9) moneysupply

9) moneysupply - Money Supply and Money Demand UCLA Winter...

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Money Supply and Money Demand UCLA Winter 2008 Professor Mark Wright
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In this section, you will learn… z how the banking system “creates” money z three ways the Fed can control the money supply, and why the Fed can’t control it precisely z Theories of money demand a portfolio theory a transactions theory: the Baumol-Tobin model
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Banks’ role in the money supply z The money supply equals currency plus demand (checking account) deposits: M = C + D z Since the money supply includes demand deposits, the banking system plays an important role.
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A few preliminaries z Reserves ( R ): the portion of deposits that banks have not lent. z A bank’s liabilities include deposits, assets include reserves and outstanding loans. z 100-percent-reserve banking : a system in which banks hold all deposits as reserves. z Fractional-reserve banking : a system in which banks hold a fraction of their deposits as reserves.
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SCENARIO 1: No banks With no banks, D = 0 and M = C = $1000.
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SCENARIO 2: 100-percent reserve banking ± After the deposit, C = $0, D = $1,000, M = $1,000. ± 100%-reserve banking has no impact on size of money supply. FIRSTBANK’S balance sheet Assets Liabilities reserves $1,000 deposits $1,000 ± Initially C = $1000, D = $0, M = $1,000. ± Now suppose households deposit the $1,000 at “Firstbank.”
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FIRSTBANK’S balance sheet Assets Liabilities reserves $1,000 $200 loans $800 The money supply now equals $1,800: –Depositor has $1,000 in demand deposits. –Borrower holds $800 in currency. deposits $1,000 SCENARIO 3: Fractional-reserve banking • Suppose banks hold 20% of deposits in reserve, making loans with the rest. • Firstbank will make $800 in loans.
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SCENARIO 3: Fractional-reserve banking FIRSTBANK’S balance sheet Assets Liabilities reserves $200 loans $800 deposits $1,000 Thus, in a fractional-reserve banking system, banks create money . Thus, in a fractional-reserve banking system, banks create money . The money supply now equals $1,800: –Depositor has $1,000 in demand deposits. –Borrower holds $800 in currency.
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SECONDBANK’S balance sheet Assets Liabilities reserves $800 loans $0 $160 $640 SCENARIO 3: Fractional-reserve banking • Secondbank will loan 80% of this deposit.
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This note was uploaded on 03/02/2010 for the course ECON ECON 102 taught by Professor Ohanian during the Winter '09 term at UCLA.

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9) moneysupply - Money Supply and Money Demand UCLA Winter...

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