CHAPTER 15

“MONEY SUPPLY

PROCESS”

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Group One Members & Roll #--1. Htoo Mg2 Latt / 82. Chaw Su Aung Win /

53. Kyauk Kay Khine / 124. Ohnmar Aye / 355. Toe Thiri Tun / 486. Nan El Khaung / 267. Chan Htut /4

MBF- Batch 1Master of Banking and Finance Programme, Yangon, Myanmar. 1

The Economics of Money, Banking, and Financial Markets: 10E, Frederic S. Nishkin

9th N

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013

OBJECTIVES OF STUDY

How money supply process is determined?

How the Banking System Create Deposit?

Who control money supply?

What cause it to change?

How might control of it be improved?

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Three Players in the money supply process

Depositors

Banks

The

central

bank

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Three Players in the money supply process

The centr

al bank

The Central Bank –

The government agent that oversees the banking system.

Responsible for the conduct of monetary policy.

In Myanmar called Central Bank

In US called Federal Reserve System

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Three Players in the Money Supply Process

Banks – (Depository Institutions)

The financial intermediaries that accept deposits from individuals and institutions.

Make Loans- Commercial Banks, Savings and loan associations, mutual savings banks and credit unions.

Banks

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Three Players in the money supply process

Depositors- Individuals and institutions that hold deposits in the banks

Depositors

The three player in the money supply process:

The Central Bank (or) Federal Reserve System

- is most important player. - conducts monetary policy involves

actions that affect the balance sheet

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Assets

Government

Securities

Loans to Financial

Institutions

Liabilities

Currency in

Circulation

Reserves

Balance SheetFederal Reserve System

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Government Securities

• The Fed’s holdings of securities issued by U.S Treasury

Loans to Financial

Institutions

• Fed provide reserves to the banking system is by making loans to banks and other financial institutions.

Balance SheetFederal Reserve System

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Balance SheetFederal Reserve System

Currency in circulation

• is the amount of currency in the hands of the public

Reserves

• Fed hold deposits from all bank with their accounts.

• Reserves consist of deposits at the fed + physically stored in the bank vaults.

• Fed provides reserves to banking system at rate called the discount rate.

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More on Reserves

• Fed requires banks to hold a fraction (10%) of deposits as reserves.    - It is called Required Reserve Ratio

IN MYANMAR

Central Bank of Myanmar requires commercial banks to hold 10% of Deposits as reserves and 50% of 10% reserves has to place at Central Bank as reserves.

Additional holding of cash are called excess reserves.

Total reserves = Required Reserves + Excess Reserves

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Note: Fed does not pay interest on liabilities, but collects interest on its assets. It means that Fed gives Bonds to commercial banks for their placing of reserve.

Earnings (in billions) go to federal government and pay for the operation of the Fed.

TOTAL RESERVE

Excess Reserve

50% of the 10% Reserve

10% of Deposit

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Control of Monetary Base

MB (high-powered money) = Currency in circulation + Reserves

Open Market Operations

• Fed exercises control over monetary base through(i) Purchases or sales of government securities in open

market(ii) (ii) Extension of discount loans to banks

• A purchase of bonds by the Fed is called an open market purchase • A sale of bonds by the Fed is called an open market sale

MB C R

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Control of the Monetary BaseOpen Market Purchase of $100 of bonds from Bank with a $100 check

The Banking System

Assets Liabilities

Securities -$100

Reserve +$100

Assets Liabilities

Securities + $100 Reserve +$100

Federal Reserve System

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Control of the Monetary Base

Nonbank Public

Assets Liabilities

Securities -$100

Checkable Deposits +$100

Assets Liabilities

Reserves + $100 Checkable Deposits + $100

Banking System

Open Market Purchase of $100 of bonds from person or corporation who deposits the Fed’s check in a local bank

Assets Liabilities

Reserve +$100

Fed Reserve System

Securities + $10014

The result of the Fed’s Open Market Purchase

Result:

Reserves increase by the amount $ 100

The Monetary Base increase by the same amount $ 100

MB C R

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If the seller receive currency for the check

Assets Liabilities

Assets Liabilities

Nonbank Public

Fed Reserve System

Securities -$100

Currency in C +$100

Securities + $100 Current in circulation +$100

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Result:

Reserves unchanged

The currency in circulation increase by the amount $ 100

Thus, The Monetary Base increase by the same amount $ 100

Conclusion: Effect on MB of OMP is certain and effect on Reserves depends on whether seller of bond keeps proceeds in currency or deposits.

The result of the Fed’s Open Market Purchase

Note:

At local bank vault cash falls by $100, deposits at Fed increase by same amount.

I.e., the transaction is simply a switch from one type of reserves to another. 17

Open Market SaleOpen Market Sale of $100 of bonds from person who pays cash

Assets Liabilities

Assets Liabilities

Nonbank Public

Fed Reserve System

Securities +$100

Currency in C - $100

Securities - $100 Currency in circulation -$100

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Result:

Reserves unchanged

The currency in circulation decrease by the amount $ 100

Thus, The Monetary Base decrease by the same amount $ 100

If instead, person uses a check written on a local bank reserves fall by $100.

Conclusion: Effect on MB of OMS is certain, effect on Reserves depends on whether buyer of bond uses currency or checkable deposits.

The result of the Fed’s Open Market Sale

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Overall Conclusion

The effect of open market operations on the monetary base is much more certain than the effect on reserve.

• Fed can control MB using Open Market Operations more effectively than it can control reserves.

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Shifts From Deposits into Currency(Jane Brown permanently withdraws $100 from her checking account.)

Result: R ↓ $100, MB unchanged

Affecting reserves without changing MB

Nonbank Public

Assets Liabilities

Currency in C +$100

Checkable Deposits -$100

Fed Reserve System

Assets Liabilities

Currency in circulation +$100

Reserves -$100

Banking System

Assets Liabilities

Reserves -$100 Checkable Deposits -$100

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Discount Loans

Also affect MB, Suppose Fed makes $100 loan to First National Bank

Result: R increase , MB increase

Reverse happens when bank pays of a discount loan (I.e., all of the +’s become –’s).

Banking System

Assets Liabilities

Reserves +$100 Discount Loans +$100

Fed Reserve System

Assets Liabilities

Discount Loans +$100 Reserve +$100

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Factors outside Fed’s control

• Certain factors affect the MB that are outside the control of the Fed

1. Float - results from check clearing process that occurs at the Fed

* first increase reserves of depositing bank * second (later) decrease the reserves of bank on which check is

drawn * result is temporary increase in MB

2. Treasury deposits at Fed

* whenever Treasury moves deposits from commercial banks to Fed the result is a decrease in MB

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Deposit Creation: Single Bank

First National Bank

Assets Liabilities

Securities -$100

Reserves +$100

First National Bank

Assets Liabilities

Deposit +$100

First National Bank

Assets Liabilities

Securities -$100

Reserves +$100

Loans +$100

Securities -$100

Loans +$100Deposit +$100

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Deposit Creation: Banking SystemBank A

Assets Liabilities

Reserves + $100 Deposits +$100

Assets Liabilities

Reserves +$10

Loans + $90

Assets Liabilities

Deposits +$90 Reserves +$90

Assets Liabilities

Loans + $81

Reserves +$9

Bank A

Bank B

Bank B

Deposits +$100

Deposits +$90

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Deposit Creation

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Deposit Creation

If Bank A buys securities with $90 check

Seller deposits $90 at Bank B and process is same

Whether bank makes loans or buys securities, get same deposit expansion

Bank A

Assets Liabilities

Reserves + $10 Deposits +$100

Securities + $90

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Deposit Multiplier

Simple Deposit Multiplier

ΔD = 1 / rr x ΔR

Deriving the formula

R = RR = r × D

D = 1 × R rr

ΔD = 1 × ΔR rr

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Deposit Creation: Banking System as a Whole

Banking System

 Securities - $ 100 Deposits + $1000

Reserves + $100

Loans + $1000

Critique of Simple Model

Deposit creation stops if:     1. Proceeds from loan kept in cash      2. Bank holds excess reserves

Assets Liabilities

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Money MultiplierM = m × MB

Deriving Money MultiplierR = RR + ER RR = r × D R = (r × D) + ER

Adding C to both sides R + C = MB = (r × D) + ER + C 1. Tells us amount of MB needed support D, ER and C 2. Increase in C or ER is not multiplied

MB = (r × D) + (e × D) + (c ×D) = (r + e + c) × D

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D = 1 × MBr + e + c

M = D + (c × D ) = (1 + c) × D

M = 1 + c × MBr + e + c

m = 1 + cr + e + c

m < 1/r because no multiple expansion for currency and because as D ↑ ER ↑ (I.e., m is much less than 10 from simple model)

↑ r or ↑ c or ↑ e results in ↓ m and M.

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Excess Reserves Ratio, e

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Factors Determining Money Supply

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Money Supply

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Determinants of the Money Supply

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Deposits at Failed Banks: 1929–33

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e, c: 1929–33

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Money Supply and Monetary Base: 1929–33

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Your Thought!Discuss about something?

Thank You

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