1. KYIV SCHOOL OF ECONOMICS APPLIED MACROECONOMICS II Instructor: Maksym Obrizan Lecture notes II
# 2. CHAPTER 18
Money Supply and Money Demand
In chapter we further explore the notion of money supply and demand that we introduced in Chapter 4
# 3. Required reserves Central banks typically require that certain percent of deposits should be stored at their vaults (i.e. banks cannot lend this portion)
# 4. Fractional-reserve banking Suppose that banks now have only 20% required reserve and they can make loans of the remaining 80%

2. # 5. How banks create money
# 6. The total money supply Now we can compute the total amount of money supply that banks create The process of transferring money from savers to borrowers is called financial intermediation
# 7. A model of money supply under fractional reserve banking The monetary base B is defined as total number of dollars held as currency C and banks as reserves R The reserve-deposit ratio rr – The currency-deposit ratio cr –
# 8. Definitions Monetary supply is now M = C+D and monetary based is B = C+R Our goal is to solve for money supply M as a function of three exogenous variables (B,rr, cr)

3. # 9. Now divide the numerator and denominator by D After making the substitution that cr=C/D and rr=R/D we obtain
# 10. Money supply is now the function of monetary base Monetary base is called high-powered money because it has a multiplied effect on money supply
# 12. How can the central bank affect the money supply? Recall that open-market operations are the purchases and sales of government bonds
# 11. The effect of three exogenous variables on the money supply

4. # 13. Other instruments Central banks also set reserve requirement (i
# 13. Other instruments Central banks also set reserve requirement (i.e. a minimum reserve-deposit ratio) Finally, the discount rate is the interest rate that central bank charges when making loans to banks
# 14. Money demand
# 16. Why inflation may be good? The amount of currency per person is usually much higher than one would expect
# 15. Portfolio theories of money demand
When a theory of money demand is primarily concerned with money as a store of value it is called a portfolio theory

5. # 17. Alternatively, a theory of money demand may emphasize a medium of exchange role of money Such theories are called transaction theories of money demand with the most prominent being the Baumol-Tobin model
# 18. How many trips to the ATM are optimal?
# 20. Deriving Average Money Holding
# 19. What is the total cost of trips to the bank/ATM?
Total Cost = Forgone Interest + Cost of Trips

6. # 21. Figure 18-2
# 22. Empirical studies of money demand
# 24. Conlcusions
# 23. The role of near money
The nonmonetary assets that have acquired some of the liquidity of money are called near money