16 Monetary Policy_ Part 1

16 Monetary Policy_ Part 1 - Agenda Principles of Money...

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1 16-1 Monetary Policy and the Federal Reserve System, Part 1 16-2 Agenda • Principles of Money Supply Creation • The Federal Reserve System • Monetary Policy Tools 16-3 Money Creation • Three groups affect the money supply: ¾ The central bank conducts monetary policy. ¾ Depository institutions (banks) accept deposits and make loans. ¾ The public (people and firms) holds money as currency and coin and as bank deposits. 16-4 Money Creation • A central bank can print money: ¾ Central bank can print money to buy real assets from the public. • This is how money gets into circulation. • People accept money if they believe other people will accept it in exchange. • The government usually decrees that the paper money is legal tender .
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2 16-5 Money Creation • A central bank can print money: ¾ The central bank’s assets are the real assets it buys from the public. ¾ The central bank’s liabilities are the money it issued to the public. • That money is called the monetary base , or high- powered money 16-6 Money creation • Required conditions for money creation: ¾ The equivalence of cash and deposits. ¾ The redeposit of loan proceeds. ¾ The holding of (fractional) cash reserves. ¾ The presence of willing borrowers. ¾ The presence of willing lenders. 16-7 The monetary base • Definitions: ¾ BASE = CU + RES, where • BASE = Monetary Base, • CU = Currency held by the non-bank public, and • RES = Reserves held by banks. ¾ Required reserves. ¾ Excess reserves. 16-8 The monetary base
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3 16-9 Currency • Definitions (continued): ¾ CU = cu DEP, where • DEP = deposits and cu > 0 and is called the currency holding ratio. – Determined by the public. ¾ Currency held is a proportion of deposits. 16-10 Bank reserves • Definitions (continued): ¾ RES = res DEP + ex DEP, where • DEP = deposits and •0 < res < 1 and is called the required reserve ratio. – The legal minimum, determined by the central bank. •0 < ex < 1 and is called the excess reserve ratio. – Above the legal minimum, determined by banks. ¾ Reserves held are a fraction of deposits. 16-11 The monetary base and deposits • Relationships: ¾ BASE = CU + RES ¾ BASE = cu DEP + res DEP + ex DEP ¾ BASE = ( cu + res + ex )DEP •o r ¾ DEP = BASE/( cu + res + ex ) 16-12 The money supply • Definitions: ¾ M = CU + DEP, where • M = Money supply ¾ M1 = currency + checking deposits. ¾
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4 16-13 The money supply • Relationships (continued): ¾ M = CU + DEP ¾ M = cu DEP + DEP ¾ M = (1 + cu )DEP 16-14 The money supply and the monetary base • Relationships (continued): ¾ If M = (1 + cu )DEP and DEP = BASE/( cu + res + ex ), then: ¾ M = (1 + cu )BASE/( cu + res + ex ) ¾ M = [ (1 + cu )/( cu + res + ex ) ] * BASE 16-15 The money multiplier •Th
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16 Monetary Policy_ Part 1 - Agenda Principles of Money...

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