Monetary policy Flashcards
open-market operations—
The primary way in which the Fed controls the supply of money is through the purchase and sale of government bonds.
How is the Quantity of Money Measured?
- Currency - the sum of outstanding paper money and coins
2. Demand deposits - the funds people hold in their checking accounts.
different symbols are
C , M1, M2
Money Supply =
Currency + Demand Deposits
reserves
The deposits that banks have received but have not lent out
If banks hold 100 percent of deposits in reserve,
the banking system does not affect the supply of money
fractional–reserve
banking
a system under which banks keep only a fraction of their deposits
in reserve.
reserve–deposit ratio
the fraction of deposits
kept in reserve
in a system of fractional reserve banking, banks ____
create money
Total Money Supply =
Original Deposit x (1/rr) where rr = reserve-deposit ratio
Each $1 of reserves generates
$(1/rr) of money
rr = 0.2, so the
original $1,000 generates
$5,000 of money
bank capital
the equity of the
bank’s owners.
leverage
is the
use of borrowed money to supplement existing funds for purposes of investment
The leverage ratio
is the ratio of the bank’s total assets to bank capital
In this example, the leverage ratio is $1000/$50,
or 20. This means that
for every dollar of capital that the bank owners have contributed, the bank has $20 of assets and, thus, $19 of deposits and debts
Money Supply Model has
three exogenous variables
Money supply model’s variables are
The monetary base , The reserve–deposit ratio , The currency–deposit ratio
The monetary base B
is the sum
of currency and bank reserves.
. C + D
The reserve–deposit ratio rr
is the fraction of deposits that banks hold
in reserve. R/D
The currency–deposit ratio cr
is the amount of currency C people
hold as a fraction of their holdings of demand deposits D. It reflects
the preferences of households about the form of money they wish
to hold. C/D
money multiplier
(cr + 1)/(cr + rr)
the monetary base is
sometimes called high–powered money.
Because the
monetary base has a multiplied effect on the money supply
The money supply is proportional to
the monetary base
a decrease
in the reserve–deposit ratio
raises the money multiplier and the money
supply
a decrease in the
currency–deposit ratio
raises the money multiplier and the money supply
The Instruments of Monetary Policy
• those that influence the monetary base
• those that influence the reserve–deposit ratio and thereby the money
multiplier.
How the Fed Changes the Monetary Base
• open–market operations- are the purchases and sales of government
bonds by the Fed
• lending reserves to banks- a reduction in the discount rate raises the monetary
base and the money supply. Also, Term Auction Facility
How the Fed Changes the Reserve–Deposit Ratio
• Reserve requirements - An increase in reserve requirements tends
to raise the reserve–deposit ratio and thus lower the money multiplier and
the money supply
• interest on reserves - an increase in the interest rate on reserves will
tend to increase the reserve–deposit ratio, lower the money multiplier, and lower
the money supply.
