25-money supply process. commercial bank balance sheet assetsliabilitites loansdeposits u.s....
Post on 22-Dec-2015
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Commercial Bank Balance Sheet
Assets Liabilitites
Loans Deposits
U.S. Bonds Borrowings from Banks
Foreign Bonds Borrowings from Fed
Reserves
Central Bank Balance Sheet
Commercial Banks are required to hold reserves with the federal reserve system.
These exist electronically
When you write a check to Bob in Philadelphia, your bank doesn’t send cash to Bob’s bank in Philadelphia.
Float
You write a $10 check to Bob living in Philadelphia– Balance sheet of Bob’s bank:
Assets Liabilities
Reserves: +10 Deposits: +10
– Initial Balance Sheet FedAssets Liabilities
Loan (Float): +10 Reserves (Bob’s Bank): +10
Float
– Check is flown to your bank back in Utah
– Balance sheet of Your bank:Assets Liabilities
Reserves: -10 Deposits: -10
– Final Balance Sheet FedAssets Liabilities
Loan (Float): -10 Reserves (Your bank): -10
Central Bank Balance Sheet
The central bank differs from commercial banks in that it has full control over the size of its balance sheet– It can create liabilities (reserves)
Publication of Central bank balance sheet is essential component of transparency.– Value of reserves is backed by assets of bank– Central Bank on the gold standard
Transparency
Value of reserves is backed up by the bonds the Fed purchases.– Why do bonds (reserves) have value?
Government uses bonds to create services These services must be paid for by taxes (reserves)
– Our balance sheetAssets LiabilityGovernment Services Taxes (Reserves)
As long as we value government services, we will value the reserves we must use to pay for them, and hence, the bonds issued by the government.
Open Market Purchase
Total reserves = 5.5 million Excess reserves are loaned out, spent, re-deposited,
spent, loaned out, redeposited . . .
Assume as deposits change, amount of currency held by public does not change.
– Deposits are not affected by a change in the demand for currency.
New Equilibrium: 5.5/D = 0.30
D=18.33
Money Supply and the Fed
Monetary base = currency plus reserves– Fed can control directly
Money Supply = currency plus deposits
Fed bought $1 in bonds
Monetary base increased by $1.
Money supply increased by $3.3.
Simple Deposit Multiplier
Let rD = required reserve-to-deposit ratio Let R = amount of reserves D=deposits Assume no excess reserves are held
rD = R/D D = R/rD D = R/rD
In example– Change in reserves: +1– Change in deposits: +1/.30 = 3.33
Discount Loans
Open Market operations and discount loans both have the same effect on the monetary base and money supply:– Reserves increase by $1– MB=C+R increases by $1
– Deposits increase by 3.3– M=C+D increases by 3.3
Open Market Sales
Open market sales have the opposite effect:– Fed balance Sheet
Assets: drop by value of sale (tbills) Liabilities: drop by value of sale (reserves)
– Commercial Bank balance sheet Assets: increase by value of sale (tbills) Assets: decrease by value of sale (reserves)
Open Market Purchase
In this case, reserves could drop below the required R/D ratio– Banks hold excess reserves as “insurance”– In the short run, banks with a shortage of
reserves can borrow from those with an excess– In long run, bank needs to either
acquire more reserves (Retire loans, or sell securities) reduce deposits (e.g. retire short-term CD liabilities)
Shifts from Deposits Into Currency
Currency held by banks (vault cash) is counted as reserves.
When you make cash withdrawals you change the balance sheet of the central bank.
Shifts from Deposits Into Currency
Change in Money Supply: – Currency: +2– Reserves: -2– Net effect =0
Change in Monetary Base:– Currency: +2– Deposits: -2– Net effect=0
Money Supply
As monetary base changes, what is impact on money supply?
Simple Deposit Multiplier– Assumes currency held by public is constant– Assumes banks only hold required reserves– Money supply changes with deposits D = R/rD
– Currency held doesn’t change, so M = D = R/rD
We will now relax these assumptions
Money Supply
Change in reserves changes deposits.
Individuals choose how much currency to hold– As people hold more deposits they may also choose to hold
more currency. Not all money bank loans out gets deposited back into bank.
Banks choose to hold excess reserves.– As deposits increase, it’s reasonable to assume the amount
of excess reserves held by banks also increases.
Money Multiplier
R=total reserves held RR=required reserves
– RR=rD*D rD=required reserve ratio
ER=excess reserves– ER=e*D e=excess reserve ratio
C=currency held by public– C=c*D c=currency ratio
Money Multiplier
Insight– m decreases as rD, e, and c increase
– A given change in the monetary base will have a smaller effect on the money supply as
The required reserve deposit ratio increases Banks desire to hold more excess reserves People desire to hold more cash