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Chapter 15: The Money Supply Process and the Money Multipliers

Chapter 15: The Money Supply Process and the Money Multipliers. Chapter Objectives http://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm Who determines the money supply? How does the central bank ’ s balance sheet differ from the balance sheets of other banks?

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Chapter 15: The Money Supply Process and the Money Multipliers

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  1. Chapter 15: The Money Supply Process and the Money Multipliers

  2. Chapter Objectives • http://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm Who determines the money supply? How does the central bank’s balance sheet differ from the balance sheets of other banks? What is the monetary base?

  3. Assets • Government securities • Provides income • Liquidity • Discount loans • Loans made to commercial banks • Assets earn interest Liabilities • Currency • Reserves • Commercial bank reserves held at Fed • Liabilities are costless

  4. Money supply is determined by the interaction of four groups: commercial banks and other depositories, depositors, borrowers, and the central bank. MB = C + R Monetary Base = Currency + Reserves

  5. MB = C + R Monetary Base = Currency + Reserves C = Currency = Notes + Coins (non-bank) R = Reserves = Vault cash + Reserves on deposit at Fed R = Reserves = Required reserves + Excess reserves Monetary Base = Currency + Vault cash + Reserves on deposit at Fed Monetary Base = Currency + Required reserves + Excess reserves

  6. Central bank increases monetary base: buys a security Note, however, that in any case the MB increases by the amount of the purchase because either C or R increases by the amount of the purchase. Keep in mind that currency in circulation means cash no longer in the central bank.

  7. Central bank decreases monetary base: sells a security When the central bank sells an asset, the MB shrinks because C (and/or R) decreases along with the central bank’s securities holdings and banks or the nonbank public own more securities but less C or R.

  8. Central bank increases monetary base: loans to a bank Central bank decreases monetary base: bank repays loan

  9. Simple Deposit Multiplier Formula ∆D = (1/rr) x ∆R • ∆D: change in deposits • ∆R: change in reserves • rr: required reserve ratio

  10. Simple Deposit Multiplier Formula ∆D = (1/rr) x ∆R The central bank can control the multiplier by changing the reserve requirement (rr): As rr increases, ∆R has less effect on ∆D As rr decreases, ∆R has more effect on ∆D

  11. Simple Deposit Multiplier Formula ∆D = (1/rr) x ∆R Weakness of the model: • banks hold excess reserves and • people prefer to hold cash

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