m1: the narrowest definition of the money supply: means of payment how is money measured in the...
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M1: The Narrowest Definition of the Money Supply: Means of Payment
How Is Money Measured in the United States Today?
Measuring the Money Supply, May 2007 M2: A Broader Definition of Money
What about Credit Cards and Debit Cards?
How Banks Create MoneyBalance Sheet for Wachovia Bank, December 31, 2006
Reserves Deposits that a bank keeps as cash in its vault or on deposit with the Federal Reserve = R
Required reserves Reserves that a bank is legally required to hold, based on its checking account deposits = RR.
Required reserve ratio The minimum fraction of deposits banks are required by law to keep as reserves RR = r D.
How Banks Create Money in a Fractional Reserve Banking System: Using T-Accounts
How Banks Create Money
Now PNC has excess
reserves and can make
a loan
How Banks Create Money: The multiple creation of money and credit
BANK INCREASE IN CHECKING ACCOUNT DEPOSITS
Wachovia $1,000
PNC + 900 (= 0.9 x $1,000)
Third Bank + 810 (= 0.9 x $900)
Fourth Bank + 729 (= 0.9 x $810)
. + •
. + •
. +
Total Change in Checking Account Deposits =$10,000
Deposit multiplier The ratio of the amount of deposits created by banks to the amount of new reserves.
The Simple Deposit Multiplier versus the Real-World Deposit Multiplier: People hold currency and banks hold excess reserves, slowing multiple creation of deposits and credit
Simple deposit multiplier = 1/r
Reserves Deposits that a bank keeps as cash in its vault or on deposit with the Federal Reserve = R = RR + ER = rD + eD
Required reserves Reserves that a bank is legally required to hold, based on its checking account deposits = RR.
Required reserve ratio The minimum fraction of deposits banks are required by law to keep as reserves RR = r D.
Excess reserves Reserves that banks hold over and above the legal requirement. ER = e D
The Money Supply Model• Money = Currency plus checkable deposits: M1
M = C + D
• The monetary base (MB)—the assets of the central bank— “backs” the money supply
• The CB’s assets = MB =The CB’s liabilities = C + R
• The Fed controls the monetary base (MB) better than it controls reserves … but it doesn’t perfectly control MB
MB = MBn + BR
• The money supply (M) is a multiple m of the monetary base
M = m x MB = m x (MBn + BR)
c = {C / D} C = c D and
e = {ER / D} ER = e D
Substituting in the previous equation
MB (r D) (eD) (c D) (r e c)D
Divide both sides by the term in parentheses
D 1
r e cMB
M D C and C c D
M D (c D) (1 c)D
Substituting again
M 1 c
r e cMB
The money multiplier is then
m 1 c
r e c
Factors that AffectThe Money Multiplier
• Changes in the required reserve ratio r– The money multiplier and the money supply are negatively
related to r
• Changes in the currency ratio c– The money multiplier and the money supply are negatively
related to c
• Changes in the excess reserves ratio e– The money multiplier and the money supply are negatively
related to the excess reserves ratio e
– The excess reserves ratio e is negatively related to the market interest rate
– The excess reserves ratio e is positively related to expected deposit outflows
Money and the Great Depression
• The Great Contraction in monetarist analysis
• Banking Crises– Currency holdings– Excess reserve holdings– Monetary contraction
