Ch. 14

# Currency rao c c d 400 800 05 excess reserve

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Unformatted text preview: plier (m) captures some factors that aﬀect the money supply, other than the changes in the monetary base. •  Examples: –  Depositor’s decision about their holdings of currency and checkable deposits –  Banks’ decision about excess reserves –  Reserve requirements •  Changes in the above factors aﬀect the size of m. 24 Deriving the Money Mul<plier •  We will abandon the two simplifying assump<ons. ⇒ Banks now can hold excess reserves and individuals can hold currency as well as deposits. •  Instead, we will assume that the desired level of currency (C) of the public and excess reserves (ER) are propor<onal to checkable deposits (D) in equilibrium. ⇒ Currency ra<o: c = C / D ⇒ Excess reserve ra<o: e = ER / D 25 Deriving the Money Mul<plier •  Recall that the total reserves in the banking system (R) consist of required reserves (RR) and excess reserves (ER). ⇒ R = RR + ER •  Recall also that RR = r × D, where r = required reserve ra<o and D = checkable deposit. •  So, we get R = (r × D) + ER. •  Note that r is less than 1. 26 Deriving the Money Mul<plier •  Recall that the monetary base (MB) equals to the sum of reserves (R) and currency (C): MB = R + C = (r × D) + ER + C •  This equa<on reveals the amount of the monetary base needed to support the exis<ng amounts of checkable deposits, currency, and excess reserves. 27 Deriving the Money Mul<plier Example 1: •  Suppose ER = 0 and C = 0 (This corresponds to the simple model of mul<ple deposit crea<on.) •  MB = (r × D) + ER + C becomes MB = r × D ⇒ = •  Since r < 1, 1/r > 1. •  \$1 increase in MB leads to more than \$1 increase in D due to the process of mul<ple deposit crea<on. 28 Deriving the Money Mul<plier Example 2: •  Suppose D = 0 and C = 0. •  MB = (r × D) + ER + C becomes MB = ER. •  Thus, a \$1 increase in MB that is held as excess reserves does not get mul<plied: excess reserves do not par<cipate in the process of mul<ple deposit crea<on, since they are held by banks instead of being lent out. 29 Deriving the Money Mul<plier Example 3: •  Suppose D = 0 and ER = 0. •  MB =...
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