ACC 818 — Module 10: Money and Banking
What money is, how the Bank of Canada and commercial banks work, and how the banking system creates money through fractional reserves.
Learning Outcomes
- Analyze the nature of money
- Explain the Canadian Banking System
- Examine the role of the Bank of Canada and commercial banks
- Discover how commercial banks create money
- Calculate expansion of money from a single new deposit
Topic 1: Functions of Money
Four functions:
- Medium of exchange — eliminates the need for barter (no double coincidence of wants).
- Store of value — preserves purchasing power for future use.
- Unit of account — standard measure of value, allowing prices to be compared.
- Standard of deferred payment — enables credit and lending.
Topic 2: The Bank of Canada (BoC)
Canada’s central bank. Four key functions:
- Manage the money supply — regulate currency in circulation.
- Federal government’s banker — issue bonds, handle foreign currency.
- Conduct monetary policy — primarily by setting interest rates.
- Oversee the financial industry and represent Canada in international monetary affairs.
Bank rate — the interest rate the BoC charges commercial banks. This is the lever that ripples through to the rates banks charge their customers.
To expand the money supply, the BoC buys government bonds → injects money into the system → stimulates spending → can also stimulate inflation.
Topic 3: How Money is Created (Fractional-Reserve Banking)
Banks are financial intermediaries between savers (depositors) and borrowers.
Balance sheet basics:
- Assets — what the bank owns (loans receivable, reserves, government bonds).
- Liabilities — what the bank owes (customer deposits).
- Bank capital = Assets − Liabilities (net worth).
Money creation process:
- A bank receives a $100 deposit.
- It must hold a fraction as reserves (say 10% = 90).
- The borrower spends the $90, which gets deposited at another bank.
- That bank holds 81. And so on.
The system multiplies the original deposit. The simple money multiplier in this stylized case is 1 / reserve ratio. Real-world multipliers are smaller because of cash drains (people hold some cash outside banks) and banks holding excess reserves.
A key takeaway: the link between BoC reserves and the broader money supply is real but not rigid — the multiplier varies over time.
Money Supply Definitions
There are multiple measures of “money supply” because liquidity exists on a spectrum (cash → demand deposits → savings deposits → near-money assets). This is why economists track several aggregates (M1, M2, etc.) rather than one number.
Key Terms
Medium of Exchange · Store of Value · Unit of Account · Bank of Canada · Bank Rate · Reserves · Fractional-Reserve Banking · Money Multiplier · Cash Drain · Bank Capital · Financial Intermediary