Lecture09_fall2009

# Lecture09_fall2009 - Review: Bank panics as cause of...

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1 Review: Bank panics as cause of Depression • Series of bank failures in 1930. Depositors lost savings. • Fear of further failures encouraged the conversion of bank deposits into currency. • A falling D/C ratio reduced the “money multiplier” and, therefore, money supply. • Falling money supply increased the interest rate, reducing investment . Money multiplier: Definitions DEFINITIONS: Money supply = Stock of money held by public (M) = currency (C) + deposits (D) Money base (B) = currency (C) + reserves (R). Note: C and R are policy levers of the Central Bank. Using definitions - M/B = (C+D)/(C+R) Divide numerator and denominator of RHS by C and R & multiply by D. Bring B to the RHS. - M = B * [(D/R)(1+D/C) / (D/R+D/C) ] Money multiplier

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2 Working with the money multiplier • Multiplier is number of dollars of money supply that can be created for every dollar of monetary base • Money multiplier = [(D/R)(1+D/C) / (D/R+D/C)] • Multiplier is greater than one if: – D/R >1 (fractional reserves)… some deposits are loaned out. – D/C > 0 … consumers deposit some money in banks. • Show that multiplier is minimized (= 1) if D/R =1 or D/C =0. Therefore, as D/R or D/C fall, multiplier falls. Bank panics and money multiplier Money multiplier = [(D/R)(1+D/C) / (D/R+D/C)] Source: Friedman and Schwartz, 1971 • We can use the values here to calculate the money multiplier in 1929 & 1931. • 1929 = 6.5 • 1931 = 4.2 D/R D/C
3 Money demand Money supply (1) Money supply (2) Interest rate R (2) R (1) Bank panics: The effect of a reduction in the money supply on interest rates

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## This note was uploaded on 01/25/2010 for the course ECON 183 taught by Professor Boustan during the Fall '09 term at UCLA.

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Lecture09_fall2009 - Review: Bank panics as cause of...

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