Class 13 - Econ 350 U.S Financial Systems Markets and...

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U.S. Financial Systems, Markets and Institutions Class 13 Econ 350 U.S. Financial Systems, Markets, and Institutions Class 13: Monetary policy: the money creation process The money creation process? Does this sound too good to be true? How can I get in on the action? While it is not possible for individuals to create money (Doh!), it is possible for the banking system as a whole to create money through the process of the lending of excess reserves. The Fed can influence the money creation process through the mechanism of open market operations. If the Fed purchases securities from a bank, then the reserves of the bank increase by the amount of the purchase. Since demand deposits are unaffected, these reserves are excess reserves which can be lent out by the bank. This lending may create a deposit in a different bank, which then gains additional excess reserves. By influencing the quantity of bank reserves, open market operations can have effects on the money supply process and interest rates. Today’s class provides a basic introduction to the structure and dynamics of the monetary policy process. We will continue the lessons in the next few classes. Course Objectives After today’s class, you should -- know the major actors in the monetary policy process. -- understand the importance of excess reserves to the money creation process. -- be familiar with the balance sheet of the Federal Reserve System. -- be able to record the effects of open market operations on a bank’s and the Fed’s balance sheets. -- understand the significance of reserve requirements to the money creation process. -- know the money multiplier and formula in the simple deposit expansion model. -- comprehend the mechanics of money creation. The Actors of the Money Supply Process In describing the process of monetary policy, we will start with the basics and build from there. First, there are four actors in the money supply process. The decisions of each influence the quantity of money in circulation. The players include 1. The central bank. In the United States, the central bank is the Federal Reserve System. The Fed influences the money supply by controlling the amount of reserves in the banking system through open market operations, by establishing the discount rate, and by setting reserve requirements. In addition, the general level of interest rates influences the opportunity cost of holding excess reserves for banks. 2. Commercial banks. Banks make loans by lending out excess reserves. The level of excess reserves that banks want to hold will help to determine the amount of lending that occurs. The more excess reserves that banks want to hold, then the less will be the amount of lending in the banking system. 112
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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.

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Class 13 - Econ 350 U.S Financial Systems Markets and...

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