# Changes in excess reserves the money supply is

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Unformatted text preview: the amount of excess reserves. Eco 029 Chapter 10, Chapter 14 Determining Money Supply (c'td) Changes in the required reserves ratio The money supply is negatively related to the required reserve ratio. Changes in currency holdings The money supply is negatively related to currency holdings. Changes in excess reserves The money supply is negatively related to the amount of excess reserves. Eco 029 Chapter 10, Chapter 14 The Money Multiplier Dene money as currency plus checkable deposits: M1 Link the money supply (M) to the monetary base (MB) and let m be the money multiplier M = m × MB Eco 029 Chapter 10, Chapter 14 Deriving the Money Multiplier Assume that the desired holdings of currency C and excess reserves ER grow proportionally with checkable deposits D. Then, c = {C/D} = currency ratio e = {ER/D} = excess reserves ratio Eco 029 Chapter 10, Chapter 14 Deriving the Money Multiplier c'td Total reserves (R)= required reserves (RR)+ excess reserves (ER) Required reserves= reserve ratio times the amount of checkable deposits: RR=r×D Substituting, we get R = r × D + ER r < 1. Why? Eco 029 Chapter 10, Chapter 14 Deriving the Money Multiplier c'td c = C /D → C = c × D ; e = ER /D → ER = e × D Substituting, we get MB = RR + C + ER = r × D + e × D + c × D = (r + e + c ) × D 1 Rewriting, we get D = r +e +c × MB M = D + C and C = c × D , so M = D + c × D = (1 + c ) × D 1c Substituting again, we get M = r +++c × MB e 1+c The money multiplier is m = r +e +c Eco 029 Chapter 10, Chapter 14 Intuition Behind the Multiplier Let r = 0.1,C=\$400B, D=\$800, ER=\$0.8B M=M1=C+D=\$1,200B c=C/D=0.5 e=ER/D=0.001 .5 m = 0.1+1+0.5+0.5 = 01601 = 2.5 0.001 . This is smaller than the simple deposit multiplier (no expansion for currency) Eco 029 Chapter 10, Chapter 14 Application: The 2007-2009 Financial Crisis During the recent nancial crisis, the monetary base more than tripled as a result of the Fed's purchase of assets and new lending facilities to stem the nancial crisis The currency ratio fell somewhat during this period, which our money supply model suggests would raise the money multiplier and the money supply because it would increase the overall level of deposit expansion. However, the eects of the decline in c were entirely oset by the extraordinary rise in the excess reserves ratio e Eco 029 Chapter 10, Chapter 14 M1 and the Monetary Base 2007-2009 Eco 029 Chapter 10, Chapter 14 Excess Reserves Ratio and Currency Ratio, 2007-2009...
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