Professional Documents
Culture Documents
The Money
Supply Process
14-2
Assets
Government securities: holdings by the Fed that affect
money supply and earn interest
Discount loans: provide reserves to banks and earn the
discount rate
These earn higher interest than liabilities, meaning the Fed
earns billions each year
14-4
14-5
Liabilities
Securities
Currency in circulation
Loans to Financial
Institutions
Reserves
High-powered money
MB = C + R
C = currency in circulation
R = total reserves in the banking system
Monetary base is also known as high-powered money
Fed controls monetary base through open market operations,
the buying and selling of securities on the open market.
14-6
14-7
14-9
Securities
-$100m
Reserves
+$100m
Assets
Securities
Liabilities
+$100m Reserves
+$100m
14-10
Liabilities
+$100m Checkable
deposits
+$100m
Assets
Securities
Liabilities
+$100m Reserves
+$100m
14-12
14-13
Liabilities
Securities
-$100m
Currency
+$100m
Liabilities
+$100m Currency in
circulation
+$100m
14-15
14-16
Liabilities
Securities
+$100m
Currency
-$100m
Liabilities
-$100m Currency in
circulation
-$100m
14-17
14-19
Banking System
Liabilities
Checkable
deposits
-$100m
Currency
+$100m
Assets
Reserves
Liabilities
-$100m Checkable
deposits
-$100m
14-20
Liabilities
Currency in
circulation
+$100m
Reserves
-$100m
14-21
14-22
Liabilities
+$100m Loans
+$100m
Assets
Loans
Liabilities
+$100m Reserves
+$100m
(borrowing from
Fed)
14-24
14-25
14-26
14-27
Liabilities
Assets
Liabilities
Securities
-$100m
Securities
-$100m Checkable
deposits
Reserves
+$100m
Reserves
+$100m
Loans
+$100m
+$100m
Liabilities
Securities
-$100m
Loans
+$100m
Excess reserves increase; Bank loans out the excess reserves; Creates
a checking account; Borrower makes purchases; The Money supply has
increased
14-28
Bank A
Liabilities
+ Checkable
$100m deposits
Assets
+ Reserves
$100m
Loans
Reserves
+
$100m
Bank B
Liabilities
+$90 Checkable
deposits
Assets
+$90 Reserves
Loans
14-29
+$10 Checkable
deposits
+$90
Bank B
Assets
Liabilities
Liabilities
+$9 Checkable
deposits
+$81
+$90
14-30
14-32
14-33
14-35
M m MB
14-36
14-37
Deriving the
Money Multiplier (contd)
The total amount of reserves (R) equals the sum of
required reserves (RR) and excess reserves (ER).
R = RR + ER
The total amount of required reserves equals the required
reserve ratio times the amount of checkable deposits
RR = r D
Subsituting for RR in the first equation
R = (r D) + ER
The Fed sets r to less than 1
14-38
Deriving the
Money Multiplier (contd)
The monetary base MB equals currency (C)
plus reserves (R):
MB = C + R = C + (r x D) + ER
Equation reveals the amount of the
monetary base needed to support the
existing amounts of checkable deposits,
currency and excess reserves.
14-39
Deriving the
Money Multiplier (contd)
c = {C / D} C = c D and
e = {ER / D} ER = e D
Substituting in the previous equation
MB (r D) (e D) (c D) (r e c) D
Divide both sides by the term in parentheses
1
D
MB
r e c
M D C and C c D
M D (c D) (1 c) D
Substituting again
1 c
M
MB
r e c
The money multiplier is then
1 c
m
r e c
14-40
2.5
0.1 0.001 0.5 0.601
This is less than the simple deposit multiplier
Although there is multiple expansion of deposits,
there is no such expansion for currency
c
14-41
14-42
Source: Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States,
18671960 (Princeton, NJ: Princeton University Press, 1963), p. 309.
14-43
Sources: Federal Reserve Bulletin; Milton Friedman and Anna Jacobson Schwartz, A Monetary History of
the United States, 18671960 (Princeton, NJ: Princeton University Press, 1963), p. 333.
14-44
Source: Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United
States, 18671960 (Princeton, NJ: Princeton University Press, 1963), p. 333.
14-45
APPLICATIONThe 2007-2009
Financial Crisis and the Money Supply
During the recent financial crisis, as shown in Figure
4, the monetary base more than tripled as a result
of the Fed's purchase of assets and new lending
facilities to stem the financial crisis
Figure 5 shows the currency ratio c and the excess
reserves ratio e for the 2007-2009 period. We see
that 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 effects of the
decline in c were entirely offset by the extraordinary
rise in the excess reserves ratio e
14-46
14-47
14-48