Unformatted text preview: th a required reserve
rate of 20%.
Bank Cap. $10M
Now suppose the Fed purchases 5 million zags. Ryan W. Herzog (GU) Money March 17, 2014 24 / 41 Central Banking An Open Market Purchase The banks balance sheet after the purchase
Securities $5M Liabilities
Bank Cap. $10M The bank now have 5M in excess reserves that can be lent out. Ryan W. Herzog (GU) Money March 17, 2014 25 / 41 Central Banking An Open Market Purchase The $5M in excess reserves will now create new deposits of $25M.
Loans $105M Bank Cap. $10M
The 5 million in excess reserves will create 5/0.20 = 25 in deposits
and 5 million in reserves
Notice that loans and deposits each increase by 25 million. Ryan W. Herzog (GU) Money March 17, 2014 26 / 41 Central Banking Monetary Base It is important to note the Fed does not have direct control over the
The Fed controls the monetary base (which is reserves plus currency).
The money supply and ultimately the state of our economy depends
on the banks ability/desire to make loans. Ryan W. Herzog (GU) Money March 17, 2014 27 / 41 Central Banking Monetary Base and M1 (ﬁgure 8.4) Figure : Monetary Base and M1 Ryan W. Herzog (GU) Money March 17, 2014 28 / 41 Central Banking Bank Reserves (ﬁgure 8.5) Figure : Bank Reserves Ryan W. Herzog (GU) Money March 17, 2014 29 / 41 Central Banking Money Multiplier
The simple money multiplier is the same as above.
For a given change in reserves, the money supply will increase by
Money Multiplier = 1
Required Reserve Rate (4) A more accurate measure of the money multiplier is the ratio of the
monetary base to the money supply (accounts for banks holding
excess reserves and currency).
Money Supply = Multiplier × Monetary Base (5) Or MS = m × MB . This implies the money multiplier is:
Ryan W. Herzog (GU) Money MS
March 17, 2014 30 / 41 Central Banking Money Multiplier (ﬁgure 8.6) Figure : The Money Multiplier Ryan W. Herzog (GU) Money March 17, 2014 31 / 41 Money Market Demand for Money The Demand for Money
The interest rate is the opportunity cost of holding money. By
holding cash, you forgo possible interest earnings.
The demand for money is the amount of wealth the individual
chooses to hold in the form of money.
There are three primary reasons for holding cash: (1) to conduct
transaction, (2) for precautionary reason, and (3) for speculative
The transaction motive states individuals will demand money to buy
goods and services.
The precautionary motive simply states people hold money during
times of uncertainty.
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