finalized econ report

8/8/2019 Finalized Econ Report

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Other Factors that affect the Money Base

Two important factors that affect the

monetary base, but are not controlledby the Fed, are:

Float

Treasury deposits at the Fed



Overview of the Fed¶s Ability toControl the Monetary Base

Two primary features that determine

the monetary base:Open market operations

Discount lending




Hence, we can split the monetary

base into two components :One that the Fed can completely control(Non-borrowed Monetary Base)

One that is less tightly controlled(Borrowed Reserves)




The money supply is positively related to boththe non-borrowed monetary base MB

nand to

the level of borrowed reserves, BR, from theFed

Float and Treasury deposits at the FederalReserve which are not in control of the Fedcan cause short-term fluctuations in monetarybase, but the Fed can offset these short-termfluctuations by its open market operationsmaintain its control over monetary base.



Multiple Deposit Creation: a SimpleModel

When the Fed supplies the banking

system with $1 of additional reserve,deposits increase by a multiple of thisamount ± a process called multipledeposit creation.

Deposit Creation: the Single Bank

Deposit Creation: the Banking System



Simple Deposit Multiplier

The multiple increase in deposits

generated from an increase in thebanking system¶s reserves

Equals the reciprocal of the required

reserve ratio:



Critique of the Simple Model

Our simple model assumes that:

1. Banks never hold excess reserves.2. Individuals and non-bank corporationsnever hold currency.

Since neither of these assumptions is

particularly realistic, we must modify andextend our model to take the behavior of banks and the non-bank public into account.



Critique of the Simple Model

Fed is not the only player whose behavior influence the level of deposits, andtherefore, the money supply.

Depositors¶ decisions regarding how muchcurrency to hold and banks¶ decision

regarding the amount of excess reservesto hold can cause the market supply tochange.



Factors that Determine the Money Supply

Changes in the Nonborrowed Monetary Base(MBn)

Changes in the Borrowed Reserves (BR)from the Fed

Changes in the Required Reserve Ratio, r

Changes in the Currency HoldingsChanges in Excess Reserves



Changes in the Nonborrowed Monetary Base (MBn )

The money supply is positively related

to nonborrowed monetary base (MBn).



Changes in the Borrowed Reserves (BR) from the Fed

The money supply is positively related

to borrowed reserve, BR, from the Fed.



Changes in the Required Reserve Ratio, r

Required reserve ratio (r ), negatively

affect monetary multiplier (m) and thusnegatively affect money supply.



Changes in the 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.



Float When the Fed clears checks for banks, itoften credits the amount of the check to a

bank that has deposited it (increases thebank¶s reserves) but only later debits(decreases the reserves of) the bank onwhich the check is drawn.

The resulting temporary net increase in thetotal amount of reserves in the bankingsystem (and hence in the monetary base)occurring from the Fed¶s check-clearing

process is called float.



Float

Float is affected by random events such asthe weather, which affects how quickly

checks are presented for payment, is notcontrolled by the Fed, but affects themonetary base.



U.S. Treasury deposits

When the U.S. Treasury moves deposits fromcommercial banks to its account at the Fed,

leading to a rise in Treasury deposits at theFed, it causes a deposit outflow at these banksand thus causes reserves in the bankingsystem and the monetary base to fall.

Thus Treasury deposits at the Fed isdetermined by the U.S. Treasury¶s actions andaffects the monetary base but are not fullycontrolled by the Fed.



Open market Operations

Open market operations are controlled bythe Fed.



Discount Lending

The Fed cannot determine the amount of borrowing by banks from the Fed (discountloans).



Non-borrowed Monetary Base(MBn )

Results primary from open market

operationsFormally defined as the monetary baseminus banks¶ borrowings from the Fed(discount loans) :

MBn= MB - BR



Borrowed Reserves (BR)

The amount of the monetary base that

is created by discount loans from theFed.



D

eposit Creation: the Single Bank

First National Bank

Securities -$100Reserves $100

Assets Liabilities



First National Bank

Securities -$100Loans $100

Assets Liab

First National Bank

Securities -$100

Reserves $100

Loans $100

Assets Liabilities

Checkable Deposits +$100



D

eposit Creation: the Banking System

Bank A

Reserves $100

Assets Lia

Checkable Deposits $100



Bank A

Reserves +$10Loans +$90

Assets Lia


Bank A

Reserves +$10Securities +$90

Assets Liabilities




Bank B

Reserves +$9Loans +$81

Assets Lia


Bank B

Reserves +$90

Assets Lia


finalized econ report

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