Econ 3440 Topic 1 Notes

ECON 3440

Topic 1: Money Demand/Money Supply

Money: Any liquid asset that can be used to finance a transaction

        Obvious Choice: Notes & Coins

Other Candidates: Assets that can be readily converted (liquid) to notes/coins i.e. chequing, savings account – NO FIXED DEPOSITS OR GOVT BONDS (not liquid & fee charged to convert)

Currency held by Households and firms (in circulation) = Notes/coins held by households and firms

‘Aside: Do not include notes/coins held by chartered banks/commercial banks in Currency held by H&F.

Do not include it because cash is not held to finance transactions rather it is held to convert chequing/savings account into cash – so motive for holding money is different.

*check (do not include in money supply)

M1: Currency held by H&F + chequing accounts held by H&F in chartered banks (*check chequing)

‘Aside: do not include money held by chartered banks or accounts held by chartered banks in BOC (chequing + saving)

Reason: as previously stated Chartered banks do no hold this money to finance transaction

In July 2015, M1 = 710 Bn

Value of Chequing Accounts held H&F = 710 Bn (M1) – 71.5 Bn (currency held by H&F) = $638.5 Bn

$638.5 Bn > 71.5 Bn  = Hence chequing accounts (in chartered banks) account for a very large part of Money Supply (reflected in M1) as chartered banks have direct control over how much deposits in chequing accounts are made. They play a substantial role in the money supply process (have direct control over money supply process).

Central Banks have an indirect control over this (how many deposits are made in chequing accounts and money supply).

Until 1980, central banks have always monitored M1

Until ’80s, M1 was the most useful measure of money that central banks monitored when they wanted to control inflation

‘Aside: MS – increases then inflation – increases

1980’s, the central banks tried to reduce inflation by decreasing the rate of growth of M1 (MS-representative). BUT even though the rate of growth of M1 dropped, inflation did NOT decrease

Reason: 1980’s, ATM’s became widely available + debit cards were widely used to finance transactions so it became very easy to transfer balances from saving → chequing (saving became very close substitute of chequing).