Herzog gu money march 17 2014 23 41 central banking an

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Unformatted text preview: th a required reserve rate of 20%. Bank 1 Assets Liabilities Reserves $20M Deposits $100 Loans $80M Bank Cap. $10M Securities $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 Bank 1 Assets Reserves $25M Loans $80M Securities $5M Liabilities Deposits $100 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. Bank 1 Assets Liabilities Reserves $25M Deposits $125 Loans $105M Bank Cap. $10M Securities $5M 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 money supply. 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: m= Ryan W. Herzog (GU) Money MS . MB (6) 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 reasons. 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. The specu...
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