What Is Money? The items in M1 clearly meet the definition of money; the items in M2+ do not do so quite so clearly but still are quite liquid. Liquidity is the property of being instantly convertible into a means of payment with little loss of value. Chequeable deposits are money, but cheques are not– cheques are instructions to banks to transfer money. Credit cards are not money. Credit cards enable the holder to obtain a loan quickly, but the loan must be repaid with money.
How Banks Create Money The Money Multiplier The money multiplier is the ratio of the change in the quantity of money to the change in the monetary base. In our example, when the monetary base increased by $100,000, the quantity of money increased by $250,000, so the money multiplier is 2.5.
The Demand for Money The Demand for Money in Canada Figure 25.6(a) shows a scatter diagram of the interest rate against real M1 from 1968 through 2004. The graph interprets the data in terms of movements along and shifts in the demand for money curve.
The Demand for Money Figure 25.6(b) shows a scatter diagram of the interest rate against real M2+ from 1968 through 2004 The graph interprets the data in terms of movements along and shifts in the demand for money curve.
Interest Rate Determination An interest rate is the amount received by a lender and paid by a borrower expressed a s percentage of the amount of the loan. The price of a bond (a financial asset) and the interest rate on it are inversely related. If the price of a bond falls, the interest rate rises. If the price of a bond rises, the interest rate falls. We can study the forces that determine the interest rate in the market for money.
Interest Rate Determination Interest Rate Target If the Bank of Canada targets the interest rate, then the quantity of money supplied by the banking system must equal the quantity of money demanded at the chosen interest rate. To achieve this quantity of money supplied, the Bank of Canada adjusts the monetary base. Figure 25.7 illustrates.