1. Monetary aggregates and money multiplier Prof. Dariusz Filar

2. M0 Central Bank money – high-powered money, the monetary base, the cash base – consists of all the currency in circulation (bills and coins) and sometimes is also defined as M0. The monetary base is referred to as „high-powered money”because it is a basis upon which a much bigger stock of money is built (including the biggest component of the money stock which are bank deposits)

3. M3 (broad money) Currency held by the public + Retail depsits with commercial banks + Other private-sector interest-bearing deposits M3 > M0

4. Monetary aggregates in Poland and Euro Area in January 2013 Poland M0 = 110, 3 bn PLN M3 = 913, 6 bn PLN M3 is 8 times the size of M0 Euro Area M0 = 906 bn € M3 = 9 769 bn € M3 is almost 11 times the size of M0

5. Money multiplier The overall supply of money depends on the amount of central bank money (high-powered money; monetary base) Increases in Hd lead to more than one-for-one increases in the overall money supply The overall supply of money is, therefore, equal to central bank money times the money multiplier

6. Understanding the money multiplier (1) Suppose central bank buys 100 units worth bonds. To pay the seller (call him Seller 1), central bank creates 100 units in central bank money. Seller 1 (if he doesn’t want to hold any currency) deposits the 100 units in a deposit at his bank – call it Bank A. This leads to an increase in deposits of 100 units.

7. Understanding the money multiplier (2) Here is the beginning of the work of the Money Multiplier: Bank A keeps 100 units x 0,1 (reserves ratio) = 10 units in reserves and buys bonds with the rest (100 – 10 = 90) from the Seller 2 Seller 2 deposits 90 units in a deposit at her bank – call it Bank B. This leads to an increase in deposits of additional 90 units.

8. Understanding the money multiplier (3) Bank B keeps 90 units x 0,1 = 9 units in reserves and buys bonds with the rest (90 – 9 = 81). It pays 81 units to the seller of those bonds – call him Seller 3 Seller 3 deposits his 81 units at a account in his bank – call it Bank C. This leads to an increase in deposits of 81 units. And so on …

9. The double „magic” of paper money Fiat money based solely on faith in continuity of cirrculation Money multiplier making the total money supply significantly larger than the monetary base

10. Monetary Policy Monetary policy is about providing an economy with a currency of stable value and avoiding disruption to the payments and banking system.

11. Monetary Policy Strategies Exchange rate strategy – the value of domestic currency is fixed to some foreign currency Monetary aggregates control strategy – the total money supply is controlled by influencing the stock of high-powered money Direct inflation targeting – central bank defines as its primary goal the achievement of a low inflation rate