MACRO LECTURE 3

MONEY SUPPLY

→ the currency held by the public in circulation and in checkable deposits

→ M = C+D where M is the total money supply, C is the currency, and D is the checkable deposits.

BANKS ROLE IN THE MONEY SUPPLY

→ Banks facilitate the creation of money through lending and the acceptance of deposits, which expands the overall money supply.

→ liabilities for banks include deposits, while assets consist of loans and other investments.

100% reserve banking

→ this is when a bank holds all deposits as reserves so there is no lending through loans

→ this means that R/D =rr=1

Fractional reserve banking

→ a banks holds a fraction of deposits as reserves, meaning they are lending out through loans thus creating assets

→ this means R/D = rr = between 0 and 1

How do banks create money through lending?

→ when a bank grants a loan it credits the borrowers deposit account, the bank has created a loan assets and a matching deposit liability

→ then when the borrower pays back the loan from bank despot it gets rid of asset for bank and deposit as a liability

MONETARY BASE

→ money printed by the central banks, which is either as currency as reserves

→ this is controlled by the central bank

→ B = C + R

RESERVE DEPOSIT RATIO

→ rr=R/D

→ this measures the proportion of deposits held as bank reserves

→ a higher rr means that there are more bank reserves relative to loans

→ indicates how much banks actually lend, which is dictated by regulations

CURRENCY-DEPOSIT RATIO

→ cr = C/D

→ measures the amount of currency held by public relative to deposits in a bank

→ a higher cr means households are holding more physical cash in comparison to in a bank account which depends on household preferences

RELATIONSHIP OF MONEY SUPPLY AND MONEY BASE

→ M = C+D

→ M = C+D/B x B = mxB (where m is the money multiplier)

MONEY MULTIPLIER

→ this is the amount of money supported by each unit of monetary base

→ m

→ C+D/B

→ C+D/C+R

→ divide all by D = C/D +D/D / C/D + R/D

→ cr+1/cr+rr

how does the cr and rr affect the money multiplier

When rr increases, the money multiplier decreases.

Why?

1. Banks must keep a larger proportion of deposits as reserves.

2. This means they have less money available to lend.

3. Fewer loans are created.

4. Fewer new deposits are generated.

5. The money multiplier falls.

When cr increases, the money multiplier decreases.

Why?

1. People decide to hold more cash instead of depositing it in banks.

2. Banks receive fewer deposits.

3. Banks have fewer funds to support lending.

4. Less money is created through the banking system.

5. The money multiplier falls.

role of central banks

→ they conduct monetary policy and ensure price stability

three main methods of monetary policy

1. Open market operations

2. Reserve requirements

3. Discount rate

OPEN MARKET OPERATIONS

→ this is when central banks buy and sell governments securities (i.e. treasuries and bonds) to influence reserve and short term interbank rates

How does open market purchases work?

→ EXPANSIONARY MONETARY POLICY