Causes of Non-Fed Variables: M2 Determination zFederal Reserve controlled variables: H NON (open market operations), r D, r T. zThis chapter -- studies key causes of k, t, mmmf, e, and DL.

Key Causes of k = C/D zInterest rates (i), i   k  zBank Panics, Panic   k  zIllegal Activity, increases the demand for cash zFinancial Innovation towards transactions convenience (e.g. credit cards) (FI), FI   k 

Key Causes of t = T/D zInterest rates (i), i   t  zMarket Risk (Stock) (  S ),  S   t  zUncertainty About the Economy (  Y ),  Y   t  zSweep Programs (SWEEP), SWEEP   t 

Key Causes of mmmf = MMMF/D zInterest rates (i), i   mmmf  zMarket Risk (Stock) (  S ),  S   mmmf  zUncertainty About the Economy (  Y ),  Y   mmmf 

Key Causes of e = ER/D zInterest rates (i), i   e  zExpected Deposit Outflows (DOE) DOE   k  zDeposit Risk, or Uncertainty About Deposit Outflows (  D )  D   e 

Recent Developments: Increasing the e-Ratio zIncreased Vault Cash for Servicing ATMs. zEstablishment of Clearing Balances with the Federal Reserve, receives some return from the Fed. zFuture – Interest on excess reserves?

Key Causes of Discount Loans (DL) zInterest rates (i), i   DL  zThe Discount Rate (i DISC ), i DISC   DL  zFed Surveillance, Surveillance   DL 

Synthesizing the Analysis zEvent  zWhat components of M2 determination are affected, and how?  zHow does this change M2 (immediately and/or through bank loaning)?

M2 Determination: A Review M2 = (1 + k + t + mmmf) (H NON + DL) (k + r D + r T t + e) The money multiplier (m 2 )

How the Components Affect M2: A Review H NON   M2  DL   M2  r D   M2  r T   M2  k   M2  t   M2  mmmf   M2  e   M2 

Example 1 -- An Increase in Interest Rates i   k   M2  i   t   M2  i   mmmf   M2  i   e   M2  i   DL   M2  Is there a money supply function?

Example (Major Panic/Bank Failures) Panic   k   M2  Could the Federal Reserve have offset the situation (Discount Window, emergency loans)? DL   M2 

Example (Keynesian Liquidity Trap) zFederal Reserve -- practicing active monetary policy. H NON   M2 

Bank Behavior zBut, banks experience high deposit risk (  D ), expected deposit outflows (DOE), and very low interest rates  desire to hold large amounts of excess reserves.  D , DOE , i   e   M2  zOffsets the effect of policy.