1. Determinants of the Money Supply
Chapters 17

2. Overview Review of Simple Money Multiplier
Connect Monetary Base to Money Supply
Factors influencing the sophisticated money multiplier
Sophisticated money multiplier for M2

3. Review Assumptions So R = rr = rd * D and D = (1/rd) * R
All borrowed money gets spent and deposited at another bank
Banks loan all excess reserves keeping only required reserves
So R = rr = rd * D and D = (1/rd) * R
1/rd is simple money multiplier, implying Fed has all control (which it doesn’t)

4. Deriving a “Sophisticated” Money Multiplier
Depositer: how much currency they want to hold
Bank
How much excess reserves they wish to hold
Also partly how much deposits are part of MS
So, make connection between MB and money supply (MS)

5. Derivation MB = R + C = (rd * D + ER) + C
= (rd * D) + (ER/D)*D + (C/D)*D
= [rd + (ER/D) + (C/D)]*D
D = MB [1/(rd + ER/D + C/D)]
Since M1 = D + C = (1 + C/D)*D
M1 = MB*[(1+C/D)/(rd + ER/D + C/D)]
M1 = MB*m
m is ‘sophisticated money multiplier

6. Factors that affect m A change in rd (board of governors)
Negatively related to m and money supply
RR declining importance: sweep accounts and ATMs
A change in (C/D)
The public’s preference for holding cash
A change in (ER/D)
The bank’s preference for holding excess reserves
Link between interest rates and excess reserves
Multiple expansion for deposits, not currency!!!

7. Ratios Represent Preferences
C/D represents people’s desire to hold cash
ER/D represents banks desire to hold excess reserves
Money multiplier is affected by changes in these behaviors, based on factors like interest rates, rates of consumption, etc.
Ultimately, the state of the economy

8. Examples rd increases C/D change, or increase in currency
ER/D change, or increase in excess reserves
Change from deposits to currency
No effect! (MB = r + c)

9. Discount loans as part of MB
MB = MBN + DL
Non-borrowed plus borrowed discount loans
If private rates are high, nothing Fed can do
Unless they close discount window, can’t control amount of loans being taken out

10. Adding M2 to m M2 is next level of what would be “money” Time Deposits
Money market deposit accounts
Money market mutual funds

11. Historical Application
Great Depression
MB increased 20%
But MS decreased 25%
Reason?
Rise in C/D
Rise in ER/D