Chapter 15. Money Supply Process Fed Balance Sheet Fed and the Monetary Base Deposit Creation

The money supply process who determines the money supply? the Federal Reserve banks depositors borrowers

I. The Fed’s balance sheet Assets U.S. government bonds necessary for open market operations Gold, SDRs used for international debts

other assets foreign bonds, currency physical assets cash in collection discount loans Fed loans to banks

Fed is self-funding open market operations discount loans both are also key to controlling money supply

Liabilities Federal reserve notes U.S. currency exchangeable for more notes Reserves deposits by banks required + excess U.S. Treasury deposits

monetary base (MB) currency + reserves C + R also called “high-powered money” $1 increase in MB will cause > $1 increase in money supply

II. Controlling MB open market operations Fed buys and sells Treasury securities affect size of monetary base use T accounts to track the effect

example open market purchase $100 million Fed buys $100 million in Tbonds Fed buys from a bank increase in bank reserves of $100 million

if Fed buys Tbonds from public, & public deposits in account increase in bank reserves of $100 million

if Fed buys Tbonds from public, & public keeps cash increase in currency of $100 million

discount loans Fed loans to bank Fed credits bank’s reserve account

reserves increase MB increases

open market purchase or discount loans increase in MB due to increase in reserves OR due to increase in currency

III. Deposit creation Fed increases reserves by $1, deposits increase by > $1 multiple deposit creation how?

example Fed buys $100 securities from bank bank securities decrease $100 bank reserves increase $100

$100 increase in reserves are excess reserves, banks lends them out by crediting checking account

borrower takes $100 loan and deposits in bank A reserves increase at bank A deposits increase at bank A

required reserve ratio = 10% bank A must keep $10 free to lend $90

borrower at bank A takes $90 loan and deposits in bank B

bank B must keep $9 free to lend $81

where are we? initial $100 open market purchase checking deposits so far: $100 + $90 + $81 = $271 money has been created

simple money multiplier how much money creation is possible? 1 reserve req. change in deposits = change in reserves x

$100 increase in reserves, $1000 increase in deposits change in = 1 .10 = $1000 $100 x $100 increase in reserves, $1000 increase in deposits

simple money multiplier leaves out 2 possibilities: (1) borrowers take some of loan as cash (2) banks hold some excess reserves need a more complex multiplier