1. Chapter 16. Determinants of the Money Supply
Money multiplier
Factors that determine multiplier & MS
Applications: Great Depression

2. given problems with simple money multiplier,
construct better multiplier
cash holdings
excess reserves holdings
based on M1 = C + D

3. I. money multiplier
how $1 change in MB will affect MS:
M = m x MB

4. 1 + c m = rD + e + c rD = required reserve ratio
c = ratio of currency to deposits
e = ratio of excess reserves to deposits

5. example
rD = .10
C = $400 billion
D = $800 billion
ER = $.8 billion or $800 million
1 + .5
m =
= 2.5
$1 increase in MB, $2.5 increase in M

6. II. Factors affecting m & MS
changes in rD
changes in c
changes in e
changes in MB

7. changes in rD higher reserve requirement fewer excess reserves to lend
smaller amount of deposit creation
smaller
multiplier
higher rD

8. example rD was .10 suppose it rises to .20 1 + .5 m = .20 + .001 + .5

9. changes in c higher c currency does not expand like deposits
smaller amount of deposit creation
smaller
multiplier
higher c

10. example original example: c = .5 suppose c = .8 1 + .8 m = = 2.00

11. changes in ER/D higher e banks hold more ER, lend less
smaller amount of deposit creation
smaller
multiplier
higher e

12. example original example: e = .001 suppose e = .005 1 + .5 m = = 2.48

13. what affects e? as interest rates rise
opportunity cost of holding ER rise
(money could be lent out) ER
fall
higher i

15. expected deposit outflows
must hold more ER

16. Factors affecting MB MB = MBn + DL MBn is nonborrowed MB
-- open market purchase will
increase MBn
-- open market sale will
decrease MBn
increase MBn will increase M

17. DL is discount loans
-- increase as banks borrow from
the Fed
-- increase as spread between
market interest rate and discount
rate increases

19. Great Depression 1930-33 big contraction in M1 big increases in c, e
depositors withdrew cash
banks increase ER due to increase in deposit outflow

22. as c and e rise,
money multiplier declines
M1 declines by 25% from