Notes for 3rd Part of Econ 330 Ch 17 The Money Supply Process Formulas Mb C R Key Terms Borrowed Reserves the non borrowed monetary base is formally defined as the monetary base minus borrowings from the Fed Discount Rate interest rate charged to banks on loans from the Fed Excess Reserves Additional reserves the banks choose to hold Float the temporary net increase in the total amount of reserves in the banking system occurring from the Fed s check clearing process High Powered Money Monetary base currency in circulation total reserves in a banking system Monetary base Sum of the Fed s Monetary Liabilities currency in circulation and reserves and the U S treasury s monetary liabilities Treasury currency in circulation primarily coins Money Multiplier a concept which tells use how much the money supply changes for a given change in the monetary base Multiple Deposit Creation the process when the Fed supplies the banking system with 1 of additional reserves deposits increase by a multiple of this amount Nonborrowed Monetary Base the tightly controlled component of monetary base that is controlled by open market operations Open Market Operations The Fed s control over monetary base through its purchase or sale of securities in the open market Open Market Purchase Purchase of bonds by the Fed Open Market Sale Sale of Bonds by the fed Required Reserve Ratio a fraction of the amount of deposits the Fed requires a bank to hold Required Reserves Reserves the Fed requires banks to hold Reserves deposits at the Fed plus currency that is physically held by banks vault cash Simple Deposit Multiplier the multiple increase in deposits generated from an increase in the banking systems reserves Notes Three Player in the Money Supply Process o Central Bank Fed most important o Banks o Depositors The Fed s Balance Sheet o Assets Securities and Loans to Financial Institutions Earn higher interest then the liabilities so Fed makes Securities Increase of holding increases Money Supply Loans to Financial Insitituions increases the Money Supply Charges a discount rate o Liabilities Currency in Circulation and Reserves Increase in either leads to increase in the money supply Feds monetary liabilities and the Treasuries monetary liabilities are the monetary base Fed s base is larger and more important Currency in Circulation Money aka IOU s from Fed Reserves Banks have an account with the Fed reserves Include reserves and vault cash Control of the Monetary Base o Also called high powered money Mb Currency in circulation Reserves in Banking system o Control the MB through open market operations and discount loans Open Market Operations purchase and sale of securities Purchase from a bank T Accounts o Banking System Securities down 100 and o Fed Securities assets up 100 and Reserves Reserves up 100 liab up 100 No change in currency but Mb increases Purchase from nonbank public o Nonbank Securities down 100 and Checkable deposits up 100 both assets o Banking System Checkable deposits up 100 and Reserves up 100 o Fed Securities assets up 100 and Reserves liab up 100 But if they deposit in a bank or Fed Nonbank Securities down 100 and currency up 100 Fed Securities up 100 and Currency up 100 o Open market purchase on reserves depends on whether the seller of the bonds keeps the proceeds from the sale in currency or in deposits o Open Market Purchase on the Mb same increases by the amount of the purchase o Nonbank Securities increase 100 and currency o Fed Securities decrease 100 and currency decrease 100 decreases 100 Monetary base effect is much more certain than the effect on reserves Sale Shifts from Deposit in Currency Nonbank checkable deposits decreases 100 and currency increases 100 Banking System Reserves decrease 100 and checkable deposits decrease 100 Fed Currency increases 100 and reserves decreases 100 o Mb stays the same but reserves changes Loan to Financial Institutions Simple affect increases Mb but when pays it off goes back down o Is a one for one change Other factors affecting Monetary Base Float the temporary net increase in the total amount of reserves in the banking system occurring from the Fed s check clearing process o Because credits before it debits check Treasury deposits at Fed decreases Mb and reserves from outflow from bank Overview of the Fed s Ability to control the Monetary Base Two parts of Mb o Less tightly controlled do not really affect Fed from controlling monetary base Float and Treasury deposits o Nonborrowed Reserves more tightly controlled From Open market operations Borrowed Reserves Nonborrowed Monetary Base Mb Borrowed Reserves Multiple Deposit Creation o Deposit Creation The Single Bank When it sells securities to the Fed for Reserves Banks can use these reserves which are excess to make loans Banks cannot safely make a loan for an amount grater than the excess reserves it has before it makes the loan o Deposit Creation The Banking System As funds transfer from banks reserve requirements force them to hold some in reserves and the rest is lent out For a 10 Reserve Requirement a 100 increase reserves will be a 1000 increase in deposits This is the same for whether a bank lends the money or buys securities o This is called the simple deposit multiplier Change in Deposits 1 RR Change in reserves Banking System for the 100 increase in reserves o Assets Securities decrease by 100 Reserves increase by 100 and loans increase by 1000 o Liabilities Checkable deposits increase by 1000 o Critique of Model Banks and depositors may not loan it all out so the Fed is not the only player in this Factors that Determine the Money Supply o Changes in the Nonborrowed Monetary Base MBn Money Supply is positively related o Changes in Borrowed Reserves BR from the Fed Money Supply is positively related to the level of borrowed reserves o Changes in the Required Reserve Ratio rr Money Supply is negatively related to the rr o Changes in Currency Holdings Money Supply is negatively related to currency holdings o Changes in Excess Reserves Money Supply is negatively related to the amount of excess reserves Overview of the Money Supply Process o Fed Nonborrowed monetary base and rr o Depositors decision to hold currency o Banks Borrowings from Fed and Excess Reserves The Money Multiplier larger change in money supply why its called high powered money o Deriving the Money Multiplier use notes from class Money Multiplier Money Monetary Base Currency ratio Currency Checkable deposits Excess