1. Chapter 15. Money Supply Process
Fed Balance Sheet
Fed and the Monetary Base
Deposit Creation

2. The money supply process
who determines the money supply?
the Federal Reserve
banks
depositors
borrowers

3. I. The Fed’s balance sheet
Assets
U.S. government bonds
necessary for open market operations
Gold, SDRs
used for international debts

4. other assets
foreign bonds, currency
physical assets
cash in collection
discount loans
Fed loans to banks

5. Fed is self-funding open market operations discount loans
both are also key to controlling money supply

6. Liabilities Federal reserve notes U.S. currency
exchangeable for more notes
Reserves
deposits by banks
required + excess
U.S. Treasury deposits

7. monetary base (MB) currency + reserves C + R
also called “high-powered money”
$1 increase in MB will cause
> $1 increase in money supply

8. II. Controlling MB open market operations
Fed buys and sells Treasury securities
affect size of monetary base
use T accounts to track the effect

9. example open market purchase $100 million
Fed buys $100 million in Tbonds
Fed buys from a bank
increase in bank reserves of $100 million

10. if Fed buys Tbonds from public, & public deposits in account
increase in bank reserves of $100 million

11. if Fed buys Tbonds from public, & public keeps cash
increase in currency of $100 million

12. discount loans
Fed loans to bank
Fed credits bank’s reserve account

13. reserves increase
MB increases

14. open market purchase or discount loans
increase in MB
due to increase in reserves OR
due to increase in currency

15. III. Deposit creation Fed increases reserves by $1,
deposits increase by > $1
multiple deposit creation
how?

16. example Fed buys $100 securities from bank
bank securities decrease $100
bank reserves increase $100

17. $100 increase in reserves are excess reserves,
banks lends them out by crediting checking account

18. borrower takes $100 loan and deposits in bank A
reserves increase at bank A
deposits increase at bank A

19. required reserve ratio = 10%
bank A must keep $10
free to lend $90

20. borrower at bank A takes $90 loan and deposits in bank B

21. bank B must keep $9
free to lend $81

22. where are we? initial $100 open market purchase
checking deposits so far:
$100 + $90 + $81 = $271
money has been created

23. simple money multiplier
how much money creation is possible? 1
reserve req.
change in
deposits =
change in
reserves x

24. $100 increase in reserves, $1000 increase in deposits change in= 1
.10
= $1000
$100 x
$100 increase in reserves,
$1000 increase in deposits

25. simple money multiplier
leaves out 2 possibilities:
(1) borrowers take some of loan as cash
(2) banks hold some excess reserves
need a more complex multiplier