Chapter19 - CHAPTER19 MoneySupply,MoneyDemand...

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Chapter Nineteen 1 CHAPTER 19 Money Supply, Money Demand  and the Banking System ® A PowerPoint Tutorial To Accompany   MACROECONOMICS, 7th. Edition N. Gregory Mankiw Tutorial written by: Mannig J. Simidian B.A. in Economics with Distinction, Duke University  M.P.A., Harvard University Kennedy School of Government M.B.A., Massachusetts Institute of Technology (MIT) Sloan School of Management
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Chapter Nineteen 2 To understand the money supply, we must understand the interaction between currency and demand deposits and how the Fed policy influences these two components of the money supply.
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Chapter Nineteen 3 M = C + D Money Supply Currency Demand Deposits In this chapter, we’ll see that the money supply is determined not only by the Federal Reserve, but also by the behavior of households (which hold money) and banks (where money is held).
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Chapter Nineteen 4 The deposits that banks have received but have not lent out are called reserves. Consider the case where all deposits are held as reserves: banks accept deposits, place the money in reserve, and leave the money there until the depositor makes a withdrawal or writes a check against the balance. In a 100-percent-reserve banking system, all deposits are held in reserve; thus the banking system does not affect the supply of money. A Sample 100-Percent-Reserve Bank Balance Sheet Assets Liabilities Reserves $1,000 Deposits $1,000
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Chapter Nineteen 5 As long as the amount of new deposits approximately equals the amount of withdrawals, a bank need not keep all its deposits in reserves. Note: a reserve-deposit ratio is the fraction of deposits kept in reserve. Excess reserves are reserves above the reserve requirement. Fractional-reserve banking , a system under which banks keep only a fraction of their deposits in reserve. In a system of fractional-reserve banking, banks create money. A Sample Fractional-Reserve Bank Balance Sheet Assets Liabilities Reserves $200 Loans $800 Deposits $1,000 Let’s look at how money creation works…
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6 Firstbank Balance Sheet Secondbank Balance Sheet Thirdbank Balance Sheet Assets Liabilities Assets Liabilities Assets Liabilities Reserves $200 Deposits $1,000 Loans $800 Reserves $128 Deposits $640 Loans $512 Reserves $160 Deposits $800 Loans $640 Assume each bank maintains a reserve-deposit ratio (rr) of 20 percent and that the initial deposit is $1,000 . Mathematically, the amount of money the original $1000 deposit creates is: Original Deposit =$1,000 Firstbank Lending = (1- rr ) × $1,000 Secondbank Lending = (1- rr ) 2 × $1,000 Thirdbank Lending = (1- rr ) 3 × $1,000 Fourthbank Lending = (1- rr ) 4 × $1,000 Total Money Supply = [1 + (1- rr ) + (1- rr ) 2 + (1- rr ) 3 + …] × $,1000 = (1 /rr ) × $1,000 = (1/.2) × $1,000 = $5,000 Money and Liquidity Creation (but not wealth creation) . . . The process of transferring funds
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Chapter19 - CHAPTER19 MoneySupply,MoneyDemand...

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