The monetary base is defined as the sum of currency in circulation and reserve

# The monetary base is defined as the sum of currency

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The monetary base is defined as the sum of currency in circulation and reserve balances (deposits held by banks and other depository institutions in their accounts at the Federal Reserve) M1 consists of: ( 1) currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions (2) traveler's checks of nonbank issuers (3) demand deposits at commercial banks (excluding those amounts held by depository institutions, the U.S. government, and foreign banks and official institutions) (4) other checkable deposits (OCDs) M2 consists of M1 plus: (1) savings deposits (including money market deposit accounts) (2) small-denomination time deposits (time deposits in amounts of less than \$100,000), less individual retirement account (IRA) and Keogh balances at depository institutions; (3) balances in retail money market mutual funds, less IRA and Keogh balances at money market mutual funds. For the purposes of this class, money supply is M1 For now, we will assume that the central bank sets the money supply at the level it desires
M1 and M2 Money Stock: M1 SA, Bil.\$ 12 11 10 09 08 07 06 05 04 03 02 Source: Federal Reserve Board /Haver Analytics 2500 2250 2000 1750 1500 1250 1000 2500 2250 2000 1750 1500 1250 1000 Money Stock: M2 SA, Bil.\$ 12 11 10 09 08 07 06 05 04 03 02 Source: Federal Reserve Board /Haver Analytics 11000 10000 9000 8000 7000 6000 5000 11000 10000 9000 8000 7000 6000 5000 M2 is about 4x M1 Demand deposits + other checkable deposits are more than 50% of M1 Savings deposits are about 64% of M2
Money, interest rates, and exchange rates Key question: what determines money demand for a household? 1/ Expected return Return relative to the return that can be expected on other assets Assume interest paid on money is zero So, holding money has a cost relative to other assets All else equal, if interest rates rise, the demand for money falls 2/ Liquidity of the asset Liquidity is a key benefit of holding money The need for liquidity rises with the average daily value of transactions So, an increase in the average value of daily transactions for a household leads to an increase in money demand Risk: riskiness of the expected return Unimportant. Increase in riskiness of holding money (higher price of goods, for example) should also impact the riskiness of holding alternatives such as bonds
Money, interest rates, and exchange rates Let’s translate this to an economy What determines total demand for money in an economy? 1/ Interest rate All else equal, higher interest rate ↑ opportunity cost of holding money Money demand ↓ 2/ Price level Price level is the price of a broad reference basket of goods and services in currency If price level ↑, firms and households must spend more money to keep consumption same So, ↑ price level means that money demand ↑ 3/ Real national income If national income rises, more goods and services are being sold in the economy Increase in real value of transactions causes a rise in money demand
Money, interest rates, and exchange rates

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• Fall '16
• nkanata
• Exchange Rate, Foreign exchange market, United States dollar