Multiple Deposit Creation and the Money Supply Process chapter 16 Multiple Deposit Creation and the Money Supply Process

Four Players in the Money Supply Process 1. Central bank: the Fed / People’s Bank of China Banks the financial intermediaries that accept deposits and make loans. Depositors who have a surplus of funds Borrowers from banks who need funds

Central bank Emerging of Central bank Unity of money Clears checks It is a government agency that oversees the banking system and is responsible for the conduct of monetary policy. Emerging of Central bank Unity of money Clears checks 3. Lender of last resort 4. Regulates banks

Function of central bank Issuing bank Bank’s bank Government’ s bank

Tyes of central bank Single type central bank system （单一式） Unitary（一元式）binary（二元式） Compound central bank system（复合式） Quasi central bank system （准央行制度） Multinational central bank system（跨国）

Fed Balance Sheet

Federal reserve system Assets Liabilities Government securities Discount loans Currency in circulation Reserves

Liabilities 1.Currency in circulation Which is the amount of currency in the hands of the public. 2.Reserves All banks have an account at the Fed in which they hold deposits. Reserves=deposit in Fed +vault cash=required reserves+ excess reserves

Assets 1. government securities Open market operations 2.discount loans Discount rate

The Monetary Base 1. high-powered money 高能货币 MB = C + R C –currency in circulation R –reserves Q: 央行主要通过什么方式来控制MB？

Control of the Monetary Base MB = C + R Open Market Purchase from Bank The Banking System The Fed Assets Liabilities Assets Liabilities Securities – $100 Securities + $100 Reserves + $100 Reserves + $100 Open Market Purchase from Public Public The Fed Securities – $100 Securities + $100 Reserves + $100 Deposits + $100 Banking System Assets Liabilities Reserves Checkable Deposits + $100 + $100 Result: R  $100, MB  $100

If Person Cashes Check Public The Fed Assets Liabilities Assets Liabilities Securities – $100 Securities + $100 Currency + $100 Currency + $100 Result: R unchanged, MB  $100 Please write the T account, if central bank sell seurities . To public To commercial banks Effect on MB certain, on R uncertain

Shifts From Deposits into Currency Public The Fed Assets Liabilities Assets Liabilities Deposits – $100 Currency + $100 Currency + $100 Reserves – $100 Banking System Assets Liabilities Reserves – $100 Deposits – $100 Result: R  $100, MB unchanged

Case analysis It is common to read in the newspaper about a Federal reserve intervention to buy or sell dollars in the foreign exchange market. Can this intervention also be a factor that affects the monetary base?

Discount Loans Banking System The Fed Assets Liabilities Assets Liabilities Reserves Discount Discount Reserves + $100 loan + $100 loan + $100 + $100 Result: R  $100, MB  $100 Conclusion: Fed has better ability to control MB than R

Deposit Creation: Single Bank When the central bank supplies the banking system with $1 of additional reserves, deposits increase by a multiple of this amount. First National Bank Assets Liabilities Securities – $100 Reserves + $100 Securities – $100 Deposits + $100 Loans + $100

Deposit Creation: Banking System Bank A Assets Liabilities Reserves + $100 Deposits + $100 Reserves + $10 Deposits + $100 Loans + $90 Bank B Reserves + $90 Deposits + $90 Reserves + $ 9 Deposits + $90 Loans + $81

Deposit Creation

Deposit Multiplier If Bank A buys securities with $90 check Bank A Assets Liabilities Reserves + $10 Deposits + $100 Securities + $90 Seller deposits $90 at Bank B and process is same Whether bank makes loans or buys securities, get same deposit expansion

Deposit Multiplier Simple Deposit Multiplier 1 D =  R rD Deriving the formula R = RR = rD  D D =  R D =  R

Banking System As a Whole Assets Liabilities Securities – $100 Deposits + $1000 Reserves + $100 Loans + $1000 Critique of Simple Model Deposit creation stops if: 1. Proceeds from loan kept in cash 2. Bank holds excess reserves