Chapter 14

Question 1

Liabilities
Feds monetary liabilities:
Currency in circulation- Federal Resreve notes in the hands of the public (paper money)
Reserves- bank deposits at the Fed plus currency held by the banks (vault cash) * Reserves are assets for the banks but liabilities for the Fed
Total reserves= required reserves (requred reserve ratio * deposits) + excess reserves (any additional reserves banks choose to hold)
Assets
Feds assets:
Securities– U.S. Treasury securities primarily
Loans to financial institutions- discount loans; discount rate is the interest rate charged by the fed for discount loans

Answer 1

The Fed’s Balance Sheet

Question 2

Monetary base= currency in circulation + reserves; MB= C + R

The Fed controls the monetary base through open market operations (its purchase or sale of securities in the open market) and through discount loans to banks.

Answer 2

Control of the Monetary Base

Question 3

the process in which $1 of additional reserves supplied to the banking system by the Fed causes deposits to increase by a multiple of this amount.

Answer 3

Multiple Deposit Creation

Question 4

the multiple increase in deposits generated from an increase in the bankings systems reserve’s.
The simple deposit multiplier is calculated as 1 / rr, where rr= required reserve ratio
So, the total change in checkable deposits= (1 / rr) x initial change in reserves
For our example: (1 / .10) x 100 million= 10 x 100 million= $1 billion

Answer 4

Simple deposit multiplier

Question 5

To Summarize the Simple Model:

Answer 5

The banking system created an expansion of deposits; each bank makes loans which creates checkable deposits, and the reserves go into another bank that makes loans.

If banks decide to use their excess reserves to purchase securities, rather than make loans, the same process occurs.

When the Fed purchases bonds, it injects noney into the banking system; the banking system multiplies that money because we have a fractional reserve banking system, and the money supply increases.

Question 6

Nonborrowed monetary base (MB) - monetary base minus borrowed reserves; results from open market operations. An increase in MB, (due to an open market purchase) raises the amount of the MB and reserves so that multiple deposit creation occurs.
* The money supply is positively related to the nonborrowed monetary base.

Answer 6

Factors That Determine the Money Supply
Changes in the Nonborrowed Base

Question 7

Borrowed reserves (BR) result from discount loans, and an increase raises the amount of the MB and reserves so that multiple deposit creation occurs.
* The money supply is positively related to the level of borrowed reserves from the Fed.

Answer 7

Factors That Determine the Money Supply
Changes in Borrowed Reserves from the Fed

Question 8

If the required reserve ratio increases and banks must hold a greater percentage of deposits on reserve, they will lend out less so multiple deposit expansion is reduced.
If I = 10, simple deposit multiplier = 10; if I = .20, the simple deposit multiplier = 5
* The money supply is negatively related to the required reserve ratio.

Answer 8

Factors That Determine the Money Supply
Changes in the Required Reserve Ratio

Question 9

If banks hold more excess reserves, they lend out less so multiple deposit expansion is reduced.

Answer 9

Factors That Determine the Money Supply
Changes in Excess Reserves

Question 10

tells us how much the money supply changes in response to a change in the monetary base.

The relationship between the money supply (M), the money multiplier (m), and the
monetary base (MB) is expressed as: M = m x MB

Where m = 1+c/rr+e+c
c= currency ÷ deposits = currency ratio
e = excess reserves ÷ deposits = excess reserves ratio

• The money multiplier is a function of the currency ratio set by depositors, the excess reserves ratio set by banks and the required reserve ratio set by the Fed.
• Therefore, the money multiplier is much smaller than the simple deposit multiplier.
• The money multiplier is usually greater than 1 so a $1 change in the monetary base typically leads to more than a $1 change in the money supply.
• That’s why the monetary base is also called high-powered money.
• If banks hold a significant quantity of excess reserves, the money multiplier is less than 1.

Answer 10

Money multiplier