Week4.ppt - ECF2331 Topic 4 Central Banks and Money Supply...

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Unformatted text preview: ECF2331 Topic 4 Central Banks and Money Supply Introduction to Central Banks fi Mon oy Supply Process Federal Open Market Committee (FOM C) it Open market operations The purchase and sale of government securities that affect interest rates and reserves. 3* Federal funds rate The federal funds rate is the interest rate on overnight leans from one bank to another The Fed's decision to increase the federal funds rate is referred as a tightening of monetary policy The Fed's decision to decrease the federal funds rate is referred as an easing of monetary policy F- l'vlishkin {the prescribed textbook} focuses on the US Federal Reserve System The US Fed's Balance Sheet Federal Reserve System @ Liabilities Securities Currencyr in eireulatien = depesits held by banks at the Fed + . . I Lei-ins te Financial Reserves Institutiens {it the disceunt rate Required Reserves Disteunt Rate reserves that the Fed re atres hanks interest rate charged hi: the Fed te held {er Jeans niae'e te hanks i Esress Reserves ae'e'i'tr'enair reserves hanks cheese te held Federal Funds Rate interest rate char ed when hanks Reanred RESEWE Rat“? {RR} herrew reserves everni'ght {rem ether the firemen at each 5 degesr't that mast hanks he held as reserves The Monetary Base (High-Powered Money) lEurrencjllr in l[Zirculation MB Total Reserves in Banking System The Fed controls over the monetary.I base through its purchases or saies of securities in the open market. and through its extension of discount loans to banks. Open Market Operations is The mdst impdrtant way in which the Fed changes the rnc-netarjiur base is thrcuugh its purchase c-r sales at bends in the dpen market. caiied open market operations. is A purchase at trends by the Fed is called an open market purchase. Fr A sale c-ftidnds by the Fed is calied an open market sale. Fr Basic Idea - A purchase cufhcnnds increases mcnnetary' base A saie dfhc-nds decreases n1dnetar].r hase Open Market Purchase from a Bank is Suppose the Fed purchases $1DD millien c-fhcunds from a bank s The Fed pays the bankwith a cheque df$1flfl millidn Banking System: The Fed : _ additic-nal $1Dflm reserves - mc-re liabilities [$1flflm reserves} _ less hculdings dfsecurities df$1flflm - mc-re assets [$1flflm werth c-fsecurities} Banking System Central bank [The Fed] Assets Liabilities $55515 Liabilities Securities -$ lfl'flIfl Securities +$lflflm Reserves +$1liiin1 Reserves +$lflfl1zn Is Net Result = an increase in reserves by $10!? millic-n witheut changes in cu rrencv in circulatien Is As a result cufthis cupen market purchase. menetafl lsase increases by slut} millien Open Market Purchase from the Nonbank Public The Feci urchases ‘Iflflm of bonds from ec- le or firms 3.: a s for them with che ues {I} People or firms selling bonds {II}I People or firms selling lacuntls deposit the Fed’s cheques in banks coshl the Fed’s cheques melee: Reserves +5le Chechhle filflflm deposits Centralhlokme Fed} I'Irlonetaryr base 'I' by $1flum Monetary “53 T 113' “Wm clue to T reserves due to l' currency in circulation Open Market Sale The Fed sells $1DD millien c-fhcunds either te hanks er the nenhank public Either reserves er currency in circulatien will he reduced. depending en whether the buyers pay fer hends with cheques erwith currency As a result. menetary base will he reduced by the ameunt efthe sale Open Market Operation: Summary It? Overall. the effect df epen market dperatic-ns en the menetary hase. threugh hdth purchases and sales. is much mere certain than the effect an reserves. :e The Fed can centrel the menetary base with epen market c-peratic-ns mere effectively than it can centrel reserves. Shifts from Deposits into Currency Suppose the public withdraws $100 million from bank deposits held at their local banks. mew —_ -$lfli}m Rem -$1fl-l}n1 Cheekable -$lflflm dcpoaits - I nfiylfl +$1Dflm } ND FIEt EffEEt fin emulates monetary base. —‘ Loans to Financial Institutions Suppose the Fed lends a bank $1DD million Banking System Reserves +$1flflm Loans +$lflflo1 Federal Reserve System Loans +$1flflm Reserves +$1flflm ‘ ltr'lonetaryr base increases by $100 million The Fed’s Ability ta Central the Menetary Ease J Daes the Fed central Dean Market flaeretlens? K Daes the Fed central the emeunt ef herrewlngs by banks? ME = Mfln+ BR where Mfln= nan—learrewed meneteryr base EH = harrewed reserves frem the Fed The Fed can't central ER as tightly: as it centrals Mfi'n M3,, = MB - HR = {c + s) - as: = {c + memes} - 3s =C+NBH Deposit Multiplier 5-“- An increase in reserves leads to an increase in checkahle deposits 1-“- Multiple Deposit lcreation : For every' $1 of additional reserves supplied to the banking system deposits increase by a multiple of this amount [i.e. greater than $1}. This process is called multiple “deposit creation. 5-“- Simple Deposit Multiplier : The multiple increase in deposits generated from an increase in the banking svstem’s reserves. 5-“- Simple Deposit Multiplier equals the reciprocal of the required reserve ratio [i.e. 1hr] For example. if rr = 1D%. the simple deposit multiplier equals 1D. This means that a $1 increase in reserves leads to a $1D increase in deposits. The Money Multiplier 3-“- Define meney as currency plus checkahle depesits. e.g. M1 3-“- The meney supply {M} can be linked tn the menetary base {MB} using the fellewing espressien: y M=<En>xma meney multipiier 3-“- Since mH. an increase in menetary base MB leads te an even greater increase in the rnc-ney supply M. Is- The fact that the rneney multiplier mH is the reasen 1why the menetary lease is called "high—pewered meney:. ...
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