1. © 2008 Pearson Education Canada15.1 Chapter 15 Multiple Deposit Creation and the Money Supply Process

2. © 2008 Pearson Education Canada15.2 Players in the Money Supply Process Central bank (Bank of Canada) Banks (depository institutions; financial intermediaries) Depositors (individuals and institutions) Borrowers (individuals and institutions)

3. © 2008 Pearson Education Canada15.3 Bank of Canada’s Balance Sheet Monetary Liabilities –Currency in circulation—in the hands of the public –Reserves - bank deposits at Bank of Canada and vault cash Assets –Government securities - holdings by the Bank of Canada that affect money supply and earn interest –Advances to banks - provide reserves to banks and earn the discount rate Bank of Canada AssetsLiabilities Government securities Currency in circulation Advances to banksReserves

4. © 2008 Pearson Education Canada15.4 Bank of Canada’s Balance Sheet (Cont’d) All LVTS and ACSS participants have accounts at the Bank of Canada (B of C) in which they hold settlement balances Chartered banks hold desired reserves to manage their short term liquidity requirements and respond to clearing drains and currency drains Reserves above that desired are known as excess reserves

5. © 2008 Pearson Education Canada15.5 The definition for the monetary base (MB) is given below.

6. © 2008 Pearson Education Canada15.6 Monetary Base

7. © 2008 Pearson Education Canada15.7 Open Market Purchase from a Bank Net result is that reserves have increased by $100 No change in currency Monetary base has risen by $100 Banking SystemBank of Canada AssetsLiabilitiesAssetsLiabilities Securities-$100Securities+$100Reserves+$100 Reserves+$100

8. © 2008 Pearson Education Canada15.8 Open Market Purchase: Summary The effect of an open market purchase on reserves depends on whether the seller of the bonds keeps the proceeds from the sale in currency or in deposits The effect of an open market purchase on the monetary base (MB) always increases the base by the amount of the purchase

9. © 2008 Pearson Education Canada15.9. Open Market Sale to Non-Bank Public for Currency Reduces the monetary base by the amount of the sale Reserves remain unchanged The effect of open market operations on the monetary base is much more certain than the effect on reserves Nonbank PublicBank of Canada AssetsLiabilitiesAssetsLiabilities Securities+$100Securities-$100Currency in circulation -$100 Currency-$100

10. © 2008 Pearson Education Canada15.10 Shifts from Deposits into Currency Nonbank PublicBanking System AssetsLiabilitiesAssetsLiabilities Chequable deposits +$100Reserves-$100Cheqeable deposits -$100 Currency-$100 Bank of Canada AssetsLiabilities Currency in circulation +$100 Reserves-$100

11. © 2008 Pearson Education Canada15.11 Bank of Canada Advances to Banks. Monetary liabilities of the Bank of Canada have increased by $100 Monetary base also increases by this amount Banking SystemBank of Canada AssetsLiabilitiesAssetsLiabilities Reserves+$100Advances+$100Advances+$100Reserves+$100

12. © 2008 Pearson Education Canada15.12 A Bank Paying Off a Loan from the Bank of Canada Net effect on monetary base is a reduction Monetary base changes one-for-one with a change in the borrowings from the Bank of Canada Banking SystemBank of Canada AssetsLiabilitiesAssetsLiabilities Reserves-$100Advances-$100Advances-$100Reserves-$100

13. © 2008 Pearson Education Canada15.13 Deposit Creation: The Banking System Bank A AssetsLiabilitiesAssetsLiabilities Reserves+$100Chequable deposits +$100Reserves+$10Chequable deposits +$100 Loans+$90 Bank B AssetsLiabilitiesAssetsLiabilities Reserves+$90Chequable deposits +$90Reserves+$9Chequable deposits +$90 Loans+$81

14. © 2008 Pearson Education Canada15.14 Increase in Assets Increase in Liabilities Reserves Loans Deposits +10 +90 +100 + 9 +81 + 90 + 8.1 +72.9 + 81 : : :

15. © 2008 Pearson Education Canada15.15 Change in deposits (ie liabilities) equals 100(1 +.9 +.81 + 72.9 + …..) = 100(.9 0 +.9 1 +.9 2 +.9 3 + ….) = 100( 1 / (1 -.9) ) = 100 ( 1 /.1) note: reserve ratio =.1 = 100 ( 10 ) = 1,000

16. © 2008 Pearson Education Canada15.16 Change in Assets Change in loans equals.9 ( 1,000) = 900 Change in reserves.1 ( 1,000) = 100

17. © 2008 Pearson Education Canada15.17 The Formula for Multiple Deposit Creation

18. © 2008 Pearson Education Canada15.18 Critique of the Simple Model Holding cash stops the process Banks may not use all of their excess reserves to buy securities or make loans