Money Multiplier and Open Market Operations
money multiplier (MM): the amount the money supply expands with each dollar increase in reserves
MM = deposits/reserves
open market operations
paying interest on reserves held by banks at the Federal Reserve
open market operations: the buying and selling of government bonds by the Federal Reserve
objectives:
influence the growth of the money supply
influence interest rates
the Federal Reserve changes the money supply by buying or selling short-term government bonds (T-Bills for short)
if they buy government bonds, the money supply increases:
to pay for the T-Bills, the Federal Reserve electronically increases the reserves of the seller, usually a bank or large dealer (MB increases)
with more reserves, the bank makes additional loans, which are used to buy goods and pay wages
people will deposit some of these payments into other banks (checking deposits increases, M1 increases)
the new deposits increase the reserves of other banks, which will also make more loans (this is the beginning of the “money multiplier” process)
summary:
the Federal Reserve can increase/decrease reserves at banks by buying/selling government bonds
the increase/decrease in reserve boosts/reduces the money supply through the money multiplier process
size of multiplier isn’t fixed but depends on how much of their assets the bank wants to hold as reserves
when the Federal Reserve buys or sells bonds, it changes the monetary base and also influences the interest rates
when the Federal Reserve buys bonds, it increases money supplies and lowers interest rates
the lower interest rates increase the quantity of loans demanded
when the Federal Reserve sells bonds, the process works in reverse
summary:
when the Federal Reserve buys or sells bonds, it changes the monetary base and influences interest rates at the same time
buying bonds stimulates the economy through higher money supplies and lower interest rates
when the Federal Reserve sells bonds, the process works in reverse (selling bonds dampens the economy through lower money supplies and higher interest rates)
money multiplier (MM): the amount the money supply expands with each dollar increase in reserves
MM = deposits/reserves
open market operations
paying interest on reserves held by banks at the Federal Reserve
open market operations: the buying and selling of government bonds by the Federal Reserve
objectives:
influence the growth of the money supply
influence interest rates
the Federal Reserve changes the money supply by buying or selling short-term government bonds (T-Bills for short)
if they buy government bonds, the money supply increases:
to pay for the T-Bills, the Federal Reserve electronically increases the reserves of the seller, usually a bank or large dealer (MB increases)
with more reserves, the bank makes additional loans, which are used to buy goods and pay wages
people will deposit some of these payments into other banks (checking deposits increases, M1 increases)
the new deposits increase the reserves of other banks, which will also make more loans (this is the beginning of the “money multiplier” process)
summary:
the Federal Reserve can increase/decrease reserves at banks by buying/selling government bonds
the increase/decrease in reserve boosts/reduces the money supply through the money multiplier process
size of multiplier isn’t fixed but depends on how much of their assets the bank wants to hold as reserves
when the Federal Reserve buys or sells bonds, it changes the monetary base and also influences the interest rates
when the Federal Reserve buys bonds, it increases money supplies and lowers interest rates
the lower interest rates increase the quantity of loans demanded
when the Federal Reserve sells bonds, the process works in reverse
summary:
when the Federal Reserve buys or sells bonds, it changes the monetary base and influences interest rates at the same time
buying bonds stimulates the economy through higher money supplies and lower interest rates
when the Federal Reserve sells bonds, the process works in reverse (selling bonds dampens the economy through lower money supplies and higher interest rates)