2 Overview Review of Simple Money Multiplier Connect Monetary Base to Money SupplyFactors influencing the sophisticated money multiplierSophisticated money multiplier for M2
3 Review Assumptions So R = rr = rd * D and D = (1/rd) * R All borrowed money gets spent and deposited at another bankBanks loan all excess reserves keeping only required reservesSo R = rr = rd * D and D = (1/rd) * R1/rd is simple money multiplier, implying Fed has all control (which it doesn’t)
4 Deriving a “Sophisticated” Money Multiplier Depositer: how much currency they want to holdBankHow much excess reserves they wish to holdAlso partly how much deposits are part of MSSo, make connection between MB and money supply (MS)
5 Derivation MB = R + C = (rd * D + ER) + C = (rd * D) + (ER/D)*D + (C/D)*D= [rd + (ER/D) + (C/D)]*DD = MB [1/(rd + ER/D + C/D)]Since M1 = D + C = (1 + C/D)*DM1 = MB*[(1+C/D)/(rd + ER/D + C/D)]M1 = MB*mm is ‘sophisticated money multiplier
6 Factors that affect m A change in rd (board of governors) Negatively related to m and money supplyRR declining importance: sweep accounts and ATMsA change in (C/D)The public’s preference for holding cashA change in (ER/D)The bank’s preference for holding excess reservesLink between interest rates and excess reservesMultiple expansion for deposits, not currency!!!
7 Ratios Represent Preferences C/D represents people’s desire to hold cashER/D represents banks desire to hold excess reservesMoney multiplier is affected by changes in these behaviors, based on factors like interest rates, rates of consumption, etc.Ultimately, the state of the economy
8 Examples rd increases C/D change, or increase in currency ER/D change, or increase in excess reservesChange from deposits to currencyNo effect! (MB = r + c)
9 Discount loans as part of MB MB = MBN + DLNon-borrowed plus borrowed discount loansIf private rates are high, nothing Fed can doUnless they close discount window, can’t control amount of loans being taken out
10 Adding M2 to m M2 is next level of what would be “money” Time Deposits Money market deposit accountsMoney market mutual funds
11 Historical Application Great DepressionMB increased 20%But MS decreased 25%Reason?Rise in C/DRise in ER/D
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