reparations by selling bonds to the central bank, drastically increasing the money supply and causing hyperinflation.

  • Why might banks hold excess reserves above the required minimum?

    Due to uncertainty about future economic conditions, banks may hold extra reserves as a precaution.