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This relationship is called the reserve multiplier

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Unformatted text preview: d more emphasis on controlling monetary growth by operating on the primary determinant of the supply of money: namely, the volume of reserves that banks and thrifts have at their disposal. Before then the operating procedure for controlling money had worked principally through the demand for money. (Before the fall of 1982, the Fed had placed equal weight on the performance of the M1 and M2 measures of money relative to their targets. Beginning in October 1982, however, the FOMC placed less weight on the behavior of M1 because of concern that Institutional distortions and an unusual change in velocity in 1982 had reduced its usefulness as an indicator and target of monetary policy. With M1 given less emphasis, the Committee decided to place substantial weight on the broader aggregates, M2 and M3, in the belief that their performance relative to economic activity would be more predictable.) An operating procedure focusing on reserves is subject to some uncertainties of its own. These stem in part from variability in the average relationship between reserves outstanding and the amount of checkable deposits that will be created. This relationship is called the reserve multiplier, and depends on reserve requirements, among other things. In the simple example of money creation in Section I, the multiplier was just the inverse of the required reserve ratio. In reality, things are a little more complicated. Because some liabilities of banks and thrifts other than checkable deposits also have reserve requirements, the amount of reserve available to support checkable deposits rises or falls depending on the outstanding amounts of those other reservable liabilities. A decrease in these other reservable liabilities would increase the amount of reserves that can support checkable deposits; an increase would have the opposite effect. Consequently, checkable deposits–and hence the money supply can rise or fall even though total reserves outstanding are unchanged because the multiplier has changed. A similar problem occurs when reserves are transferred among institutions with different reserve requirements becau...
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This note was uploaded on 12/30/2010 for the course SOC 101 taught by Professor Zhung during the Spring '10 term at Punjab Engineering College.

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