Lecture8 - Economics 310 Money and Banking Topic3(a...

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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 Chapter 14 Chapter 9, pages 207 - 212
3 Lecture 1 Model of Money Supply (M1) M = m H Where M = M1 money supply H = money base m = (1+c)/(r+c+e) What will change the domestic money supply? OMOs that change the money base Changes in r, c or e

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4 Lecture 1 Changes in H An open market operation will change the money base OM purchase will increase H OM sale will reduce H The change in the money base will change the M1 money supply ΔM = ΔH * = ΔH * (1 + c)/(c + r + e)
5 Lecture 1 The required reserve ratio r specifies what proportion of deposits should be held in reserve Holding more in reserve means that fewer loans are made Fewer loans means fewer deposits created The M1 money supply and the money multiplier, m , both fall as r rises.

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6 Lecture 1 The currency ratio The currency ratio, c, specifies the ratio between currency holdings and deposits If c rises, fewer funds are deposited, and so fewer funds are available for lending. Lending falls and fewer additional deposits are created The M1 money supply and the money multiplier, m, both fall as c rises
7 Lecture 1 Excess reserves The excess reserve ratio, e, specifies the proportion of deposits that will be held as excess reserves Money held as excess reserves cannot be lent, and so will not generate new deposits which in turn could be lent out The M1 money supply and the money multiplier, m, both fall as e rises

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8 Lecture 1 Excess reserves But why would banks hold excess reserves, and what will influence them to hold greater excess reserves?
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