The Money Supply and theBanking System

Outline:

• What counts as money?

• Measuring the money stock

• Financial intermediaries

• The typical bank balance sheet

• The fractional reserve system

An asset is considered

liquid if it can be converted

to cash quickly and with little

cost

LeastLiquid

MostLiquid

Bonds,Equities

SpecializedEquipment

Home Equity

Oriental Rugs, Jewelry

Farm LandMoney

Cash in circulation

($521 billion)

Checkable deposits

($587 billion)+TravelersChecks

($8 billion)

Savingsaccounts($1,737 billion) Money

MarketMutualFunds

($873 billion)

Monetary AssetsJanuary 31, 2000

Small TimeDeposits

($963 billion)

Large TimeDeposits

($716 billion)

Most Liquid

Least Liquid

M1 includes

•Currency in circulation

•Traveler’s checks

•Checkable deposits at commercial banks

•Other checkable deposits (OCDs)1

1Includes NOW, ATS, credit union share draft accounts, and demand deposits

9.2 / .8%

237.2 / 21.6%

326.7 / 29.8%

523.2 / 47.7%

Travelers' Checks

OCDs

Demand deposits

Currency

Source: Federal Reserve Bulletin

OCDs means “other checkable deposits.”

Components of M1, July 17, 2000 (in billions)

M2 includes

•M1

•Savings deposits

•Small time deposits

•Money market mutual funds (MMMFs)

3694.4 / 48.6%

1016.0 / 13.4%

1799.2 / 23.7%

1096.3 / 14.4%

MMMFs

Small time deposits

Savings deposits

M1Components of M2, July 17, 2000 (in billions of dollars)

Financial Intermediaries

We use this to term to describe businesses that specialize in brokering between depositors (savers) and borrowers.

Institutions that are permitted by law to hold checkable deposits include:

1. Savings and loan associations (S & L’s)

2. Mutual savings banks

3. Credit unions

4. Commercial banks

Assets Amount ($) Liabilities and Net Worth Amount ($)Property and buildings $20 million Demand deposits $100 millionGovernment bonds $25 million Net worth $20 millionLoans $65 millionCash in vault $2 millionReserves on account $8 millionTotal assets $120 million Total Liabilities + Net Worth $120 million

Depository institutions are required by law to hold a minimum fraction of their deposit liabilities in a non-interest bearing account at the Federal Reserve Bank

Legislation

•Federal Reserve Act of 1913

•DIDMCA of 1982

•Total reserves: Vault cash plus reserves on account at the Federal Reserve Bank (the “Fed”).

•Required reserves: The minimum amount a reserves a bank must hold to comply with the legal reserve requirement.

•Required reserve ratio: The minimum fraction of checking account balances (or deposit liabilities) that bank must hold as reserves.

Type of Deposit Minimum required reserve (%)

Very large checkable deposits (over $54

million)

3

Other checkable deposits 10 All other deposits 0

Source: Federal Reserve Board

Reserve Requirements in the U.S.