Chapter 16 determinants of the money supply
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Chapter 16. Determinants of the Money Supply. Money multiplier Factors that determine multiplier & MS Applications: Great Depression. given problems with simple money multiplier, construct better multiplier cash holdings excess reserves holdings based on M1 = C + D. I. money multiplier.

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Chapter 16. Determinants of the Money Supply

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Chapter 16 determinants of the money supply

Chapter 16. Determinants of the Money Supply

  • Money multiplier

  • Factors that determine multiplier & MS

  • Applications: Great Depression


Chapter 16 determinants of the money supply

  • given problems with simple money multiplier,

  • construct better multiplier

    • cash holdings

    • excess reserves holdings

  • based on M1 = C + D


I money multiplier

I. money multiplier

  • how $1 change in MB will affect MS:

    M = m x MB


Chapter 16 determinants of the money supply

1 + c

m =

rD + e + c

rD = required reserve ratio

c = ratio of currency to deposits

e = ratio of excess reserves to deposits


Example

1 + .5

example

rD = .10

C = $400 billion

D = $800 billion

ER = $.8 billion or $800 million

m =

= 2.5

.10 + .001 + .5

$1 increase in MB, $2.5 increase in M


Ii factors affecting m ms

II. Factors affecting m & MS

  • changes in rD

  • changes in c

  • changes in e

  • changes in MB


Changes in r d

changes in rD

  • higher reserve requirement

    • fewer excess reserves to lend

    • smaller amount of deposit creation

smaller

multiplier

higher

rD


Example1

1 + .5

example

  • rD was .10

  • suppose it rises to .20

m =

.20 + .001 + .5

m = 2.14


Changes in c

changes in c

  • higher c

    • currency does not expand like deposits

    • smaller amount of deposit creation

smaller

multiplier

higher

c


Example2

1 + .8

example

  • original example: c = .5

  • suppose c = .8

m =

= 2.00

.10 + .001 + .8


Changes in er d

changes in ER/D

  • higher e

    • banks hold more ER, lend less

    • smaller amount of deposit creation

smaller

multiplier

higher

e


Example3

1 + .5

example

  • original example: e = .001

  • suppose e = .005

m =

= 2.48

.10 + .005 + .5


What affects e

what affects e?

  • as interest rates rise

    • opportunity cost of holding ER rise

    • (money could be lent out)

ER

fall

higher

i


Chapter 16 determinants of the money supply

  • expected deposit outflows

    • must hold more ER


Factors affecting mb

Factors affecting MB

  • MB = MBn + DL

    • MBn is nonborrowed MB

      -- open market purchase will

      increase MBn

      -- open market sale will

      decrease MBn

    • increase MBn will increase M


Chapter 16 determinants of the money supply

  • DL is discount loans

    -- increase as banks borrow from

    the Fed

    -- increase as spread between

    market interest rate and discount

    rate increases


Great depression 1930 33

Great Depression 1930-33

  • big contraction in M1

  • big increases in c, e

    • depositors withdrew cash

    • banks increase ER due to increase in deposit outflow


Chapter 16 determinants of the money supply

  • as c and e rise,

    • money multiplier declines

    • M1 declines by 25% from 1930-33


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