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Chapter 16. Determinants of the Money SupplyPowerPoint Presentation

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

m =

rD + e + c

rD = required reserve ratio

c = ratio of currency to deposits

e = ratio of excess reserves to deposits

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

changes in c

- higher c
- currency does not expand like deposits
- smaller amount of deposit creation

smaller

multiplier

higher

c

changes in ER/D

- higher e
- banks hold more ER, lend less
- smaller amount of deposit creation

smaller

multiplier

higher

e

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

- MBn is nonborrowed MB

- 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

- 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

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