Chapter 11 The central bank, Depository Institutions, and the Money Supply Process.

2  Some Complicating Realities in the Multiplier Model Some Complicating Realities in the Multiplier Model  Modifying the Multiplier Model Modifying the Multiplier Model  The central bank’s Control over the Money Supply The central bank’s Control over the Money Supply  Summary of major points Summary of major points

3 Some Complicating Realities in the Multiplier Model  In our simple model, we assumed that banks do not hold excess reserves  in fact, banks do choose to hold excess reserves  these excess reserves are leakages from the flow of new deposits  this will lower the volume of loans and deposits created at each stage

4 Some Complicating Realities in the Multiplier Model  We also ignored the fact that individuals will choose to hold some currency  this means that all loan proceeds may not become redeposited in the banking system  this will also reduce the flow of reserves and deposits from bank to bank

5 Modifying the Multiplier Model  Total reserves are equal to required reserves plus excess reserves TR = RR + ER TR = r D D + ER  Assume that depository institutions hold excess reserve assets equal to a constant proportion of deposit liabilities (eD) where e = ER/D

6 Modifying the Multiplier Model  This means that TR = r D D + eD = (r D + e)D  This means that, for a given change in total reserves, the change in deposits will be

7 Modifying the Multiplier Model  The multiplier is now smaller than before  The multiplier is not under the complete control of the Fed  the Fed cannot control e

8 Modifying the Multiplier Model  The public can also affect the money multiplier by its currency-holding behavior----We can see that open market purchases of securities by the central bank may result in an increase of both reserves and currency in the hands of the public.  Assume the public wants to hold currency equal to a constant proportion of its checkable deposits (cD) where c = C/D

9 Modifying the Multiplier Model  Thus, the money supply is equal to M = D + C = D + cD = (1 + c)D  We define the monetary base (MB) as the sum of reserves and currency in the hands of the public  基础货币：准备金加上公众手中持有的货币，用 MB 表示。 MB = TR + C MB = (r D + e)D + cD = (r D + e + c)D

10 Modifying the Multiplier Model  Rearranging, we get  The money supply is equal to deposits plus currency

11 Modifying the Multiplier Model  Rearranging, we get

12 Modifying the Multiplier Model  In terms of changes in the money supply that result from changes in the monetary base, we get  We will refer to this as the money multiplier  货币乘数：基础货币增加导致货币供给增 加的倍数。

13 Factors that Affect the Money Multiplier

14 Factors that Affect the Money Multiplier

15 The Fed’s Control over the Money Supply  The Fed’s control of the money supply is not complete  the public controls c (the proportion of deposits held as currency)  depository institutions control e (the proportion of deposits held as excess reserves)

16 Summary of Major Points  The Fed’s open market operations affect the quantity of reserves in the banking system  when the Fed buys securities, reserves of depository institutions rise  when the Fed sells securities, reserves of depository institutions fall

17 Summary of Major Points  Depository institutions must hold reserve assets  reserves in excess of required reserves are called excess reserves  When the Fed makes a discount loan or a loan is paid off, reserves are affected

18 Summary of Major Points  For a depository institution, a deposit inflow will increase total deposit liabilities and total reserve assets  a depository institution can adjust to the inflow of deposits by expanding its loans and “creating” additional deposits equal to the amount of excess reserves that result from the deposit inflow

19 Summary of Major Points  As the proceeds of a loan are spent, the lending institution will lose reserves  another institution will gain reserves  this institution can expand loans and create additional deposits in the amount of excess reserves that flow to it

20 Summary of Major Points  Following an initial injection of reserves, the total volume of reserves in the banking system does not change  the composition of reserves changes  as deposits expand at each stage, required reserves rise and excess reserves fall

21 Summary of Major Points  The total expansion of loans and deposits is a multiple of the initial injection of reserves into the banking system  in the simplest model, the multiplier is 1/r D  ignores excess reserves and currency  the lower the required reserve ratio, the larger the multiplier is

22 Summary of Major Points  The monetary base is reserves plus currency in the hands of the public  in a more elaborate model that takes account of excess reserves and currency holding s of the public, the multiplier is a multiple of the change in the monetary base  it is smaller than the simple multiplier  it is influenced by the behavior of the Fed, deposit institutions, and the public

23 Summary of Major Points  Even if the Fed can control the monetary base, it may have difficulty controlling the money supply in the short run  over a longer period, the fluctuations in the multiplier tend to offset one another