Chapter 14 Flashcards
Which groups affect the money supply?
Central bank
Depository institutions (banks)
Public (people and firms)
What is the monetary base/high-powered money?
Sum of reserve deposits and currency
What are bank reserves?
When bank reserves are equal to deposits - 100% reserve banking
Bank lend out some deposits since only a fraction of reserves are needed
When reserve-deposit ratio is <100% - fractional reserve banking
What are open-market operations?
Raising or lowering the monetary base through open-market operations
To increase, prints money and uses it to buy assets - open-market purchase
Reserve-deposit is higher than desired; this leads to a multiple expansion of loans and deposits
Bank increases their loans until the reserve-deposit ratio returns to desired level
To decrease monetary base, uses open-market sale
What is the monetary multiplier?
Relationship between monetary base and money supply
M = money supply
BASE = monetary base
DEP = bank deposits
RES = bank reserve
CU = currency held by nonbank public
res = banks’ desired reserve-deposit ratio (RES/DEP)
cu = public’s desired currency-deposit ratio (CU/DEP)
What is the money supply?
Money supply consists of currency held by the public and deposits so
M = CU + DEP
Monetary base is held as currency by the public and as reserves by banks so
BASE = CU + RES
Taking the ratio of these 2 equations give
M/BASE = (CU + DEP)/(CU + RES)
What are bank runs?
If people think a bank won’t be able to give them their money, they may panic and rush to withdraw their money
To prevent, FDIC insures bank deposits, so that depositors know their funds are safe and there will be no need to withdraw their money
How is the federal reserve’s balance sheet structured?
Largest asset is Treasury securities
Gold, foreign exchange and federal agency securities
Major liability is currency outstanding
Some is held in bank vaults - vault cash - rest is held by public
Major liability is deposits by banks
RES = vault cash + banks’ deposits
Monetary base = banks’ reserves + currency held by nonbank public
What is the primary method for changing the monetary base?
Open-market operations
The interest rate when banks borrow reserves is federal funds rate - in line with other short-term interest rates
What are reserve requirements?
Fed forces banks to hold reserves of about 10% of the value of their transaction deposit
What is the discount window?
Lending reserves to banks so they can meet depositors’ demands or reserve requirement
Interest rate on such borrowing is called discount rate
Discount loan increases monetary base
What is the lender of last resort?
If you cannot borrow from anyone else, you can borrow from the Fed
