chapter 15 Multiple Deposit Creation and the Money

chapter 15 Multiple Deposit Creation and the Money Supply Process

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 Copyright © 2001 Addison Wesley Longman TM 15 - 2

Fed Balance Sheet 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) Copyright © 2001 Addison Wesley Longman TM 15 - 4

Summary: Factors that Affect the Monetary Base Copyright © 2001 Addison Wesley Longman TM 15 - 5

Control of the Monetary Base MB = C + R Open Market Purchase from Bank The Banking System Assets Liabilities Assets The Fed Liabilities Securities – $100 Securities + $100 Reserves + $100 Open Market Purchase from Public The Fed Assets Liabilities Securities – $100 Deposits + $100 Banking System Assets Liabilities Securities + $100 Reserves Checkable Deposits + $100 Result: R $100, MB $100 Copyright © 2001 Addison Wesley Longman TM 15 - 6

If Person Cashes Check Public Assets The Fed Liabilities Assets Liabilities Securities – $100 Securities + $100 Currency + $100 Result: R unchanged, MB $100 Effect on MB certain, on R uncertain Currency + $100 Shifts From Deposits into Currency Public Assets The Fed Liabilities Assets Deposits – $100 Currency + $100 Liabilities Currency + $100 Reserves – $100 Banking System Assets Liabilities Reserves – $100 Deposits – $100 Result: R $100, MB unchanged Copyright © 2001 Addison Wesley Longman TM 15 - 7

Discount Loans Banking System The Fed Assets Liabilities Reserves Discount + $100 loan + $100 Reserves + $100 Result: R $100, MB $100 Conclusion: Fed has better ability to control MB than R Copyright © 2001 Addison Wesley Longman TM 15 - 8

Deposit Creation: Single Bank Assets First National Bank Liabilities Securities Reserves – $100 + $100 Assets First National Bank Liabilities Securities – $100 Deposits Reserves + $100 Loans + $100 Assets First National Bank Liabilities Securities – $100 Deposits Loans + $100 Copyright © 2001 Addison Wesley Longman + $100 TM 15 - 9

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

Deposit Creation Copyright © 2001 Addison Wesley Longman TM 15 - 11

Deposit Multiplier If Bank A buys securities with $90 check Bank A Assets Liabilities Reserves + $10 Deposits + $100 Securities + $90 Seller deposits $90 at Bank B and process is same Whether bank makes loans or buys securities, get same deposit expansion 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 D= 1 r. D 1 D = r. D Copyright © 2001 Addison Wesley Longman R R TM 15 - 13

Banking System As a Whole Banking System Assets Liabilities Securities – $100 Deposits Reserves + $100 Loans + $1000 Critique of Simple Model Deposit creation stops if: 1. Proceeds from loan kept in cash 2. Bank holds excess reserves Copyright © 2001 Addison Wesley Longman TM 15 - 14