Chapter 13 Multiple Deposit Creation and the Money Supply Process

© 2004 Pearson Addison-Wesley. All rights reserved 15-2 Meaning and Function of Money Economist’s Meaning of Money 1.Anything that is generally accepted in payment for goods and services 2.Not the same as wealth or income Functions of Money 1.Medium of exchange 2.Unit of account 3.Store of value Evolution of Payments System 1.Precious metals like gold and silver 2.Paper currency (fiat money) 3.Checks 4.Electronic means of payment 5.Electronic money: Debit cards, Stored-value cards, Smart cards, E-cash

15-3 Federal Reserve’s Monetary Aggregates

© 2004 Pearson Addison-Wesley. All rights reserved 15-4 Growth Rates of Fed’s Monetary Aggregates

© 2004 Pearson Addison-Wesley. All rights reserved 15-5 Four Players in the Money Supply Process 1.Central bank: the Fed 2.Banks 3.Depositors 4.Borrowers from banks Federal Reserve System 1.Conducts monetary policy 2.Clears checks 3.Regulates banks

© 2004 Pearson Addison-Wesley. All rights reserved 15-6 The Fed’s Balance Sheet Federal Reserve System Government securities Discount loans Currency in circulation Reserves AssetsLiabilities Monetary Base, MB = C + R

© 2004 Pearson Addison-Wesley. All rights reserved 15-7 Control of the Monetary Base Open Market Purchase from Bank The Banking System The Fed AssetsLiabilitiesAssetsLiabilities Securities – $100Securities + $100Reserves + $100 Reserves + $100 Open Market Purchase from Public Public The Fed AssetsLiabilitiesAssetsLiabilities Securities – $100Securities + $100Reserves + $100 Deposits + $100 Banking System AssetsLiabilities ReservesCheckable Deposits+ $100 Result: R  $100, MB  $100

© 2004 Pearson Addison-Wesley. All rights reserved 15-8 If Person Cashes Check Public The Fed AssetsLiabilitiesAssetsLiabilities Securities – $100Securities + $100 Currency + $100 Currency + $100 Result: R unchanged, MB  $100 Effect on MB certain, on R uncertain Shifts From Deposits into Currency Public The Fed AssetsLiabilitiesAssetsLiabilities Deposits – $100Currency + $100 Currency + $100Reserves – $100 Banking System AssetsLiabilities Reserves – $100Deposits – $100 Result: R  $100, MB unchanged

© 2004 Pearson Addison-Wesley. All rights reserved 15-9 Discount Loans Banking System The Fed AssetsLiabilitiesAssetsLiabilities Reserves DiscountDiscountReserves + $100 loan + $100 loan + $100 + $100 Result: R  $100, MB  $100 Conclusion: Fed has better ability to control MB than R

15-10 Deposit Creation: Single Bank First National Bank Assets Liabilities Securities– $100 Reserves+ $100 First National Bank Assets Liabilities Securities– $100Deposits+ $100 Reserves+ $100 Loans+ $100 First National Bank Assets Liabilities Securities– $100Deposits+ $100 Loans+ $100

© 2004 Pearson Addison-Wesley. All rights reserved Deposit Creation: Banking System Bank A Assets Liabilities Reserves+ $100Deposits+ $100 Bank A Assets Liabilities Reserves+ $10Deposits+ $100 Loans + $90 Bank B Assets Liabilities Reserves+ $90Deposits+ $90 Bank B Assets Liabilities Reserves+ $ 9Deposits+ $90 Loans + $81

© 2004 Pearson Addison-Wesley. All rights reserved Deposit Creation

© 2004 Pearson Addison-Wesley. All rights reserved Deposit Creation If Bank A buys securities with $90 check Bank A Assets Liabilities Reserves+ $10Deposits+ $100 Securities+ $90 Seller deposits $90 at Bank B and process is same Whether bank makes loans or buys securities, get same deposit expansion

© 2004 Pearson Addison-Wesley. All rights reserved Deposit Multiplier Simple Deposit Multiplier 1  D =   R r Deriving the formula R = RR = r  D 1 D =  R r 1  D =   R r

© 2004 Pearson Addison-Wesley. All rights reserved Deposit Creation: Banking System as a Whole Banking System Assets Liabilities Securities– $100Deposits+ $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