Econ+310+Winter+2010+Topic+3_a_

Econ+310+Winter+2010+Topic+3_a_ - Economics 310 Money and...

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Economics 310 Money and Banking Topic 3(a) The Banking System and the Money Supply
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2 Lecture 1 Reading 9 th ed. – Chapter 14 8 th ed. – Chapters 13 and 14 Assignment Posted to CTools site Please refer to the file of assignment questions included in CTools resources Due Sunday, 5:00pm Please submit files to the CTools site
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3 Lecture 1 Goals in this topic 1. To understand how money is created in the economy 2. To understand the extent to which the central bank is able to control the money supply 3. To understand what other factors may influence the money supply
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4 Lecture 1 The Fed’s Balance Sheet Assets Liabilities Gold and precious  metals Domestic bonds Official Foreign  Reserves (i.e. foreign  currency, foreign assets  etc) Domestic currency in  circulation Reserve Accounts (i.e.  accounts in which banks  hold their reserves)
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5 Lecture 1 Central Bank Liabilities Two major liabilities Currency in circulation Bank reserves Accounts held by banks at the Fed Cash held by banks: “vault money” Central bank liabilities are the most basic forms of liquidity Use various names for these liabilities The money base Base money High powered money
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6 Lecture 1 What is Base Money, and why is it important? Base money: value of the outstanding liabilities of the central bank Essentially the most liquid form of money Base money is linked closely to other measures of the money supply that include less liquid assets E.g. M1, M2 etc. We will develop the “money multiplier” model to understand this connection
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7 Lecture 1 Base money and the M1 measure M1 = Currency + Checkable Deposits Checkable deposits are created by the banking system when loans are issued The quantity of loans issued by banks is limited by the banking system’s need/desire to hold reserves Required reserve ratio is the minimum reserves a bank must hold as a proiportion of deposits The Fed currently requires US commercial banks to hold at least 10% of all deposits in reserve Central Bank can control Quantity of currency outstanding Total quantity of bank reserves Via Open Market Operations (OMOs) Hence the central bank can exercise control over the M1 money supply
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8 Lecture 1 Open Market Operations Central Bank’s purchase or sale assets in the open market Fed’s open market operations are overseen by the FOMC Open market operations change the central bank’s asset holdings Must also change the liabilities outstanding Currency in circulation Bank reserves Since base money is simply the sum of Central Bank liabilities, open market operations will have a direct impact on base money
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9 Lecture 1 Example: Open Market Sale The Fed’s T-account The Fed sells $100-worth of bonds, and receives payment in currency : Assets  Liabilities Securities         -$100 Currency Outstanding   - $100
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10 Lecture 1 Example: Open Market Sale The non-banking public’s T-account The Non-banking public buys $100-worth of bonds from the Fed, and pays with currency : Assets  Liabilities Securities         +$100   Currency     -$100
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