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Lecture 28: Money supply

Lecture 28: Money supply . Mishkin Ch14 – part B page 351- 369 . Introduction. What affect money supply? Money supply = monetary multiplier *money base Monetary multiplier Money base. What affect monetary base?. Open market operations are controlled by the Fed.

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Lecture 28: Money supply

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  1. Lecture 28: Money supply Mishkin Ch14 – part B page 351- 369

  2. Introduction • What affect money supply? • Money supply = monetary multiplier *money base • Monetary multiplier • Money base

  3. What affect monetary base? • Open market operations are controlled by the Fed. • The Fed cannot determine the amount of borrowing by banks from the Fed (discount loans). • Split the monetary base into two components • Discount loans: borrowed reserves, BR • Remainder: non-borrowed monetary base, MBn, (MBn= MB - BR ) • M = m*(MBn + BR)

  4. Factors that determine the money supply • Previously we knew that required reserve ratio (r), currency ratio (c), and excess reserves ratio (e) negatively affect monetary multiplier (m) and thus negatively affect money supply. • The money supply is positively related to nonborrowed monetary base (MBn). • The money supply is positively related to borrowed reserve from the Fed (MR).

  5. Changes in the nonborrowed monetary base (MBn ) • M = m*(MBn + BR) • The Fed’s open market purchase  increase in nonborrowed monetary base (MBn)  increase in monetary base (MB)  support more currency and deposits  increase money supply (M). • The money supply (M) is positively related to the nonborrowed monetary base (MBn). • How about open market sale?

  6. Changes in the borrowed reserves (MR)from the Fed • M = m*(MBn + BR) • If discount loans increase  borrowed reserves (BR) increase  monetary base (MB) increase  support more currency and deposits and thus a higher money supply. • The money supply is positively related to the level of borrowed reserves, BR, from the Fed.

  7. Overview of the money supply process

  8. Application I: explain money supply movements

  9. change in MB (mainly MBn) is important for long-term movements. • change in m (currency ratio c)is important for short-term movements.

  10. Explain money supply movements – cont’d • Over long periods, the primary determinant of movements in the money supply is the nonborrowed monetary base, which is controlled by the Fed’s open market operations.

  11. Application II: bank panics and reduction in money supply

  12. Application: bank panics and money supply – cont’d • Bank panics  relative risks of deposits increase, relative expected return of deposits decrease  demand for deposits decrease  people shift to holding cash  currency ratio c increase  money multiplier m decrease  money supply decrease. • In times of uncertainty  expected deposit outflow increases  banks would increase excess reserves ratio e  money multiplier m decrease  money supply decrease.

  13. Application: bank panics and money supply – cont’d • Although the Fed tried its best to increase monetary base, it can not fully offset the negative effect of money multiplier on money supply.

  14. Recap • The relationship between money supply and: • excess reserve ratio  interest rate, expected deposit outflow • currency ratio (short-term effects) • Nonborrowed monetary base  open market operation (long-term effects)

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