chapter 15: The Money Supply Process

Question 1

The Players in the Money Supply Process

Answer 1

1. The Central bank:
   US: Federal Reserve System – Euro Area: ECB
2. Banks: depository institutions; financial intermediaries
3. Depositors: individuals and institutions
4. Borrowers

Question 2

The process of money creation

Answer 2

by Gold convertibility with coverage ratio

Question 3

loans are lended to (in process money creation)

Answer 3

• to other commercial banks
• by buying government bonds in the secondary market
• to other central banks (buying foreign currencies (international reserve))

Question 4

what are the assets and liabilities in the The Fed’s Balance Sheet

Answer 4

Liabilities

• Currency in circulation: in the hands of the public
• Reserves: bank deposits at the Fed and vault cash

Assets

• Government securities: holdings by the Fed that affect money supply and earn interest
• Discount loans: provide reserves to banks and earn the discount rate

Question 5

coverage ratio (def)

Answer 5

is a measure of a company’s ability to service its debt and meet its financial obligations. The higher the coverage ratio, the easier it should be to make interest payments on its debt or pay dividends.

Question 6

open market operations

Answer 6

is a way to control the monetary base (high powered money):

- its by buying and selling securities in the open market - throught the loans to banks

Question 7

The reserve ratio

Answer 7

The reserve ratio is the portion of reservable liabilities that commercial banks must hold onto, rather than lend out or invest.

Question 8

Balance sheet of a commercial bank after opening a checkable deposit

Answer 8

Assets: Banknotes, are the (cash) reserve or bank reserve of the commercial bank
Liabilities: Deposit

+ reserve ratio, borrowed from banknotes

Question 9

Critique of the Simple Model

Answer 9

Holding cash stops the process
• Currency has no multiple deposit expansion

Banks may not use all of their excess reserves to buy securities or make loans.

Depositors’ decisions (how much currency to hold) and bank’s decisions (amount of excess reserves to hold) also cause the money supply to change.

Question 10

Factors That Determine the Money Supply

Answer 10

Changes in the nonborrowed monetary base MBn
• The money supply is positively related to the non-borrowed monetary base, MBn

Changes in borrowed reserves from the Fed
• The money supply is positively related to the level of borrowed reserves, BR, from the Fed

• Changes in the required reserves ratio
• The money supply is negatively related to the required reserve ratio.

• Changes in currency holdings
The money supply is negatively related to currency holdings.

• Changes in excess reserves
The money supply is negatively related to the amount of excess reserves.

Question 11

nonborrowed monetary base (MBn)

Answer 11

• is the monetary base minus discount loans (borrowed reserves).
• (or M0) is the total amount of a currency that is either in general circulation in the hands of the public or in the form of commercial bank deposits held in the central bank’s reserves.

Question 12

excess reserves

Answer 12

are capital reserves held by a bank or financial institution in excess of what is required by regulators, creditors, or internal controls. (the new money)

Question 13

currency holdings

Answer 13

any currency in which the Trustee maintains the Trust Fund in accordance with the Contribution Agreements/Arrangements.

Question 14

borrowed reserves from the FED

Answer 14

are equal to the sum of credit extended through the Federal Reserve’s regular discount window programs and credit extended through certain Federal Reserve liquidity facilities.

Question 15

required reserves ratio

Answer 15

is the fraction of deposits that regulators require a bank to hold in reserves and not loan out.

Question 16

The Money Multiplier

Answer 16

is a phenomenon of creating money in the economy in the form of credit creation, which is based on the fractional reserve banking system. Money multiplier is also known as the monetary multiplier.

Question 17

The monetary base MB equals currency (C) plus reserves (R):

Answer 17

MB = C + R = C + (r × D) + ER

• Equation reveals the amount of the monetary base needed to support the existing amounts of checkable deposits, currency, and excess reserves.

Question 18

deriving the money mutliplier

Answer 18

A bank loans or invests its excess reserves to earn more interest. A one-dollar increase in the monetary base causes the money supply to increase by more than one dollar. The increase in the money supply is the money multiplier.

Question 19

when m (money multiplier) = 2.5

Answer 19

This is less than the simple deposit multiplier
Although there is multiple expansion of deposits,
there is no such expansion for currency

Question 20

Recap / summary money supply process

Answer 20

• The stock of money in the economy is more than the amount of physical money issued by the central bank
• The central bank imperfectly controls the stock of money in the economy
• The amount of scriptural money created by the commercial banks depends on: # money agents + reserves banks

Question 21

• The amount of scriptural money created by the commercial banks depends on:

Answer 21

• The amount of money agents choose to deposit in banks

* The amount of reserves banks decide to keep (above the required reserve ratio)

Question 22

Quantitative Easing and the Money Supply, 2007–2017 (history)

Answer 22

• When the global financial crisis began in the fall of 2007, the Fed initiated lending programs and large-scale asset purchase programs in an attempt to bolster the economy.
• By the fall of 2017, these purchases of securities had led to a quintupling of the Fed’s balance sheet and a 350% increase in the monetary base.
• These lending and asset-purchase programs resulted in a huge expansion of the monetary base and have been given the name “quantitative easing.”
• This increase in the monetary base did not lead to an equivalent change in the money supply because excess reserves rose dramatically

Question 23

quantitive easing (def)

Answer 23

QE for short—is a monetary policy strategy used by central banks like the Federal Reserve. With QE, a central bank purchases securities in an attempt to reduce interest rates, increase the supply of money and drive more lending to consumers and businesses.

Question 24

monetary system

Answer 24

a set of institutions that provides a supportive framework for the creation of money in an economy by the government. (creation money+ controling supply money+ quantity theory of money + meaning money)

Question 25

Shortage of Money system

Answer 25

One of the missions of the central bank is to regulate the quantity of money to an adequate level: Sufficient but not excessive

Insufficient:
• not enough currency : some transactions may fail to occur+ Credit rationing by banks: transactions that need a loan would not occur

A shortage of money slows down economic activity

Question 26

Excess of money (meaning+ what happens)

Answer 26

Too much money implies a loss of purchasing power of one monetary unit, so it creates inflation

Money and inflation
• More money stimulates the demand for goods and services
• If supply remains unchanged, prices will increase