1 / 34

Chapter 13

Chapter 13. Multiple Deposit Creation and the Money Supply Process. Money Supply (MS) Process Definition: The mechanism that determines the money supply, or the implementation of monetary policy.  It is important to understand the MS Process to

nitza
Download Presentation

Chapter 13

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter 13 Multiple Deposit Creation and the Money Supply Process Dr. Reyadh Faras

  2. Money Supply (MS) Process • Definition: The mechanism that determines the money supply, or the implementation of monetary policy.  • It is important to understand the MS Process to understand exactly how do the tools of monetary policy change the money supply, and thereby affect economic indicators (e.g. interest rates, inflation, output, employment).  Dr. Reyadh Faras

  3. THE FOUR PLAYERS IN THE MS PROCESS 1. The central bank The most important player since it ultimately controls the supply of money in the economy. 2. Commercial banks Depository institutions that accept deposits and make loans. 3. Depositors Bank customers (individuals, companies and institutions) holding bank deposits. 4. Borrowers from banks Bank customers (individuals, companies, etc) who borrow money from banks. Dr. Reyadh Faras

  4. CENTRAL BANK'S BALANCE SHEET AND THE MONETARY BASE Monetary policy works by affecting the Central bank's balance sheet. Assets 1. Securities: Most of the assets are government securities. 2. Discount Loans: Loans that the central bank makes to banks. Dr. Reyadh Faras

  5. Liabilities 1.  Currency in Circulation: Cash in the hands of the public, outside the banking system. 2. Reserves: Which are in the form of either: a) bank deposits at the central bank (RR), or b) cash at commercial banks (ER).   Reserves are a liability of the Central Bank and an asset for commercial banks Dr. Reyadh Faras

  6. The Federal Reserve’s Balance Sheet Dr. Reyadh Faras

  7. Monetary Base • Known also as high-powered money because an increase in it leads to multiple increases in the money supply. • Consists of central bank notes outstanding, coins and reserves. • Central bank notes outstanding and coins can be defined as currency in circulation (C), thus the monetary base is defined as: MB = C (currency) + R (reserves) Dr. ReyadhFaras

  8. CONTROL OF THE MONETARY BASE (MB) • Open market operations: Definition:The purchase and sale of government securities by the Central Bank. • Expansionary monetary policy: When the Central Bank wants to stimulate the economy, it increases the MS through an open market purchase of securities, or discount loans. • Contractionary monetary policy: When the Central Bank wants to slowdown the economy, it reduces the MS through an open market sale of securities, or increasing (RRR). Dr. Reyadh Faras

  9. Open Market Operations Open Market Purchase from a Bank • The C.B. buys government securities from a bank. • The bank gives the C.B. $100 government securities. • The C.B. pays for the securities by increasing the bank’s reserves by $100.  Dr. Reyadh Faras

  10. The bank: reserves increase by $100 while its holdings of securities decline by $100. • The T-account for the bank is: Commercial Bank Dr. Reyadh Faras

  11. Central Bank: liabilities increase by $100 because of the increase in __________, while its assets increase by $100 because of the increase in its ___________. The T-account for the central bank is: The Central Bank Result: Reserves and MB increased by $100 (amount of OMO), but money supply increased by more than $100 (Why?). Dr. Reyadh Faras

  12. Open Market Purchase from Non-bank Public Non-bank public:Any natural or judicial person other than commercial banks. There are two possible cases: CASE 1:The central bank buys a ($100) government security from the non-bank public, and the seller makes a bank deposit. The T-account for the non-bank public is: Non-Bank Public Dr. Reyadh Faras

  13. When the commercial bank receives the check, it credits the depositor's account with $100 and then deposits the check at its account at the central bank who increases its _______ by $_____. The T-account for the commercial bank is: Commercial Bank Dr. Reyadh Faras

  14. The central bank's holdings of _______ increase by $____, while the _______ increase by $____. The Central Bank Similar to the case of purchasing securities from a bank (increase in ____, _____ and ____) Dr. Reyadh Faras

  15. CASE 2:The central bank buys a ($100) T-Bond from the non-bank public, and the person cashes the check. The T-account for the non-bank public is: Non-Bank Public Dr. Reyadh Faras

  16. The central bank's holdings of _______increase by $____, while _________ increase by $____. The Central Bank Result: Reserves unchanged, while (C) and (MB) increased by the amount of the OMO. Dr. Reyadh Faras

  17. General Result for purchases: The effect of open market purchase is to increase the MB by the amount of the OMO whether the seller keeps the proceeds in deposits or in currency. Dr. Reyadh Faras

  18. Open Market Sale If the central bank sells $100 of bonds to a bank or non-bank public, the monetary base declines by $100. If the buyer pays for the bonds with currency, his T-account is: Non-Bank Public Dr. Reyadh Faras

  19. The central bank lowers its holdings of securities and currency by $100. Its T-account is: The Central Bank Result Open market sale reduces MB by the same amount, although reserves are unchanged (Why?) Dr. Reyadh Faras

  20. General result for sale and purchases The effect of OMOs on MB is more certain than its effect on reserves. Thus, the central bank can control MB more effectively than reserves by using OMOs. Dr. Reyadh Faras

  21. Discount Loans Commercial Bank The Central Bank Result If the Central Bank makes a discount loan, (R) and (MB) increase by the same amount. Dr. Reyadh Faras

  22. Shifts from Deposits into Currency Commercial Bank The Central Bank Result Has no effect on the central bank liabilities because the increase in (C) is cancelled out by a decline in (R). Dr. Reyadh Faras

  23. MULTIPLE DEPOSIT CREATION: A SIMPLE MODEL Assumptions: • The commercial bank holds no excess reserves. • The public don’t hold cash. • The required reserve ratio is 10%. Dr. Reyadh Faras

  24. MULTIPLE DEPOSIT CREATION:A SIMPLE MODEL Deposit Creation: The Single Bank Assume that the central bank conducts Open Market Purchase of $100 from a bank. The T-account is: 1) Open Market Purchase Dr. Reyadh Faras

  25. 2) Making a loan 3) The bank deposits the loan in the borrower’s account Dr. Reyadh Faras

  26. 4) The borrower withdraws the amount of the loan 5) The final effect on the bank’s balance sheet Dr. Reyadh Faras

  27. Result: The initial increase in reserves from the open market purchase has been converted by the bank into $100 of additional loans and $100 of deposits. Dr. Reyadh Faras

  28. Deposit Creation: The Banking System 1) Assume the $100 deposit (created by the loan) is deposited at bank (A),the T-account is: Bank A • Bank (A)’s required reserves equal $______, and excess reserves equal $______ • The maximum amount of loans the bank can make is $______. Dr. Reyadh Faras

  29. 2) Bank (A) makes a loan Bank A The borrower from Bank (A) uses the money to make purchases 3) The seller deposits the amount of the purchase in his bank (B) Bank B Dr. Reyadh Faras

  30. Bank (B) now has $___ of reserves. It only needs $____ as required reserves, it can lend $_____. • Bank (B) creates a new loan of $____ and a new deposit of $___ for the borrower. When check clears, R= $___, L= $ ___ and D= $ ___.  T-account of Bank B is: Bank (B) The $ ____ spent by the borrower (from Bank B) will be deposited in another bank (Bank C). Dr. Reyadh Faras

  31. Result: • The initial increase in reserves in the banking system of $____, so far has increased checkable deposits in the system by $ 271 (= ____+ ____ +____). • As a result, if all banks make loans for the full amount of their excess reserves, the total increase in deposits will be $ 1000. • In general, deposits increase as follows: ∆ D = (1/RRR) x  ∆ R = (1/____) x (_____) = $______ • Where ∆ D = change in checkable bank deposits (D)           RRR = required reserve ratio            ∆ R = change in Reserves (R) Dr. Reyadh Faras

  32. Deposit Creation Dr. Reyadh Faras

  33. The Money Supply Expansion and Contraction Processes Dr. Reyadh Faras

  34. Simple Deposit Multiplier • The multiple increase in deposits generated from an increase in the banking system's reserves. • The simple multiple deposit creation process depends on two factors to get full potential deposit expansion of the Simple Deposit Multiplier on D, e.g. 10X: 1. Banks hold NO excess reserves (ER) 2. No cash (C) is held by the public Note: • The central bank directly controls the MB, but can't directly control MS, it is influenced by public's behavior (cash demand) and bank's behavior (holding excess reserves). Dr. Reyadh Faras

More Related