1. © 2008 Pearson Education Canada
Chapter 16
Determinants of the Money Supply
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2. © 2008 Pearson Education Canada
The Money Supply Model
Define money as currency plus chequable deposits: M1
The Bank of Canada can control the monetary base better than it can control reserves
Link the money supply (M) to the monetary base (MB) and let m be the money multiplier
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3. Deriving the Money Multiplier
Assume the desired level of currency (C) and excess reserves (ER) grows proportionately with chequable deposits (D)
Then:
c = (C / D) = currency ratio
r = DR / C = desired reserve ratio
e = (ER / D) = excess reserve ratio
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4. Deriving the Money Multiplier (Cont’d)
The monetary base (MB) equals reserves (R) plus currency (C)
MB = R + C = ( (r x D) + ER ) + C
Shows the monetary base needed to support existing amounts of r, D, ER and C
An increase in MB going into C is not multiplied, but an increase in MB going into D is multiplied via the deposit multipler
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5. The Money Multiplier in Terms of the Currency Ratio
After several computations
M = (1+c)/(c+r) x MB
where m = (1+c)/(c+r)
M = m x MB and MB = 1/m x MB
While there is a multiple expansion of deposits, there is no such expansion for currency
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6. Factors that Determine the Money Multiplier
Changes in the currency ratio c
The money multiplier and the money supply are negatively related to c
Changes in the desired reserve ratio r
The money multiplier and the money supply are negatively related to r
Market Interest Rates
Expected Deposit Outflows
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7. © 2008 Pearson Education Canada
Additional Factors
Open market operations are controlled by the Bank of Canada
The Bank of Canada cannot determine the amount of borrowing by banks from the Bank of Canada
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8. © 2008 Pearson Education Canada
Split the monetary base into two components
MB = MBn + BR therefore M = m (MBn + BR)
MBn = nonborrowed monetary base
MB = monetary base
BR = borrowed reserves from the Bank of
Canada
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9. © 2008 Pearson Education Canada
Since M = m (MBn + BR)
The money supply (M) is
- positively related to the non-borrowed
monetary base MBn
- positively related to the level of borrowed
reserves (BR) from the Bank of Canada
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10. © 2008 Pearson Education Canada
Money Supply Response
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11. Deposits of Failed Commercial Banks in U.S. in the Depression
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12. Desired Reserves and Currency Ratios
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13. © 2008 Pearson Education Canada
M1 and the Monetary Base
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