Chapter 11

The central bank, Depository Institutions, and the Money Supply

Process

.

2

Some Complicating Realities in the Multiplier Model

Modifying the Multiplier Model The central bank’s Control over the Money

Supply Summary of major points

3

Some Complicating Realities in the Multiplier Model

In our simple model, we assumed that banks do not hold excess reservesin fact, banks do choose to hold excess

reservesthese excess reserves are leakages from the

flow of new depositsthis will lower the volume of loans and deposits

created at each stage

4

Some Complicating Realities in the Multiplier Model

We also ignored the fact that individuals will choose to hold some currencythis means that all loan proceeds may not

become redeposited in the banking systemthis will also reduce the flow of reserves and

deposits from bank to bank

5

Modifying the Multiplier Model

Total reserves are equal to required reserves plus excess reserves

TR = RR + ERTR = rDD + ER

Assume that depository institutions hold excess reserve assets equal to a constant proportion of deposit liabilities (eD) where

e = ER/D

6

Modifying the Multiplier Model

This means thatTR = rDD + eD = (rD + e)D

This means that, for a given change in total reserves, the change in deposits will be

1

D

D TRr e

7

Modifying the Multiplier Model

The multiplier is now smaller than before The multiplier is not under the complete

control of the Fedthe Fed cannot control e

8

Modifying the Multiplier Model

The public can also affect the money multiplier by its currency-holding behavior----We can see that open market purchases of securities by the central bank may result in an increase of both reserves and currency in the hands of the public.

Assume the public wants to hold currency equal to a constant proportion of its checkable deposits (cD) where

c = C/D

9

Modifying the Multiplier Model Thus, the money supply is equal to

M = D + C = D + cD = (1 + c)D We define the monetary base (MB) as the sum of

reserves and currency in the hands of the public 基础货币：准备金加上公众手中持有的货币，用

MB表示。MB = TR + C

MB = (rD + e)D + cD = (rD + e + c)D

10

Modifying the Multiplier Model

Rearranging, we get1

D

D MBr e c

The money supply is equal to deposits plus currency

1

D

M D C MB Cr e c

11

Modifying the Multiplier Model

Rearranging, we get

1

D

M MB cDr e c

1 1

D D

M MB c MBr e c r e c

1

D

cM MBr e c

12

Modifying the Multiplier Model

In terms of changes in the money supply that result from changes in the monetary base, we get

1

D

cM MBr e c

We will refer to this as the money multiplier货币乘数：基础货币增加导致货币供给增加的倍数。

13

Factors that Affect theMoney Multiplier

14

Factors that Affect theMoney Multiplier

15

The Fed’s Control over the Money Supply

The Fed’s control of the money supply is not completethe public controls c (the proportion of deposits

held as currency)depository institutions control e (the proportion

of deposits held as excess reserves)

16

Summary of Major Points

The Fed’s open market operations affect the quantity of reserves in the banking systemwhen the Fed buys securities, reserves of

depository institutions risewhen the Fed sells securities, reserves of

depository institutions fall

17

Summary of Major Points

Depository institutions must hold reserve assetsreserves in excess of required reserves are

called excess reserves When the Fed makes a discount loan or a

loan is paid off, reserves are affected

18

Summary of Major Points

For a depository institution, a deposit inflow will increase total deposit liabilities and total reserve assetsa depository institution can adjust to the inflow

of deposits by expanding its loans and “creating” additional deposits equal to the amount of excess reserves that result from the deposit inflow

19

Summary of Major Points

As the proceeds of a loan are spent, the lending institution will lose reservesanother institution will gain reservesthis institution can expand loans and create

additional deposits in the amount of excess reserves that flow to it

20

Summary of Major Points

Following an initial injection of reserves, the total volume of reserves in the banking system does not changethe composition of reserves changesas deposits expand at each stage, required

reserves rise and excess reserves fall

21

Summary of Major Points

The total expansion of loans and deposits is a multiple of the initial injection of reserves into the banking systemin the simplest model, the multiplier is 1/rD

ignores excess reserves and currency the lower the required reserve ratio, the larger the

multiplier is

22

Summary of Major Points

The monetary base is reserves plus currency in the hands of the publicin a more elaborate model that takes account of

excess reserves and currency holding s of the public, the multiplier is a multiple of the change in the monetary base it is smaller than the simple multiplier it is influenced by the behavior of the Fed, deposit

institutions, and the public

23

Summary of Major Points

Even if the Fed can control the monetary base, it may have difficulty controlling the money supply in the short runover a longer period, the fluctuations in the

multiplier tend to offset one another