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Causes of Non-Fed Variables: M2 Determination zFederal Reserve controlled variables: H NON (open market operations), r D, r T. zThis chapter -- studies key causes of k, t, mmmf, e, and DL.

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Key Causes of k = C/D zInterest rates (i), i k zBank Panics, Panic k zIllegal Activity, increases the demand for cash zFinancial Innovation towards transactions convenience (e.g. credit cards) (FI), FI k

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Key Causes of t = T/D zInterest rates (i), i t zMarket Risk (Stock) ( S ), S t zUncertainty About the Economy ( Y ), Y t zSweep Programs (SWEEP), SWEEP t

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Key Causes of mmmf = MMMF/D zInterest rates (i), i mmmf zMarket Risk (Stock) ( S ), S mmmf zUncertainty About the Economy ( Y ), Y mmmf

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Key Causes of e = ER/D zInterest rates (i), i e zExpected Deposit Outflows (DOE) DOE k zDeposit Risk, or Uncertainty About Deposit Outflows ( D ) D e

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Recent Developments: Increasing the e-Ratio zIncreased Vault Cash for Servicing ATMs. zEstablishment of Clearing Balances with the Federal Reserve, receives some return from the Fed. zFuture – Interest on excess reserves?

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Key Causes of Discount Loans (DL) zInterest rates (i), i DL zThe Discount Rate (i DISC ), i DISC DL zFed Surveillance, Surveillance DL

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Synthesizing the Analysis zEvent zWhat components of M2 determination are affected, and how? zHow does this change M2 (immediately and/or through bank loaning)?

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M2 Determination: A Review M2 = (1 + k + t + mmmf) (H NON + DL) (k + r D + r T t + e) The money multiplier (m 2 )

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How the Components Affect M2: A Review H NON M2 DL M2 r D M2 r T M2 k M2 t M2 mmmf M2 e M2

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Example 1 -- An Increase in Interest Rates i k M2 i t M2 i mmmf M2 i e M2 i DL M2 Is there a money supply function?

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Example 2 -- 1929-33 (Major Panic/Bank Failures) Panic k M2 Could the Federal Reserve have offset the situation (Discount Window, emergency loans)? DL M2

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Example 3 -- 1934-41 (Keynesian Liquidity Trap) zFederal Reserve -- practicing active monetary policy. H NON M2

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1934-41 -- Bank Behavior zBut, banks experience high deposit risk ( D ), expected deposit outflows (DOE), and very low interest rates desire to hold large amounts of excess reserves. D , DOE , i e M2 zOffsets the effect of policy.

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Chapter 15. Money Supply Process

Chapter 15. Money Supply Process

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