1. Multiple Deposit Creation and the Money Supply Process
Chapter 16

2. Overview The Fed’s T-account Controlling the Monetary Base
Multiple Deposit Expansion
Simple Deposit Multiplier
Critique of the Simple Model

3. ∆ Money Supply (MS) = ∆ Interest Rate (i)
How does Fed change MS??
4 players involved
Federal Reserve
Banks
Depositers
Borrowers

4. The Fed’s Balance Sheet
Assets
Securities
Discount Loans
Gold and SDR’s
Special Drawing Rights
Coin (Treasury)
Cash in Process of Collection
Foreign Assets
Liabilities
Federal Reserve Notes Outstanding
Member Bank Reserves
Treasury Deposits
Foreign/Other Deposits
Foreign Central Banks
Other Gov’t agencies
Deferred availability cash items
Capital Account (Stock)

5. The Fed’s Balance Sheet
Assets
Government Securities
Discount Loans
Liabilities
Currency in Circulation
Reserves
Monetary Liabilities: Currency and Reserves
Increase in either results in increase in MS
Changes in assets = changes in liabilities

6. Monetary Base (High-powered money)
Monetary Base (MB) = Currency in Circulation (c) + Reserves (r) + Treasury “Currency”
Increase the MB: Assets
Securities purchased
Discount loans given
Gold/SDR’s purchased
“Float”: temporary check-clearing asset
Purchase of foreign bonds, currency
Decrease the MB: Liabilities
Treasury/Foreign Deposits
Other Federal Reserve Liabilities
Capital liabilities

7. Term Review
Reserves: deposits at the fed plus currency physically held by banks
Required Reserve Ratio: fraction of DEPOSITS that must be held as currency
Discount Rate: the interest rate charged to banks for discount loans from the Fed

8. Controlling MB Daily changes out of Fed’s control Tools to control MB
Treasury Deposits
Float
Tools to control MB
Open-Market Operations
Discount Loans
Reserve Ratio (probably not, not as useful)

9. Open Market Operations
Purchase of bonds by Fed (open market purchase)
T-account examples
O.M purchase from a bank
O M. Purchase from public
Federal Reserve check deposited
Federal Reserve check cashed
In each case, MB is increased
BUT, effect on reserves (R) in ambiguous!!
Depends on whether the check is deposited or cashed

10. Two more examples Shifts from reserves to currency Discount Loans
MB are not changed
Reserves ARE changed
Fed again has less control over reserves
Discount Loans

11. Multiple Deposit Creation/Expansion
FR increase in reserves usually leads to an increase in MS several times as large
Say Fed buys bonds from 1st nat. bank
1st national can now loan out $100 because RR hasn’t changed
The act of lending has created money!
Bank can’t lend out more than its excess reserves
3) Borrower spends money (writes check on other bank)
DD in First National go out
Vendor puts earnings of $100 in Bank A

12. Expansion Continues
4) With reserve ratio at 10%, Bank A can RELOAN $90 of the deposit!
2nd borrower spends money
2nd Vendor deposits at Bank B
At 10% RR, Bank B loans out $81
3rd Vendor deposits in Bank C
At 10% RR, Bank C loans out $72.90
9) 3rd Vendor deposits in Bank D
Etc., etc.
Infinite series

13. Simple Deposit Multiplier
∆DD = (1/rr) ∆ R
Applies to changes in entire banking system
Equilibrium when no excess reserves exist in the banking system
But doesn’t work if…
Banks keep new funds as excess reserves
Borrowers/Vendors keep cash, don’t redeposit

14. Review Three ways Fed changes MS Buying/selling bonds Discount Loans
Sets multiplier in motion
FOMC
Discount Loans
Same as buying/selling bonds, increases or decreases a banks reserves
Board of Governors
Reserve ratio
Determines the magnitude of the multiplier effect