Chapter 14

Chapter 14 - Players in the Money Supply Process 0 Central...

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Unformatted text preview: Players in the Money Supply Process 0 Central bank (Federal Reserve System) W‘fi‘éfig ify".{}a’:a-ta sweat; Ci-QC-EQEG‘P-S 0 Banks (depositorV institutions; financial intermediaries) o Depositors (individuals and institutions) PfiEflié -—-‘> sierra-59dmrfi damage as less as a, emf-“'33 ’3" CELZJV‘P~-exic\r‘~lirw’} Saws? 1-593! @323 10/28/2010 10/28/2010 Fed’s Balance Sheet ‘ 0 Monetary Liabiiities — Currency in circulation: in the hands of the public — Reserves: bank deposits at the Fed and vauit cash - Assets — Government securities: hoidings by the Fed that affect money supply and earn interest - Discount loans: provide reserves to banks and earn the discount rate CMWVWW 3w cirgmafigw u - vctéaéflfig) s Vfi‘i‘ir'gr’rjrfl P“ ' -' :Z‘alrir were s are " <23 3.3K? 1 25;”. Reflewes sewage . mm ‘e \) Zagbua‘s’fid — 2)E;4 ease. rates: « Monetary Base High-powered money m 5 flea;— t. 2 J a. tittEKjt’iiri‘tzffit-A, "its: C = currency in circulation R = total reserves in the banking system )6,ng y“ 31K aim: e. 10/28/2010 ‘:s r- x‘wu. r336“ 193%.?“ [email protected]fl»m WWW-Ju— k. -. - \‘1 Open Market Purchase from a Bank ' . a” r a ’ R30 Pure-m see ith Banking System Federal Reserve System Securities +$100 - Net resuit is that reserves have increased by $100 0 No Change in currency 0 Monetary base has risen by $100 M5 :— L Jr 2; =7 0‘ “(A ’Q‘TGWX 355% Q Wt {@{Exéii-E} "i‘ 2.2% 53“»3 Open Market Purchase fromfi Nonbank Public I (ire-m «emewrmi r- ” 3;“ ‘x’UV‘ZM’v‘fiflé (ER-CO Ci“? died“;- gw“ W“: 13:33, , (W, . k“) 7 Banking System Reserves +£100 Checkable +$ 100 deposits Securities +3100 Resees +$100 - Person selling bonds to the Fed deposits the Fed’s check in the bank - Identical result as the purchase from a bank ° 0" m ii\% Federal Reserve ystem ‘" 30ers 33%;;an 55mg: or: Jfixm‘odmi’fi 4: Open Market Purchase from Nonbank Public II * aloe $€.£E§®£ to {,céé‘n NonbankPubiic L305, FederalReserve System Securities —$100 Securities +3100 Currency in +$100 ' circulation o The person seiiing the bonds cashes the Fed's check o Reserves are unchanged o Currency in circulation increases by the amount of the open market purchase 0 Monetary base increases by the amount of the open - market purchase " §Sfiumeu CA5 d€.§70533“{¥7i‘x42% than W‘xe‘éir‘ceaufi it": 5‘ ficw‘fii W\ *m warm?» V‘Mdmg mié’iii’ Open Market Purchase: Summary 0 The effect of an open market purchase on reserves depends on whether the seiier of the bonds keeps the proceeds from the safe in currency or in deposits 0 The effect of an open market purchase on the monetary base always increases the monetary base by the amount of the purchase 7.x, 3 10/28/2010 1.2. :3 Open Market Sale Federal Reserve System Securities -$100 Currency in -$100 circulation Nonbank 1’ublic Seourities +$100 _ - Reduces the monetary base by the amount of the sale - Reserves remain unchanged - The effect of open market operations on the monetary base is much more certain than the effect on reserves Shifts from Deposits into Currency ' ’ .3» < ' i“ an. )3» '—‘ ‘ cage-'5. w . '. *- jog gwi'fi/r sag ting; {*V.B*i-«._Ucw{;§5§§:.@_ fiiégaflgi iii-33w J N013 bank Public C306 - Checkablc —$100 Reserves -$100 Checkable -$100 deposits deposits Net effect Currency +$100 on monetary liabilities Federal Reserve System Currency in +$100 circulation l*\\\0 A it) W‘s?) is zero Reserves are changed by random fluctuations Monetary base is a more stabie variable 10/28/2010 10/28/2010 Making a Discount Loan to a Bank {H «C- 3 - : I. _ $0 fix in loot/ma wt my; met/1% A. Banking System Federal Reserve System Reserves +$100 Discount +$100 Discount $100 Reserves +$ 100 loans loan - (borrowing from Fed) - Monetary liabilities of the Fed have increased by $100 0 Monetary base also increases by this amount - ‘ ,» ! LA r i a i M . ° ’V \h d: {Jigsaws rim/:5 sea. “‘67:; £114”; “’nfiis Vmipl\é5§-*V&u ¥%Ai the, 3‘ “we t:1.3,,f:§£“£.l..j”?t,..i *2“ :- (borrowing from Fed) -' ’n 5m 1! i .‘h \ fi pmmfi 100104 Wfiwgi mag/“3 a; Vegeflrfistéj this} Paying Off a Discount Loan from the Fed Banking System Reserves -$! 00 Discount —$10{) loans 0 Net effect on monetary base is a reduction - Monetary base changes one-for—one with a change in the borrowings from the Federal Reserve System Federal Reserve System Discount $100 loans (borrowing from Fed) {if Mm $.13“; L: 10/28/2010 Other Factors Affecting the Monetary Base 0 Float - Treasury deposits at the Federal Reserve 0 Interventions in the foreign exchange market Fed's Ability to Control the Monetary Base 0 Open market operations are controlled by the Fed o The Fed cannot determine the amount of 3 borrowin b banks from the Fed g y W ’3 YWQH‘fiiZ‘ 2” 0 Split the monetary base into two components ‘7???“ 3 Wm 50% Mg . P E? ’ 4: A} 1-45”, “. MB”: MB - BR - The money supply is positively related to both the non-borrowed monetary base MB” and to the level of borrowed reserves, BR, from the Fed 10/28/2010 Deposit Creation: Single Bank I h Aseeme 6‘3“ "“ a 1' i‘ize "k 1‘ :5 e n. rm 1. .. a \3 Q f,-‘%§Kfl§,&5§ "at « 2 First Natio al Ban gem tom/t av“? smog flax} '91:. vi? _> mun/t2. HOWE aflii'w‘w} {:3 555555,, e «5mm 53 riggiéeéfif J. V. . E; First National Bank Excess reserves increase _ _ _ _ Bank Ioans out the excess reserves Securities $100 _ Creates a checking account _ Borrower makes purchases The money supply has increased toe/m6 “the, £366 -—%1‘3 {we L4- _' d 61‘3") gs ril— S 33‘. ipgw g~$owdé is: woum‘té +6 mag (A of fth @rzjefisen firm”, ifiggsggge (5,. 1; 'i Deposit Creation: The Banking System at - ‘. n a . e .z-L \OG \ as {gifig a s ‘-§~‘€:‘. 2" 2:7,. Reserves +3100 Checkabie +$100 Reserves +$10 Checkable +$100 deposits deposits Reserves +390 Checkable +$90 Reserves +$9 Checkable +3907 deposits deposits 10/28/2010 Table 1 Creation of Deposits (assuming 10% reserve requirement and a $100 increase in reserves) The Formula for Mufitipae Deposit Creation Assuming banks do not hold excess reserves Required Reserves (RR) = Tote} Reserves (R) R = Required Reserve Ratio (7') times the total amount of checkable deposits (D) Substituting T007919 aha-“V1536 Wm" r x D =R 2 Dividing both sides by r Ag; “.1 £1..— u‘“ l D = 1x R 7’ £333 7;; many}: ‘m eeeoé‘vifs Taking the change in both sides yields 1 (I? :72? ' \ 2 e v; fi‘kmb’ihgtg. 2i": fiaéé (’v {if-‘3 ’ d 1 - a. Q»? ~ _ ' ~ A“ xii-ii " {gyrii {" AD_ ;>< AR r. g") (erbmffioi 33‘3me f” \. iv: if“ r” ,w- H» .W . h , 1“ we} g; i 153:“); ,1. A}, a Mrs 10/28/2010 Critique of the Simple Model - Holding cash stops the process — Currency has no multiple deposit expansion - Banks may not use ali of their excess reserves to buy securities or make loans. 0 Depositors’ decisions (how much currency to hold) and bank’s decisions (amount of excess reserves to hold) also cause the money supply to change. Summary Table 1 Money Supply Response 10 ill/K :> :m Q in. 5:; a)??? :6 W\ :7 vhvfilpl lea“ Show“ Bis, “a l a, *- $74-$31“ “’5! wafer") Wka 3‘; ‘g‘ééfl’l‘ap‘; a,” '1? ixvmi I Wm M fl" ME :> [PMS Factors that Determine the Money Supply m em __> 0 Changes in the nonborrowed monetary base flit) tmifiéfltfilé w MBn (In O’nbory‘flweé ffififi ‘GGr‘r‘Csede z: f9 — The money supply is positively related to the ’3‘" _ l‘AE"; Nitm + %R non borrowed monetary base MB” 4‘ man, SW Mg a I? M be.an - Changes in borrowed reserves from the Fed m g)? a? I? W) :7 [rm ma ‘. . we; “We ' ' ' (20?“ w ‘4 H 0‘ his} — The money supply [5 posxtsvely related to the he" was": '5‘Efl .n :1»; 27:3»: - - “red- Ievel of borrowed reserves, BR, from the Fed Factors that Determine the Money Supply g‘ at x V”. "@511"; 3" thfl‘éfi“: “vb I '1 3, 0 Changes in the required reserves ratio gem-o- — The money supply is negatively related to the we required reserve ratio: . H , h w the r {a a seated fl“ 1m 1‘3 "Mi: mt") W353 ‘ ' maggg‘QKChanges In currency holding ’ " \- I (mm/33% The money supply is negatively related to ,._/' 1', ' \f V_ V I X “5 0‘3" currency holdings. .. 0 Changes in excess reserves ’ The money supply is negatively related to the” amount of excess reserves. # Oii\\)'!l'\/V\Y\63 We l1 inf-«aura. 5%) Wesl- fi‘ a" 2 . €¥ {gtz‘ElF-Jag 31> \U wsxjififfb ‘54:}?ng muigflewa alga-GEE (éwfl U; u} i... . 3 ‘5‘? \eee \Fmgvxwl \E; UREA" at? 5:? \U 7 11 C 1 ‘ “= n . ~ «a ‘- . \ 93C) \fjfg, '"fl/XQE‘J, fill/7: -4 } J‘— f' “Vi "r ‘ - I E ' ‘1 ' "I'd 6% 03/39 Y8€60f€€> Oi” if {6/1 U5} W0 i0: mg; . The Money Multiplier 0 Define money as currency pius checkable deposits: M1 0 Link the money supply (M) to the monetary base (MB) and let m be the money multiplier MszMB b7 W\ = Q'Eexceee (NW- f3“) Deriving the Money Multiplier I Assume that the desired holdings of currency C and excess reserves ER grow proportionaliy with checkable deposits D. Then, 0 = {C/D} : currency ratio 8 = {ER/D} : excess reserves ratio is \i‘a"w~°:,\f‘-€5ri}{zf i 12 Deriving the Money Multiplier II The total amount of reserves (R) equals the sum of required reserves (RR) and excess reserves (ER). R = RR + ER The total amount of required reserves equals the required reserve ratio times the amount of Checkable deposits RR : r X D Subsituting for RR in the first equation R : (r X D) + ER The Fed sets r to less than 1 Deriving the Money Multiplier III 0 The monetary base MB equals currency (C) plus reserves (R): MB=C+R=C+(rXD)+ER 0 Equation reveals the amount of the monetary base needed to support the existing amounts of checkable deposits, currency and excess reserves. 10/28/2010 13 Intuition Behind the Money Multiplier Deriving the Money Multiplier IV c={C/D}:>C=CXD and e:{ER/D}:> ER:ex D Substituting in the previous equation M‘B=(rx D)+(ex D)+(cx D)=(r+e+c)x D Divide both sides by the term in parentheses I r+e+c M=D+C andC=ch _-M=D+(c>< D)=(1+c)>< D Substituting again D: XMB 1+ 0 r+e+c The money multiplier is then M: xMB l+c m: r+e+c Ex: C r = required reserve ratio = 0.10 C = currency in circulation I $400B D = checkable deposits = $800B ER = excess reserves : $0.8B M 2 money supply (Ml) : C + D ; $i,200B C 3 $4003 : 05 $8003 a: $033 =o.001 $8008 1+0.5 1.5 m 2.5 = 0.1+0.001+0.5 = 0.601 = This is less than the simple deposit multiplier Aithough there is multiple expansion of deposits, there is no such expansion for currency f’” a J i :5} re. are a; i a ma ar- ‘x “1&3; 10/28/2010 refs; [Pr => 431W: “fig/ah $1355 \l/tmfixiyi‘fl icemmewm 16% i4 Application: The Great Depression Bank Panics, 1930 - 1933. - Bank failures (and no deposit insurance) determined: — Increase in deposit outflows and holding of currency (depositors) — An increase in the amount of excess reserves (banks) 0 For a reiatively constant MB, the money supply decreased due to the fall of the money multiplier. FIGURE 1 Deposits of Failed Commercial Banks, 1929—1933 Depooils is millions) SOD 400 300 Start of first ‘ 100 Banking . = Crisis 'III‘ ;; EnfioéFinai Banking Crisis; 3'5 / 50 4O 30 20 w o 1929 1930 1931 1932 1933 Source: Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1367-1960 (Princeton, NJ: Princeton University Press, 1963), p. 309. 10/28/2010 15 10/28/2010 FIGURE 2 Excess Reserves Ratio and Currency Ratio, 1929-1933 Samar.)- E‘ai‘se, Exam Reserves 5 Ratio, e ‘ 0.08 Ended Aw—e .' 1.; Final Bankfing ' ‘-. 0-D? Crisis 0.06 ' 0.05 (33¢ 0. 03 Star! of first Banking 0.02 0.01 _ _. . . - 00 1929 $30 3931 1982 1983 Sources: Federal Reserve Bulletin; Miiton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1957‘ 1960 (Princeton, NJ: Princeton University Press, 1963), p. 333. FIGURE 3 M1 and the Monetary Base, 1929—1933 Money Suppiy {o billions) 29 23 27 25 25 24 23 22 / 21 Start of 20 Fits! Ban king Crisis '\ End o! 1929 1930 1931 1932 1963 Source: Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 186%1960 (Princeton, NJ: Princeton University Press, 1963), p. 333. 16 ...
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This note was uploaded on 02/21/2011 for the course ECON 2035 taught by Professor Stahl during the Spring '08 term at LSU.

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Chapter 14 - Players in the Money Supply Process 0 Central...

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