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Chapter 15. Money Supply ProcessFed Balance Sheet Fed and the Monetary Base Deposit Creation
The money supply processwho determines the money supply? the Federal Reserve banks depositors borrowers
I. The Fed’s balance sheetAssets U.S. government bonds necessary for open market operations Gold, SDRs used for international debts
other assets foreign bonds, currency physical assets cash in collection discount loans Fed loans to banks
Fed is self-funding open market operations discount loansboth are also key to controlling money supply
Liabilities Federal reserve notes U.S. currencyexchangeable for more notes Reserves deposits by banks required + excess U.S. Treasury deposits
monetary base (MB) currency + reserves C + Ralso called “high-powered money” $1 increase in MB will cause > $1 increase in money supply
II. Controlling MB open market operationsFed buys and sells Treasury securities affect size of monetary base use T accounts to track the effect
example open market purchase $100 millionFed buys $100 million in Tbonds Fed buys from a bank increase in bank reserves of $100 million
if Fed buys Tbonds from public, & public deposits in accountincrease in bank reserves of $100 million
if Fed buys Tbonds from public, & public keeps cashincrease in currency of $100 million
discount loans Fed loans to bank Fed credits bank’s reserve account
reserves increase MB increases
open market purchase or discount loansincrease in MB due to increase in reserves OR due to increase in currency
III. Deposit creation Fed increases reserves by $1,deposits increase by > $1 multiple deposit creation how?
example Fed buys $100 securities from bankbank securities decrease $100 bank reserves increase $100
$100 increase in reserves are excess reserves,banks lends them out by crediting checking account
borrower takes $100 loan and deposits in bank Areserves increase at bank A deposits increase at bank A
required reserve ratio = 10%bank A must keep $10 free to lend $90
borrower at bank A takes $90 loan and deposits in bank B
bank B must keep $9 free to lend $81
where are we? initial $100 open market purchasechecking deposits so far: $100 + $90 + $81 = $271 money has been created
simple money multiplierhow much money creation is possible? 1 reserve req. change in deposits = change in reserves x
$100 increase in reserves, $1000 increase in deposits change in= 1 .10 = $1000 $100 x $100 increase in reserves, $1000 increase in deposits
simple money multiplierleaves out 2 possibilities: (1) borrowers take some of loan as cash (2) banks hold some excess reserves need a more complex multiplier
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