12. monetary policy

12. monetary policy - Monetary Policy 4 November 2010 1...

Info iconThis preview shows pages 1–4. Sign up to view the full content.

View Full Document Right Arrow Icon
Monetary Policy 4November2010 1 Reading Chapter 14 of Abel/Bernanke/Croushore Chapter 11 of Dornbusch/Fischer/Startz Ben S. Bernanke and Vincent R. Reinhart, Conducting Monetary Policy at Very Low Short—Term Interest Rates, paper presented at the meetings of the Amer- ican Economic Association, Jan 3, 2004 (available at www.federalreserve.gov) 2 Fractional Reserve Banking and Money Supply Previously we take that the (nominal) money supply is at the pure discretion of the central bank. This is not exactly true. Commercial banks and the non-bank general public also play a role in determining the amount of nominal balance in circulation. The central bank issues currency and use the proceeds to buy assets from banks and the economy at large to get the currency into circulation. Historically the assets were mostly gold and other precious metals. More recently in the U.S. Figure 1: Money Supply 1
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
and other advanced industrial economies, the assets are predominantly short— term government securities. In some other countries, the assets are mostly U.S. currencies and U.S. dollar—denominated assets. The currency issued is considered as the central bank’s liability because cur- rency, technically speaking, is the debt obligations of the central bank: By design and in theory, the public can demand the central bank to return the assets it previously acquired with their holdings of the currency issued by the central bank. The liability of the central bank is the monetary base of the economy, sometime known as high—powered money. Central Bank’s Balance Sheet Assets Liabilities Non-monetary assets Currency If the general public holds onto the currency issued by the central bank in entirety, the monetary base is also the economy’s money supply — the quantity of money in circulation. For a variety of reasons, people choose to deposit a substantial fraction of money holding in commercial banks. The commercial banks can choose to just do nothing with the deposits. In this case the bank’s asset is the currency acquired and its liability just the same amount of deposits. Commercial Bank’s Balance Sheet (100% reserve) Assets Liabilities Currency Deposit Because the public can write checks against their deposits in banks to pay for purchases, deposit is part of the money supply. The whole of money supply is equal to the dollar value of currency held by the non-bank public and the amount of funds the public have previously deposited in banks. If banks choose to hold onto all currency received from depositors, the monetary base remains the economy’s money supply. Commercial Banks’s Balance Sheet (fractional reserve) Assets Liabilities Currency (reserve) Deposit Loans In reality, banks do not just let their deposits sitting idle but loan a substan- tial fraction out to earn interest income. The amount of deposits (currency) 2
Background image of page 2
kept within banks for meeting the demand for withdrawal is known as banks’ reserves. In this case,
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 4
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 15

12. monetary policy - Monetary Policy 4 November 2010 1...

This preview shows document pages 1 - 4. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online