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Money And Banks > Chapter 15 > Flashcards

Chapter 15 Flashcards

1
Q

Who oversees the banking system and conducts the monetary policy?

A

The Central bank.

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2
Q

What are the three players in the money supply process?

A

The Central bank, banks, and depositors.

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3
Q

What is the meaning of currency in circulation in the CB balance sheet?

A

It is the amount of currency in the hands of the public, which is a liability of the CB as it is issued by it and accepted as a medium of exchange and a means of payments.

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4
Q

What are banks?

A

Depository institutions and financial intermediaries

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5
Q

Who are depositors?

A

Individuals and institutions

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6
Q

What are the assets on the Central Bank’s balance sheet?

A

Securities and loans to financial institutions.

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7
Q

What are the liabilities on the Central Bank’s balance sheet?

A

Currency in circulation and reserves.

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8
Q

What is currency in circulation?

A

The amount of currency in the hands of the public, which is a liability of the Central Bank.

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9
Q

What are reserves?

A

Deposits at the Central Bank plus currency physically held by banks, which are assets for banks but liabilities for the Central Bank.

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10
Q

What are required reserves and excess reserves?

A

Required reserves are the minimum amount of reserves that banks are required to hold, while excess reserves are reserves held above the required amount.

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11
Q

What is the monetary base?

A

The sum of currency in circulation and reserves, which are monetary liabilities of the Central Bank and an important part of the money supply.

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12
Q

Why is currency in circulation considered a liability of the Central Bank? Does it include any additional currency that is not yet in the hands of the public?

A

as it is issued by it and accepted as a medium of exchange and a means of payments.(it does not include any additional currency that is not yet in the hands of the public. If the currency has been printed but is not circulating means it is not anyone asset or
liability and thus can not affect anyone’s behaviour)

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13
Q

Why are reserves assets for the banks and liabilities for the CB?

A

because banks can demand payment on them at any time and the CB is required to satisfy its obligation by paying.

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14
Q

How does an increase in Reserves affect the money supply?

A

An increase in reserves leads to an increase in the level of deposits and hence in the money supply.

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15
Q

What is the formula for the Monetary Base?

A

MB=C + R

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16
Q

Why do we focus only on the monetary liabilities of the CB when discussing the Monetary Base?

A

because treasury’s monetary liabilities are too small so we will ignore it .

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17
Q

What is included in the Monetary Base?

A

MB=C + R + treasury’s monetary liabilities
(treasury currency in circulation , primarily
coins)

* Monetary liabilities of the CB (C + R) is part
of the MB.

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18
Q

Why are the monetary liabilities of the CB important for the money supply?

A

The monetary liabilities of the CB, which include currency and reserves, are important for the money supply because an increase in either or both of them will lead to an increase in the money supply, assuming everything else is held constant.

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19
Q

What are the assets of the central bank?

A
  • Government Securties
  • Loans to financial institution
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20
Q

How do government securities held by the central bank affect the money supply?

A

An increase in government or other securities held by CB increase the money supply and earn interest.

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21
Q

How does the CB provide reserves to banks?

A

CB provides reserves to banks by making loans to banks and other financial institutions ( discount loans) and earn the discount rate.

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22
Q

Can an increase in loans to banks be a source of increase in the money supply?

A

An increase in loans to banks can be also a source of
increase in the money supply

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23
Q

What are the two reasons that CB assets are important?

A
  1. changes in the asset items lead to changes in reserves and the monetary base and consequently to changes in the money supply.
  2. These assets earn interest rates ( CB assets earn income and its liabilities cost practically nothing)
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24
Q

What does MB stand for in the equation MB = C + R?

A

Monetary Base

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25
Q

Define high-powered money.

A

The sum of the Fed’s monetary liabilities (currency in circulation and reserves) and the U.S. Treasury’s monetary liabilities (Treasury currency in circulation, primarily coins)

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26
Q

What does C represent in the equation
MB = C + R?

A

C = currency in circulation

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27
Q

What does R represent in the equation MB = C + R?

A

R = total reserves in the banking system

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28
Q

How does the central bank exercise control over the monetary base?

A
  • Its purchases or sales of securities in the open market (open market operations).
  • Its extension of discount loans to banks.
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29
Q

What are open market operations?

A

The purchase of bonds by the
CB.

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30
Q

Explain the concept of an open market sale

A

The sale of bonds by the CB.

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31
Q

How are open market operations typically conducted?

A

Open market operations usually done through primary
dealers “ government securities dealer”.

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32
Q

What is the net change in reserves after an open market purchase of $100 million?

A

Net result is that reserves have increased by $100m

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33
Q

Did the currency in circulation experience any change during the open market purchase?

A

No change in currency

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34
Q

How does a $100m open market purchase impact the monetary base?

A

Monetary base has risen by $100m

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35
Q

Explain how open market purchases expand reserves.

A

open market purchases of bonds expands reserves because the CB pays for bonds with reserves.

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36
Q

According to the equation MB = C + R, what is the relationship between the monetary base, currency, and reserves?

A

Because monetary base equals currency plus reserves
“MB=C+R”, Then monetary base will increase by an amount equal to the amount of the purchase

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37
Q

What is the result of an open market purchase by the central bank?

A

CB purchase bonds –> CB pays to get them with reserves–> (R) increase in the market with no change in C –> MB increases.

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38
Q

Does an open market purchase affect the currency in circulation (C)?

A

NO

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39
Q

How does an open market purchase impact the monetary base (MB)?

A

The effect of an open market purchase on the monetary base always increases the monetary base by the amount of the purchase

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40
Q

How does an open market sale affect the monetary base?

A

monetary base will decrease by an amount equal to
the amount of the sale .

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41
Q

How does an open market sale influence the overall money supply?

A

The effect of open market sale on the monetary base is to be declined and hence I expect a decline in MS.

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42
Q

Why does the monetary base decrease by the amount of the open market sale?

A

Because monetary base equals currency
plus reserves “MB=C+R”

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43
Q

How does a decrease in the monetary base impact the money supply?

A

A decrease in the monetary base, resulting from an open market sale, generally leads to a contraction in the money supply.

44
Q

If the public withdraws $100 million in cash from deposits, what happens to the banking system’s reserves?

A

It means that the banking system loses 100m of deposits and hence of reserves

45
Q

What happens to the reserves in the banking system when there is a shift from deposits into currency?

A

Reserves decreases

46
Q

Can you explain why the monetary base remains unaffected during a shift from deposits into currency?

A

For the CB this action means that
Currency increases by 100m
Reserves decreases by 100m
So the monetary base = C + R is unaffected

47
Q

What happens to the assets and liabilities of the banking system during a shift from deposits into currency?

A

The assets and liabilities of the banking system both decrease by the same amount as the shift from deposits into currency.

Reserves and checkable deposits decrease

48
Q

What happens to the reserves of the banking system when there is a shift from deposits into currency?

A

The reserves of the banking system decrease by the same amount as the shift from deposits into currency.

49
Q

Explain why the net effect on monetary liabilities is zero during a shift from deposits into currency for CB.

A

The net effect on monetary liabilities is zero because the decrease in liabilities (deposits) is offset by an equal increase in another form of liability (currency in circulation).

50
Q

Can you calculate the new amount of currency in circulation after a $100 million shift from deposits into currency?

A

After a $100 million shift from deposits into currency, the new amount of currency in circulation would increase by $100 million.

51
Q

What is the impact on the assets and liabilities of the nonbank public when there is a shift from deposits into currency?

A

The shift from deposits into currency by the nonbank public results in a decrease in their checkable deposits, which are considered assets. At the same time, their liabilities remain unaffected since they are converting one form of money (deposits) into another (currency).

52
Q

How does the public’s increased desire for cash affect the monetary base?

A

The monetary base is unaffected by the public’s
increased desire for cash.

53
Q

What is the impact on reserves when there is a shift from deposits into currency?

A

Random fluctuations of reserves can occur as a result
of random shifts into currency and out of deposits and
vice versa.

54
Q

Which variable, monetary base or reserves, is more under the control of central banks?

A

CBs have more control over MB than reserves

55
Q

How do monetary liabilities of the central bank change when it makes a loan to a financial institution?

A

When the CB makes a loan to a bank for example by
an amount equal to “$100 M”, the bank will be credited with $100 M of reserves from the proceeds of the loan therefore Monetary liabilities of the CB have increased by $100 M

56
Q

When the central bank makes a loan to a bank, what happens to the reserves of the bank?

A

Reserves of the bank increases with the amount of the loans

57
Q

What is the impact on the monetary base when the central bank lends money to a financial institution?

A

Monetary base also increases by the same amount of the loan that the CB lend to financial institution

58
Q

Describe the changes in assets and liabilities for the banking system and the central bank when a loan is made.

A

When a loan is made by the central bank to a financial institution, the assets of the banking system increase by the loan amount (in this case, +$100m) due to the additional reserves received. Simultaneously, the liabilities of the banking system also increase by the loan amount (+$100m) as it now owes this amount to the central bank. For the central bank, its assets remain unchanged as it has provided a loan, while its liabilities increase by the loan amount (+$100m) as it now owes the reserves to the financial institution.

59
Q

What happens to the monetary liabilities of the central bank when financial institutions pay off their loans?

A

Liabilities of the CB decrease with the amount of loan

60
Q

What happens to the monetary liabilities of the central bank when financial institutions pay off their loans?

A

Monetary base also decreases by this amount since reserves decreased

61
Q

Can you explain the relationship between the change in borrowing from the central bank and the change in the monetary base?

A

MB changes in a one to one ratio with the change in the borrowing from the CB.

62
Q

What happens to reserves, currency in circulation, and the monetary base when a bank takes a loan from the central bank?

A

Reserves increase by the same amount as the loan, while there is no effect on currency in circulation. As a result, the monetary bacreases by the same amount as the loan.

63
Q

What are some factors that affect the monetary base but are not controlled by central banks?

A

The factors that affect the monetary base but are not controlled by central banks include float and treasury deposits at the central bank and interventions in the foriegn exchange markets.

64
Q

Explain how float influences the monetary base.

A

Float refers to the temporary net increase in total reserves and the monetary base when central banks credit a bank’s account before debiting the account on which a check is drawn during check clearing.

65
Q

How do treasury deposits at the central bank impact the monetary base?

A

When the treasury moves deposits from commercial banks to its account in the central bank, it causes a deposit outflow from the banks, resulting in a net decrease in total reserves and the monetary base.

66
Q

What is the relationship between check clearing and the temporary increase in reserves and the monetary base?

A

The process of check clearing involves central banks crediting the reserves of a bank that has deposited a check before debiting the reserves of the bank on which the check is drawn. This temporary net increase in reserves leads to a corresponding increase in the monetary base.

67
Q

Can you identify factors that affect the monetary base but are not within the control of central banks?

A

Float and treasury deposits are two factors that influence the monetary base but are not controlled by central banks.

68
Q

What role do random events play in influencing the monetary base through float?

A

Random events, such as the timing of check presentations for payment, can impact the speed at which float affects the monetary base.

69
Q

What are the factors that the central bank can control to influence the monetary base?

A

Open market operations (OMO)

70
Q

Can the central bank directly determine the amount of borrowing by banks from the central bank?

A

No, although the central bank sets the discount rate, it cannot directly determine the amount of borrowing by banks.

71
Q

What are the two components into which the monetary base is split?

A

The two components are the non-borrowed monetary base (MBn) and borrowed reserves (BR).

72
Q

Which component of the monetary base is completely controlled by the central bank?

A

The non-borrowed monetary base (MBn) is completely controlled by the central bank.

73
Q

How can fluctuations in float and treasury deposits affect the control of the monetary base?

A

Fluctuations in float and treasury deposits can complicate the control of the monetary base, but they are usually predictable by the central bank and can be offset through open market operations.

74
Q

What is the relationship between the money supply and both the non-borrowed monetary base (MBn) and borrowed reserves (BR)?

A

The money supply is positively related to both the non-borrowed monetary base (MBn) and the level of borrowed reserves (BR) from the central bank.

75
Q

What is the definition of borrowed reserves (BR)?

A

Borrowed reserves are the part of the monetary base that is created by loans and is less tightly controlled by the central bank

76
Q

What is the definition of the non-borrowed monetary base (MBn)?

A

The non-borrowed monetary base (MBn) is the part of the monetary base that is completely controlled by the central bank and primarily results from open market operations (OMO).

77
Q

How is the non-borrowed monetary base (MBn) calculated?

A

The non-borrowed monetary base (MBn) is calculated by subtracting the borrowed reserves (BR) from the monetary base (MB). The formula is: MBn = MB - BR.

78
Q

What is the primary source of control for the non-borrowed monetary base (MBn)?

A

The primary source of control for the non-borrowed monetary base (MBn) is open market operations (OMO) conducted by the central bank.

79
Q

What is the relationship between borrowed reserves (BR) and the control of the monetary base?

A

Borrowed reserves (BR) are less tightly controlled by the central bank compared to the non-borrowed monetary base (MBn), which is primarily controlled through open market operations

80
Q

What does the formula MBn = MB - BR represent?

A

The formula MBn = MB - BR represents the calculation of the non-borrowed monetary base (MBn) by subtracting the borrowed reserves (BR) from the total monetary base (MB).

81
Q

What is multiple deposit creation?

A

Multiple deposit creation refers to the phenomenon where an increase in reserves in the banking system by the central bank leads to a multiple increase in the total deposits.

82
Q

How does multiple deposit creation occur in a simple model with a single bank?

A

In a simple model with a single bank, multiple deposit creation occurs when the central bank conducts an open market purchase, increasing the bank’s reserves. The bank can then use these reserves to make loans, creating an equal amount of checkable deposits.

83
Q

What happens when a bank makes a loan and sets up a checking account for the borrower?

A

When a bank makes a loan and sets up a checking account for the borrower, it increases its liabilities by the amount of the loan (creating checkable deposits) and increases its assets by the loan amount. This act of lending by the bank creates money in the form of checkable deposits.

84
Q

How does the act of lending by the bank create money?

A

When a bank lends money and creates checkable deposits, it effectively increases the money supply. The borrowers use these loans to make purchases from individuals and corporations, and when these checks are deposited in other banks, the reserves of the lending bank decrease, but the total deposits in the banking system increase.

85
Q

What assumptions are made in the model regarding bank behavior and the use of currency?

A

The assumptions in the model are that banks do not want to hold excess reserves and that all checks written on accounts at the bank are deposited in other banks rather than converted into cash. These assumptions are made to simplify the model and focus on the process of multiple deposit creation.

86
Q

What is the limitation on the amount of loans a bank can safely make?

A

The limitation on the amount of loans a bank can safely make is that it cannot lend more than its excess reserves. In other words, a bank should have sufficient reserves to cover the potential withdrawals resulting from the loans it has made.

87
Q

What happens to excess reserves in the process of multiple deposit creation?

A

Excess reserves increase during the process of multiple deposit creation. This occurs when a bank receives additional reserves beyond what is required for its reserve requirements.

88
Q

What does the bank do with the excess reserves in multiple deposit creation?

A

The bank loans out the excess reserves. Instead of keeping the reserves idle, the bank extends loans to borrowers, effectively utilizing the excess reserves.

89
Q

What is created when the bank loans out the excess reserves in multiple deposit creation?

A

When the bank loans out the excess reserves, it creates a checking account for the borrower. The loan amount becomes a liability for the bank, represented by the checkable deposits in the borrower’s account.

90
Q

What happens when the borrower makes purchases using the loaned funds in multiple deposit creation?

A

The borrower uses the loaned funds to make purchases, typically by writing checks. These checks are deposited in other banks, resulting in the movement of funds from one bank to another within the banking system.

91
Q

What is the overall impact on the money supply in multiple deposit creation?

A

The multiple deposit creation process increases the money supply. As the bank loans out the excess reserves, new checkable deposits are created, effectively increasing the total amount of money in circulation

92
Q

In the multiple deposit creation model, what is the total increase in checkable deposits in the banking system from an initial increase of 100m in reserves?

A

The total increase is 1000m, which is tenfold the reciprocal of the 10% required reserve ratio (rr).

93
Q

What is the simple deposit multiplier?

A

The simple deposit multiplier is the reciprocal of the required reserve ratio (rr). It relates an increase in reserves (∆R) to a change in total checkable deposits (∆D) in the banking system. The formula is: ∆D = 1/rr × ∆R.

Where :
∆D : change in total checkable deposits in the banking system
rr :required reserve ratio.
∆R :change in reserve for the banking system

94
Q

How can the formula for multiple deposit creation be derived?

A

The formula can be derived by assuming that banks do not hold excess reserves. The required reserves (RR) are equal to the required reserve ratio (r) multiplied by the total amount of checkable deposits (D). Substituting the equation, we get r * D = R. Dividing both sides by r gives us D = (1/r) * R. Taking the change in both sides yields the formula for multiple deposit creation: Change in D = (1/r) * Change in R.

95
Q

When will deposit creation stop in the banking system?

A

Deposit creation will stop when excess reserves in the banking system are zero.

96
Q

What are the critiques of the simple model of multiple deposit creation?

A
  • If borrowers keep loan proceeds as currency, the deposit creation process stops.
  • If banks choose to hold excess reserves instead of making loans or purchasing securities, the full expansion of deposits does not occur.
  • Factors such as depositors’ decisions on holding currency and banks’ decisions on holding excess reserves also affect deposit levels and the money supply.
97
Q

What determines the level of checkable deposits in the banking system when it is in equilibrium?

A

The level of reserves in the banking system determines the level of checkable deposits when the system is in equilibrium, with excess reserves equal to zero. A given level of reserves supports a corresponding level of checkable deposits.

98
Q

What factors determine the money supply?

A

There are several factors that determine the money supply, including changes in the non-borrowed monetary base (MBn). When there is an increase in MBn, typically resulting from open market purchases (OM purchases), both the monetary base (MB) and reserves (R) increase. This leads to multiple deposit creation and an increase in the money supply (MS). Conversely, if there is an open market sale, the opposite effect occurs, decreasing MBn and subsequently decreasing MS. Overall, the money supply is positively related to the non-borrowed monetary base (MBn).

99
Q

What is the relationship between open market purchases, the non-borrowed monetary base (MBn), and the money supply (MS)?

A

Open market purchases of securities result in an increase in the non-borrowed monetary base (MBn). This increase in MBn leads to an expansion of reserves (R) and subsequently stimulates multiple deposit creation. As a result, the money supply (MS) increases. The process can be summarized as follows: OM purchases of securities -> Increase in MBn -> Increase in reserves (R) -> Increase in deposit creation -> Increase in the money supply (MS).

100
Q

What happens to the money supply when banks increase their holdings of loans from the central bank?

A

When banks increase their holdings of loans from the central bank, it leads to an increase in borrowed reserves (BR). This increase in BR expands the reserves (R) available in the banking system, enabling multiple deposit creation. As a result, the money supply (MS) increases.

101
Q

What is the relationship between borrowed reserves and the money supply?

A

Borrowed reserves (BR) from the central bank play a role in determining the money supply (MS). An increase in borrowed reserves leads to an expansion of reserves (R), allowing for multiple deposit creation and an increase in the money supply. Conversely, a decrease in borrowed reserves contracts the reserves, limiting deposit creation and resulting in a decrease in the money supply.

102
Q

What happens to the money supply when the required reserve ratio (rr) on checkable deposits increases?

A

When the required reserve ratio on checkable deposits increases, it means that banks are required to hold a higher percentage of reserves (RR) against their deposits. This reduces the amount of reserves available for multiple deposit creation, resulting in a decrease in the creation of new deposits. As a consequence, the money supply (MS) decreases.

103
Q

What is the relationship between the required reserves ratio and the money supply?

A

The required reserve ratio (rr) has an inverse relationship with the money supply (MS). An increase in the required reserve ratio reduces the amount of reserves (RR) available for deposit creation, resulting in a decrease in the money supply. Conversely, a decrease in the required reserve ratio expands the reserves, allowing for more deposit creation and an increase in the money supply.

104
Q

What happens to the money supply when banks increase their holdings of excess reserves?

A

When banks increase their holdings of excess reserves, it means that they are holding onto more reserves than required by the reserve ratio. This reduces the amount of reserves available for making loans and engaging in multiple deposit creation. As a result, the expansion of new deposits and the money supply (MS) is limited.

105
Q

What happens to the money supply when there is an increase in currency holdings?

A

An increase in currency holdings refers to a situation where individuals and banks switch from holding checkable deposits to holding more physical currency. This reduces the overall level of multiple deposit creation and decreases the expansion of the money supply (MS). As a result, the money supply decreases.

106
Q

How does a decrease in currency holdings affect the money supply?

A

A decrease in currency holdings occurs when individuals and banks shift from holding physical currency back into checkable deposits. This allows for more reserves to be available for lending and multiple deposit creation. Consequently, the expansion of new deposits and the money supply (MS) increases.

107
Q

What is the relationship between currency holdings and the money supply?

A

Currency holdings have a negative relationship with the money supply (MS). When individuals and banks increase their holdings of physical currency, it reduces the amount of reserves available for deposit creation and decreases the expansion of the money supply. Conversely, a decrease in currency holdings allows for more lending and results in an increase in new deposits and the money supply.

Money And Banks (6 decks)

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