# Chapter 16. Determinants of the Money Supply - PowerPoint PPT Presentation

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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

• 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

• how \$1 change in MB will affect MS:

M = m x MB

1 + c

m =

rD + e + c

rD = required reserve ratio

c = ratio of currency to deposits

e = ratio of excess reserves to deposits

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

• changes in rD

• changes in c

• changes in e

• changes in MB

### changes in rD

• higher reserve requirement

• fewer excess reserves to lend

• smaller amount of deposit creation

smaller

multiplier

higher

rD

1 + .5

### example

• rD was .10

• suppose it rises to .20

m =

.20 + .001 + .5

m = 2.14

### changes in c

• higher c

• currency does not expand like deposits

• smaller amount of deposit creation

smaller

multiplier

higher

c

1 + .8

### example

• original example: c = .5

• suppose c = .8

m =

= 2.00

.10 + .001 + .8

### changes in ER/D

• higher e

• banks hold more ER, lend less

• smaller amount of deposit creation

smaller

multiplier

higher

e

1 + .5

### example

• original example: e = .001

• suppose e = .005

m =

= 2.48

.10 + .005 + .5

### what affects e?

• as interest rates rise

• opportunity cost of holding ER rise

• (money could be lent out)

ER

fall

higher

i

• expected deposit outflows

• must hold more ER

### 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

• DL is discount loans

-- increase as banks borrow from

the Fed

market interest rate and discount

rate increases

### 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

• as c and e rise,

• money multiplier declines

• M1 declines by 25% from 1930-33