Class 14 - Econ 350 U.S. Financial Systems, Markets and...

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Econ 350 U.S. Financial Systems, Markets and Institutions Class 14 Econ 350 U.S. Financial Systems, Markets, and Institutions Class 14: Determinants of the Money Supply In today’s class, we continue our discussion of the money creation process that we started last time. We will look at the determinants of the money supply and how the different actors in the monetary policy process can influence the money supply. We relax the assumptions of the banking system that we made in the last class, and then explore the factors that help to determine the money creation process. We further examine the concept of the monetary base, and how changes in the monetary base can lead to multiplied changes in the money supply. The notes for today will be relatively short compared to most classes, but also relatively dense. Course Objectives After today’s class, you should -- know the determinants of the money multiplier m. -- understand the relationships between the money supply, money multiplier, and monetary base. -- know the roles that each of the actors play in the money supply process. -- learn about the non-borrowed monetary base and discount loans. -- begin to understand the market for bank reserves. Review Let’s start with a review of some of the concepts from last class. The major actors in the monetary supply process are the Federal Reserve Banks (the Fed), member commercial banks (banks), depositors, and borrowers. The monetary base (MB) is the sum of the Federal Reserve and Treasury’s monetary liabilities. MB = C + R; where C = currency (or cash if you include coins) and R = reserves. R = RR + ER RR = r x D In the simple model, D = (1/r) x R In the simple model, we assumed that there were no time deposits, no excess reserves, and no cash drain. We will relax those assumptions now. When the Fed makes an open market purchase, it has little control over whether the proceeds of that purchase are kept as deposits (which create reserves) or as currency 123
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Econ 350 U.S. Financial Systems, Markets and Institutions Class 14 (which does not create reserves). Thus, the Fed has more control over the monetary base as a whole than it does over the quantity of reserves. Open Market Operations will change either currency or reserves MB = C + R A change in currency or reserves changes the monetary base. Because of cash drain, the Fed has more control over the monetary base than over the quantity of reserves. Deriving the Money Multiplier Here, when we discuss the money supply, we are talking about M1. Remember that M1 includes cash and checks essentially. Since we are dealing with M1, we will again assume for now that banks hold no time deposits (or savings accounts). So M = M1 = C + D The money supply is the sum of currency (C) and demand deposits (D). The simple multiple deposit expansion model of the last class showed the relationship
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This note was uploaded on 05/09/2009 for the course ECON 350 taught by Professor Christianson during the Spring '08 term at Binghamton University.

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Class 14 - Econ 350 U.S. Financial Systems, Markets and...

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