Chapter 7 - Multiple Deposit Creation and the Money Supply Process

Chapter 7 - Multiple Deposit Creation and the Money Supply Process

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Unformatted text preview: Chapter 7 Multiple Deposit Creation and the Money Supply Process A. The Central Banks Balance Sheet The central bank the government agency that oversees the banking system and is responsible for the conduct of monetary policy; in the United States, it is called the Federal Reserve System. The operation of the Fed and its monetary policy involve actions that affect its balance sheet, its holdings of assets and liabilities. The following is a simplified balance sheet that includes just four items that are essential to our understanding of the money supply process. Liabilities: The two liabilities on the balance sheet, currency in circulation and reserves, are often referred to as the monetary liabilities of the Fed. Currency in circulation : the amount of currency in the hands of the public. Reserves : all banks have an account at the Fed in which they hold deposits. Reserves consist of deposits at the Fed plus currency that is physically held by banks (called value cash because it is stored in bank vaults). Reserves are assets for the banks but liabilities for the Fed. Central Bank Government securities Discount loans Currency in circulation Reserves Assets Liabilities 7-1 Total reserves = Required Reserves (reserves that the Fed required banks to hold) + Excess Reserves (any additional reserves the banks choose to hold) Monetary base(MB) : the sum of the Feds monetary liabilities (currency in circulation + reserves) and the U.S. Treasurys monetary liabilities (primarily coins). When discussing the monetary base, we will focus only on the Feds monetary liabilities since U.S. Treasurys monetary liabilities account for less then 10% of the base. Thus MB = C + R Assets: There are two assets of the Feds balance sheet: Government securities: this category of assets covers the Feds holdings of securities issued by the U.S. Treasury. Discount loans: The Fed can provide reserves to the banking system by making discount loans to banks. An increase in discount loans can also be the source of an increase in the money supply. The two assets on the Feds balance sheet are important for two reasons: 1. Changes in the asset items lead to changes in reserves and consequently to changes in the money supply. 2. Because these assets earn interest while the liabilities do not, the Fed makes billions of dollars every year. B. Control of the Monetary Base The Fed exercises control over the monetary base through: Its purchases or sales of government securities in the open market, called open market operations. Its extension of discount loans to banks. 7-2 a. Open market operations This is the primary way that the Fed causes changes in the monetary base. A purchase of bonds by the Fed is called open market purchase, and a sale of bonds by the Fed is called an open market sale....
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Chapter 7 - Multiple Deposit Creation and the Money Supply Process

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