MONETARY THEORY 2 nd Week Money Supply Monetary

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MONETARY THEORY 2 nd. Week: Money Supply / Monetary Policy

MONETARY THEORY 2 nd. Week: Money Supply / Monetary Policy

Money Supply - Money Stock ARE MONEY SUPPLY AND MONEY STOCK IDENTICAL CONCEPTS? If

Money Supply - Money Stock ARE MONEY SUPPLY AND MONEY STOCK IDENTICAL CONCEPTS? If money supply is completely determined by the Central Bank (exogenous), they are IDENTICAL CONCEPTS. Because in this case, money supply is completely independent from INTEREST RATES and other economic variables.

Is Money Supply ENDOGENOUS? Or Is it EXOGENOUS? If the Monetary Authority can manage

Is Money Supply ENDOGENOUS? Or Is it EXOGENOUS? If the Monetary Authority can manage the money supply of the economy by creating the base money, which is completely under its control, the Money Supply is said to be exogenous. On the contrary, if the preferences and decisions of other market players and therefore the money demand of the market determines the money supply, Money Supply is determined in an endogenous process.

There are 3 groups of players in the Money Supply Theory: • The Central

There are 3 groups of players in the Money Supply Theory: • The Central Bank • Commercial Banks • Public (non-bank sector) HOW DO THEY AFFECT THE MONEY SUPPLY PROCESS?

Assumptions of the Monetarist Money Multiplier Approach: The money multiplier model is derived from

Assumptions of the Monetarist Money Multiplier Approach: The money multiplier model is derived from the development of the simple 'deposit multiplier' approach. 1. There is only one bank in the economy, 2. Banks only accept demand deposits, 3. Banks do not reserve any other reserve than the reserve requirement rate set by the Central Bank, 4. Money deposited in banks is not withdrawn by the public.

Deposit multiplier •

Deposit multiplier •

Bank Money Creation Process Assume that the first amount deposited at the bank is

Bank Money Creation Process Assume that the first amount deposited at the bank is 1000 TL and RRR is %10. Bank Bank Bank. . . Banking System Deposit Amount 1000, 00 900, 00 810, 00 729, 00 656, 10 590, 49 531, 44 478, 30. . . 10000, 00 Credit Created 900, 00 810, 00 729, 00 656, 10 590, 49 531, 44 478, 30 430, 47. . . 9000, 00 Rezerve 100, 00 90, 00 81, 00 72, 90 65, 61 59, 05 53, 14 47, 83. . . 1000, 00

Example There is an initial amount of 100 TL deposited in the banking system.

Example There is an initial amount of 100 TL deposited in the banking system. If the required reserve rate is 25%, what is the total deposit amount created in the system? Solution: The money multiplier is 1 / 0. 25 = 4. This means that there will be 4 times the deposit of the first deposited in the system. 100 TL of this amount is reserve; 300 TL is the credits created.

Public’s Cash Handling Preference • People can choose to keep their money in the

Public’s Cash Handling Preference • People can choose to keep their money in the form of • Cash (C) or • Demand deposits (DD). • The higher the cash preference rate (c = C / DD), the smaller the deposit multiplier.

As a result, reserves have a reducing effect on the currency multiplier: •

As a result, reserves have a reducing effect on the currency multiplier: •

 • TD: time deposit • DD: demand deposit By defining TD/DD = t’

• TD: time deposit • DD: demand deposit By defining TD/DD = t’ When t’ increases, M 2 increases, M 1 Money supply decreases. • Considering the distinction between time and demand deposits, we can obtain the new deposit multiplier as follows:

MONEY MULTIPLIER APPROACH (Friedman -Schwarts & Cagan) • The relationship between money supply and

MONEY MULTIPLIER APPROACH (Friedman -Schwarts & Cagan) • The relationship between money supply and base money in the economy is formulated as; �� = ��. ��

The base money (H) of the Central Bank consists of two components; H =

The base money (H) of the Central Bank consists of two components; H = Hb + DL Øthe base money (H) ØIndebted part that it can fully control (Hb) ØThe part where the Central Bank's control power is weak and created with discount credits (DL)

As a result, the variables that determine the Money multiplier: •

As a result, the variables that determine the Money multiplier: •