CHAPTER 15 “MONEY SUPPLY PROCESS” The Economics of Money, Banking, and Financial Markets: 10E, Frederic S. Nishkin Group One Members & Roll #- - Htoo Mg2 Latt / 8 Chaw Su Aung Win / 5 Kyauk Kay Khine / 12 Ohnmar Aye / 35 Toe Thiri Tun / 48 Nan El Khaung / 26 Chan Htut /4 Group One MBF- Batch 1 Master of Banking and Finance Programme, Yangon, Myanmar. 9th Nov 2013 MBF1;4th Smt; G1 Presentation: Economics of Money, Banking, & Financial Markets

OBJECTIVES OF STUDY How money supply process is determined? How the Banking System Create Deposit? Who control money supply? What cause it to change? How might control of it be improved? Group One

Three Players in the money supply process Depositors Banks The central bank

Three Players in the money supply process The Central Bank – The government agent that oversees the banking system. Responsible for the conduct of monetary policy. In Myanmar called Central Bank In US called Federal Reserve System The central bank

Three Players in the Money Supply Process Banks Banks – (Depository Institutions) The financial intermediaries that accept deposits from individuals and institutions. Make Loans- Commercial Banks, Savings and loan associations, mutual savings banks and credit unions.

Three Players in the money supply process Depositors- Individuals and institutions that hold deposits in the banks Depositors The three player in the money supply process: The Central Bank (or) Federal Reserve System is most important player. conducts monetary policy involves actions that affect the balance sheet

Federal Reserve System Balance Sheet Federal Reserve System Assets Government Securities Loans to Financial Institutions Liabilities Currency in Circulation Reserves

Federal Reserve System Balance Sheet Federal Reserve System Government Securities The Fed’s holdings of securities issued by U.S Treasury Loans to Financial Institutions Fed provide reserves to the banking system is by making loans to banks and other financial institutions.

Federal Reserve System Balance Sheet Federal Reserve System Currency in circulation is the amount of currency in the hands of the public Reserves Fed hold deposits from all bank with their accounts. Reserves consist of deposits at the fed + physically stored in the bank vaults. Fed provides reserves to banking system at rate called the discount rate.

More on Reserves • Fed requires banks to hold a fraction (10%) of deposits as reserves.    - It is called Required Reserve Ratio IN MYANMAR Central Bank of Myanmar requires commercial banks to hold 10% of Deposits as reserves and 50% of 10% reserves has to place at Central Bank as reserves. Additional holding of cash are called excess reserves. Total reserves = Required Reserves + Excess Reserves

TOTAL RESERVE Excess Reserve 50% of the 10% Reserve 10% of Deposit Note: Fed does not pay interest on liabilities, but collects interest on its assets. It means that Fed gives Bonds to commercial banks for their placing of reserve. Earnings (in billions) go to federal government and pay for the operation of the Fed.

Control of Monetary Base MB (high-powered money) = Currency in circulation + Reserves Open Market Operations • Fed exercises control over monetary base through Purchases or sales of government securities in open market (ii) Extension of discount loans to banks • A purchase of bonds by the Fed is called an open market purchase • A sale of bonds by the Fed is called an open market sale MB C R

Control of the Monetary Base Open Market Purchase of $100 of bonds from Bank with a $100 check The Banking System Assets Liabilities Securities -$100 Reserve +$100 Federal Reserve System Assets Liabilities Securities + $100 Reserve +$100

Control of the Monetary Base Open Market Purchase of $100 of bonds from person or corporation who deposits the Fed’s check in a local bank Nonbank Public Assets Liabilities Securities -$100 Checkable Deposits +$100 Banking System Assets Liabilities Reserves + $100 Checkable Deposits + $100 Fed Reserve System Assets Liabilities Securities + $100 Reserve +$100

The result of the Fed’s Open Market Purchase Result: Reserves increase by the amount $ 100 The Monetary Base increase by the same amount $ 100 MB C R

If the seller receive currency for the check Nonbank Public Assets Liabilities Securities -$100 Currency in C +$100 Fed Reserve System Assets Liabilities Securities + $100 Current in circulation +$100

The result of the Fed’s Open Market Purchase Reserves unchanged The currency in circulation increase by the amount $ 100 Thus, The Monetary Base increase by the same amount $ 100 Conclusion: Effect on MB of OMP is certain and effect on Reserves depends on whether seller of bond keeps proceeds in currency or deposits. Note: At local bank vault cash falls by $100, deposits at Fed increase by same amount. I.e., the transaction is simply a switch from one type of reserves to another.

Open Market Sale Nonbank Public Fed Reserve System Open Market Sale of $100 of bonds from person who pays cash Nonbank Public Assets Liabilities Securities +$100 Currency in C - $100 Fed Reserve System Assets Liabilities Securities - $100 Currency in circulation -$100

The result of the Fed’s Open Market Sale Reserves unchanged The currency in circulation decrease by the amount $ 100 Thus, The Monetary Base decrease by the same amount $ 100 If instead, person uses a check written on a local bank reserves fall by $100. Conclusion: Effect on MB of OMS is certain, effect on Reserves depends on whether buyer of bond uses currency or checkable deposits.

Overall Conclusion The effect of open market operations on the monetary base is much more certain than the effect on reserve. Fed can control MB using Open Market Operations more effectively than it can control reserves.

Affecting reserves without changing MB Shifts From Deposits into Currency(Jane Brown permanently withdraws $100 from her checking account.) Nonbank Public Assets Liabilities Checkable Deposits -$100 Currency in C +$100 Fed Reserve System Assets Liabilities Currency in circulation +$100 Reserves -$100 Banking System Assets Liabilities Reserves -$100 Checkable Deposits -$100 Result: R ↓ $100, MB unchanged

Discount Loans Banking System Fed Reserve System Also affect MB, Suppose Fed makes $100 loan to First National Bank Banking System Assets Liabilities Reserves +$100 Discount Loans +$100 Fed Reserve System Assets Liabilities Discount Loans +$100 Reserve +$100 Result: R increase , MB increase Reverse happens when bank pays of a discount loan (I.e., all of the +’s become –’s).

Factors outside Fed’s control • Certain factors affect the MB that are outside the control of the Fed 1. Float - results from check clearing process that occurs at the Fed * first increase reserves of depositing bank * second (later) decrease the reserves of bank on which check is drawn * result is temporary increase in MB 2. Treasury deposits at Fed * whenever Treasury moves deposits from commercial banks to Fed the result is a decrease in MB

Deposit Creation: Single Bank First National Bank Assets Liabilities Securities -$100 Reserves +$100 First National Bank Assets Liabilities Securities -$100 Deposit +$100 Reserves +$100 Loans +$100 First National Bank Assets Liabilities Securities -$100 Deposit +$100 Loans +$100 MBF1;4th Smt; G1 Presentation: Economics of Money, Banking, & Financial Markets

Deposit Creation: Banking System Bank A Assets Liabilities Reserves + $100 Deposits +$100 Bank A Assets Liabilities Reserves +$10 Deposits +$100 Loans + $90 Assets Bank B Liabilities Reserves +$90 Deposits +$90 Assets Bank B Liabilities Reserves +$9 Deposits +$90 Loans + $81 MBF1;4th Smt; G1 Presentation: Economics of Money, Banking, & Financial Markets

Deposit Creation

Deposit Creation 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 ΔD = 1 / rr x ΔR Deriving the formula R = RR = r × D D = 1 × R rr ΔD = 1 × ΔR

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

Money Multiplier M = m × MB Deriving Money Multiplier R = RR + ER RR = r × D R = (r × D) + ER Adding C to both sides R + C = MB = (r × D) + ER + C Tells us amount of MB needed support D, ER and C 2. Increase in C or ER is not multiplied MB = (r × D) + (e × D) + (c ×D) = (r + e + c) × D

D = 1 × MB r + e + c M = D + (c × D ) = (1 + c) × D M = 1 + c × MB m = 1 + c m < 1/r because no multiple expansion for currency and because as D ↑ ER ↑ (I.e., m is much less than 10 from simple model) ↑ r or ↑ c or ↑ e results in ↓ m and M.

Excess Reserves Ratio, e

Factors Determining Money Supply

Money Supply

Determinants of the Money Supply

Deposits at Failed Banks: 1929–33

e, c: 1929–33

Money Supply and Monetary Base: 1929–33

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