Chapter 14.3: Determining the Money Supply Flashcards
How do banks affect the money supply through their creation of chequable deposits?
- Banks remove some currency from circulation: dollar bills that are sitting in bank vaults, as opposed to sitting in people’s wallets, aren’t part of the money supply. 2. Much more importantly, banks create money by accepting deposits and making loans - that is, they make the money supply larger than just the value of currency in circulation.
What happens to a bank’s loans, reserves, chequable deposits, and equity when Silas makes adds $1000 to his bank account?
Loans: no change
Reserves: +$1000
Chequable deposits: +$1000
Equity: no change
What happens to a bank’s loans, reserves, chequable deposits, and equity when the bank decides to loan $900 of Silas’ money ($1000) to another customer?
Loans: +$900
Reserves: -$900
Chequable deposits: No change
Equity: No change
What are excess reserves?
A bank’s reserves over and above the reserves required by law or regulation.
How do you calculate the total increase in chequable deposits with $1000 of excess reserves (in a chequable deposits only system)?
Increase in chequable deposits from $1000 in excess reserves = $1000 + ($1000 * (1-rr)) + ($1000 * (1-rr)^2) + ($1000 * (1-rr)^3) +…
OR
Increase in chequable deposits from $1000 in excess reserves = $1000/rr
What does the Bank of Canada control? What does it not control?
The BoC controls the sum of bank reserves and currency in circulation, called the monetary base, but it does not control the allocation of that sum between bank reserves and currency in circulation.
What is the monetary base?
The sum of currency in circulation and bank reserves.
How is the monetary base different from the money supply?
- Bank reserves, which are part of the monetary base, aren’t considered part of the money supply, because it’s not available for spending.
- Chequable deposits, which are part of the money supply because they are available for spending, are not part of the monetary base.
What is considered part of both the money supply and monetary base?
Currency in circulation.
What is the money multiplier?
The ratio of the money supply to the monetary base (aka money supply/monetary base).
How much of the monetary base consists of currency in circulation?
90%
What generates a multiplier effect on the money supply?
Banks creating money when they lend out excess reserves.
What reduces the size of the multiplier in reality?
In reality, consumers hold some funds as cash rather than chequable deposits, which “leaks out” and reduces the size of the multiplier.
Assume that total reserves are equal to $200 and total chequable deposits are equal to $1,000. Also assume that the public does not hold any currency. Now suppose that the reserve ratio falls from 20% to 10%. Trace out how this leads to an expansion in bank deposits.
Since they only have to hold $100 in reserves instead of $200, banks will lend out that $100. Whoever borrows the $100 will deposit it in a bank, which will lend out $100 * (1-rr) = $100 * 0.9 = $90. Whoever borrows the $90 will put that in the bank, which will lend out $90*0.9 = $81, and so on. Overall, deposits will increase by $100/0.1 = $1000.
What is the definition of money?
Any asset that can easily be used to purchase goods and services.
