Chapter 17 the Money Supply Process I 3 Players in the Money Supply Process a Central Bank i The government agency that oversees the banking system and is responsible for the conduct of monetary policy in the US is the FED b Banks Depository Institutions i The financial intermediary that accept deposits from individuals and institutions and make loans commercial banks savings and loan associations mutual savings banks credit unions c Depositors II The Fed s Balance Sheet i Individuals and institutions that hold deposits in banks a Liabilities increase in this will lead to increase of money supply i Monetary Base sum of Fed s monetary liabilities currency in circulation and reserves and the US Treasury s monetary liabilities treasury currency in circulation and primary coins 1 Mostly refer to the Fed because the treasurer account for very small percent less than 10 ii Currency in Circulation amount of money in the hands of the public iii Reserves physically held by banks vault cash consists of deposits at the Fed plus currency that is 1 Assets for the banks liabilities for the Fed 2 Required reserve reserve the banks are required to hold 3 excess Reserves amount that is excess of reserve a 10 requirement 1 Changes in the asset items lead to changes in the reserves monetary base and thus changes in money supply 2 assets earn interest ii Government Securities securities issued by the US Treasury 1 Can provide reserves to the banking system by purchasing securities increasing its assets Leads to increase in money supply borrowing from the fed so banks can meet reserve iii Discount Loans requirement increase leads to increase in the money supply 1 2 called Discount rate equals currency in circulation plus the total reserve in the b Assets i Importance III Control of the Monetary Base a Monetary Base banking system i MB C R 1 MB Monetary Base 2 C Currency in Circulation 3 R Total reserves in the banking system ii Fed controls MB through purchase or sale of government securities in the Open Market Operations and through its extension of discount loans to banks b Federal Reserve Open Market Operations i Open Market Purchase ii Open Market Sale iii Open Market Purchase form a Bank purchase of bonds by the Fed sale of bonds by the Fed 1 Bank Balance Sheet Increasing in Cash by amount in assets a b Decrease in Securities by amount in assets 2 Fed Balance Sheet a b Increase in Asset Securities Increase in Liabilities Reserves 3 Monetary Base also increases by amount iv Open Market Purchase from the Nonbank Public v READ 414 420 IV Multiple Deposit Creation additional reserves deposits increase by a multiple of this amount INCREASE is the reciprocal of the reserve requirement a Multiple Deposit Creation Fed Supplies the banking system with x if b i 10 so it will be a 10times the initial increase c Simple Deposit Multiplier i D 1 r R 1 D Change in total checkable deposit I the banking system 2 3 R change in reserve for the banking system r required reserve ratio V Factors that Determine the Money Supply a Changes in the Non Borrower Monetary Base MBn Increase in MBn is from an open market purchase i ii Money Supply is positively related to the nonborrowered monetary base MBn b Changes in the Borrower reserves BT from the Fed i The money supply is positively related to the level or borrowered reserves BR from the Fed c Changes in the reserve ratio r i Money supply is negatively related to the required reserve ratio r d Changes in Currency Holdings e Change in excess reserves i Money Supply is negatively related to currency holdings i Money supply is negatively related to the amount of excess reserves VI Overview of the Money Supply Process a Chart on page 428 VII The Money Multiplier a Tells one how much the money supply changes for a given change in the monetary base b M m MB i M money supply M1 C D ii m money multiplier iii MB monetary base c Deriving the Money Multiplier i c currency ratio C D 1 C currency holdings 2 D checkable deposits ii e excess reserves ratio ER D 1 ER excess reserve 2 D Checkable Deposits iii R RR ER iv RR r D 1 R amount of reserves in the banking system 2 RR required reserves 3 ER excess reserves 1 RR amount of reserves in the banking system r required reserve ratio 2 3 D Checkable deposits v R r D ER vi MB R C r D ER C 1 MB Monetary Base vii MB r D e D c D D r e c viii m 1 c r e c 1 m money multiplier ix Money multiplier of x tells us that a 1 increase in the monetary base leads to a x increase in the money supply M1 x