1. chapter 15 Multiple Deposit Creation and the Money Supply Process

2. Copyright © 2001 Addison Wesley Longman TM 15- 2 Four Players in the Money Supply Process 1.Central bank: the Fed 2.Banks 3.Depositors 4.Borrowers from banks Federal Reserve System 1.Conducts monetary policy 2.Clears checks 3.Regulates banks

3. Copyright © 2001 Addison Wesley Longman TM 15- 3 The Monetary Base 1.MB= C + R = (Fed notes) + (bank deposits) + (Treasury currency) – (coin) Asset = Liabilities of Fed balance sheet  2.(Fed notes) + (bank deposits) = (securities) + (discount loans) + (gold and SDRs) + (coin) + (cash items in process of collection) + (other Fed assets) – (Treasury deposits) – (foreign and other deposits) – (deferred-availability cash items) – (other Fed liabs) Float = (cash items in process of collection) – (deferred-availability cash items) Substituting 2 into 1 and using definition of float: MB = (securities) + (discount loans) + (gold and SDRs) + (float) + (other Fed assets) + (Treasury currency) – (Treasury deposits) – (foreign and other deposits) – (other Fed liabs)

4. Copyright © 2001 Addison Wesley Longman TM 15- 4 Summary: Factors that Affect the Monetary Base

5. Copyright © 2001 Addison Wesley Longman TM 15- 5 Control of the Monetary Base MB = C + R Open Market Purchase from Bank The Banking SystemThe Fed AssetsLiabilitiesAssetsLiabilities Securities – $100Securities + $100Reserves + $100 Reserves + $100 Open Market Purchase from Public Public The Fed AssetsLiabilitiesAssetsLiabilities Securities – $100Securities + $100Reserves + $100 Deposits + $100 Banking System AssetsLiabilities ReservesCheckable Deposits+ $100 Result: R  $100, MB  $100

6. Copyright © 2001 Addison Wesley Longman TM 15- 6 If Person Cashes Check Public The Fed AssetsLiabilitiesAssetsLiabilities Securities – $100Securities + $100 Currency + $100 Currency + $100 Result: R unchanged, MB  $100 Effect on MB certain, on R uncertain Shifts From Deposits into Currency Public The Fed AssetsLiabilitiesAssetsLiabilities Deposits – $100Currency + $100 Currency + $100Reserves – $100 Banking System AssetsLiabilities Reserves – $100Deposits – $100 Result: R  $100, MB unchanged

7. Copyright © 2001 Addison Wesley Longman TM 15- 7 Discount Loans Banking System The Fed AssetsLiabilitiesAssetsLiabilities Reserves DiscountDiscountReserves + $100 loan + $100 loan + $100 + $100 Result: R  $100, MB  $100 Conclusion: Fed has better ability to control MB than R

8. Copyright © 2001 Addison Wesley Longman TM 15- 8 Deposit Creation: Single Bank First National Bank Assets Liabilities Securities– $100 Reserves+ $100 First National Bank Assets Liabilities Securities– $100Deposits+ $100 Reserves+ $100 Loans+ $100 First National Bank Assets Liabilities Securities– $100Deposits+ $100 Loans+ $100

9. Copyright © 2001 Addison Wesley Longman TM 15- 9 Deposit Creation: Banking System Bank A Assets Liabilities Reserves+ $100Deposits+ $100 Bank A Assets Liabilities Reserves+ $10Deposits+ $100 Loans + $90 Bank B Assets Liabilities Reserves+ $90Deposits+ $90 Bank B Assets Liabilities Reserves+ $ 9Deposits+ $90 Loans + $81

10. Copyright © 2001 Addison Wesley Longman TM 15- 10 Deposit Creation

11. Copyright © 2001 Addison Wesley Longman TM 15- 11 Deposit Multiplier If Bank A buys securities with $90 check Bank A Assets Liabilities Reserves+ $10Deposits+ $100 Securities+ $90 Seller deposits $90 at Bank B and process is same Whether bank makes loans or buys securities, get same deposit expansion

12. Copyright © 2001 Addison Wesley Longman TM 15- 12 Deposit Multiplier Simple Deposit Multiplier 1  D =   R r D Deriving the formula R = RR = r D  D 1 D =  R r D 1  D =   R r D

13. Copyright © 2001 Addison Wesley Longman TM 15- 13 Banking System As a Whole Banking System Assets Liabilities Securities– $100Deposits+ $1000 Reserves+ $100 Loans+ $1000 Critique of Simple Model Deposit creation stops if: 1. Proceeds from loan kept in cash 2. Bank holds excess reserves