Chapter+14+Determinants+of+the+Money+Supply (1)

# Chapter+14+Determinants+of+the+Money+Supply (1) - Chapter...

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Chapter 14 Determinants of the Money Supply Process - The Money Supply Model and the Money Multiplier - Factors That Determine the Money Multiplier - Additional Factors That Determine the Money Supply - Application - Explaining Movements in the Money Supply, 1980–2002 - The Great Depression Bank Panics, 1930–1933 Motivation : control of the money supply is far more complicated. Our critique of this model indicated that decisions by depositors about their holdings of currency and by banks about their holdings of excess reserves also affect the money supply. To deal with this critique, in this chapter we develop a money supply model in which depositors and banks assume their important roles. The resulting framework provides an in-depth description of the money supply process to help you understand the complexity of the Fed’s role. The Money Supply Model and the Money Multiplier Focus on M1 (simple definition of money): currency plus checkable deposits From ch13: the Fed can control the monetary base better than it can control reserves Money supply (M); monetary base (MB); an m be the money multiplier Deriving the Money Multiplier Let C: currency, D: checkable deposits, R: total reserves, RR: required reserves, ER: excess reserves, r: reserve ratio 1

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Money multiplier m is a function of the currency ratio set by depositors c, the excess reserves ratio set by banks e, and the required reserve ratio set by the Fed r. Intuition behind the Money Multiplier 3

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The money multiplier of 2.5 tells us that, given the required reserve ratio of 10% on checkable deposits and the behavior of depositors as represented by c = 0.5 and banks as represented by e = 0.001, a \$1 increase in the monetary base leads to a \$2.50 increase in the money supply (M1). Factors that Determine the Money Multiplier Changes in the required reserve ratio r The money multiplier and the money supply are negatively related to r 4
Changes in the currency ratio c The money multiplier and the money supply are negatively related to c Changes in the excess reserves ratio e The money multiplier and the money supply are negatively related to the excess reserves ratio e

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## This document was uploaded on 10/28/2011 for the course 220 301 at Rutgers.

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Chapter+14+Determinants+of+the+Money+Supply (1) - Chapter...

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