Where do all the checking account deposits come from?
-Landmark bank keeps$200 in required reserves and loans out the rest, $800, toKaldi’s who needs to pay its employees. Kaldi’s deposits $800 at Central Bank of Boone County.-Central Bank of Boone County keeps $160 in required reserves and loans out therest to Sparky’s.Sparky’s deposits $640 at Commerce Bank.-Commerce Bank keeps $128 in required reserves and loans out the rest to DeuceDeuce deposits $512 at Bank of America-Bank of America keeps $102.4 in required reserves and loans out the rest toShakespeare’s Initial $1000 deposit created more deposits in the banking system.This is called multiple deposit creation. If you count total amount of deposits created. $1000(Your money) +$800(Kaldi’s money) +$640(Sparky’s money)+$512(Deuce’s money)+…The multiple creation will continue until $5000 worth of deposits are created$1000*simple deposit multiplier=$5000Simple deposit multiplier=1/Required Reserve Ratio=1/rDIn our example, 1/0.2=5If the Fed takes out $1000 worth of reserves from banks (open markets sale), thenmoney supply or deposits would contract by $5000Simple deposit multiplier is too simple Banks typically hold more reserves than what’s required.And non-bank public typically hold more cash as their deposit balance increases Both of these weaken multiple deposit creationDerive the relationship between monetary base(MB) and money supply(M).They are linked through money multiplierFor every dollar change in bank reserves, by how much will money supply change?M=m*MBM=C+DMB=C+RrD=RR/D=required reserves ratioC/D=currency to deposit ratio ER/D=excess reserves to deposit ratio M=(C/D)+1/(C/D) +rD+(ER/D)For example, C=500 bil, D=1,000 bil, rD= RR/D=O.1, ER=150bilC/D=0.5, rD= 0.1, ER/D=0.15
Chapter 18 Monetary PolicyConventional policy tools Open Market operations -Purchase and sale of T-bills Discount policy Reserve requirements (no longer used)Interest on reserve balances (introduced in 2008)The main monetary policy instrument or operational target-Federal funds market and federal funds rate