Money Commercial Banking Final Diagram Version

8/11/2019 Money Commercial Banking Final Diagram Version

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1- AssetsReal AssetsEg. Land, real estate.

Financial AssetsEg.Bonds: a promise to pay acertain amount of money at

maturity & paying a certaininterest rate( bonds can be sold& bought at a certain marketprice)Treasury Bills:Gov. borrows

from the public by issuingTBs(it`s usually for 3 months &gov. pays a certain interest rate


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2-Components of Money SupplyMoney Supply

definitions

M1::Coins & currency in

CirculationDemand deposits

Traveler checks

M2:M1+ saving accounts& short time deposits

ie near money

M3:M2+long time

Deposits &certificates

Narrow Definition Broad Definitions


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How do commercial banks createmoney (deposits)

If the Central Bank allows the commercial banks tocreate deposits, the money supply increases .

HOW???


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Questions regarding the case study:1) Show the initial & final balance sheets ofcommercial banks 1 & 2.2) What is the money supply multiplier?

3) In one equation , show by how much will themoney supply increase after all banks end thecredit creation process.4- What are the main assumptions of the previouscalculations regarding the increase in moneysupply?


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1-Balance Sheet of Comm. Bank 1(initially)

AssetsReserves 1000

Loans or inv. 900(900 is withdrawn).

1000

LiabilitiesDeposits 1000

Deposits 900(900 is withdrawn)

1000


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Final Balance Sheet of Comm. Bank

(1) Assets--------------------------Reserves 100Loans or inv. 900------------------------- 1000

Liabilities--------------------------Deposits 1000

------------------------ 1000

Try initial & final sheets of Bank (2) yourself


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2- Money Supply Multiplier:

Shows how money supply changes due to aninitial change in reserves.3-Money supply multiplier=

Change in money supply/ initial change inreserves

Money supply multiplier= 1/legal reserve ratio=1/10% = 10 in the previous case studyThus, Change in MS= (10)(+1000)=$ 10,000


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4-Main assumptions of previous calculations:

Legal reserve ratio = required reserve ratioThere is no cash drain----------------------------------------------------The previous case shows that Central Bank can change moneysupply by affecting the ability of Commercial Banks to createdeposits through some of its instruments: changing the legal reserveratio,( when legal reserve ratio decreases money supply increases)& by open market operations (ie Central Bank buying & thusinjecting the financial body & increasing Money supply or selling &thus decreasing money money supply)Money supply curve is vertical as it can be controlled by the Centralbank


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5-Money supply reflects the Central Bank`sdesires-5-

Quantity Supplied of money

Interest Rate

Money supply curve


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6-Interest rate: is the cost of

borrowing money.If people hold money (ie they do not financiallyinvest it by buying bonds or investing in other

interest earning assets), do they face any cost?YES, as they have sacrificed the interest ratethat could have been obtained if they would haveinvested their money in bonds

Thus, cost of holding money is the interestrate.


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But why do we have various interest rates?

Interest rates may vary as:Loans have different dates of maturity

Assets have different levels of liquidity (abilityto convert the asset into cash with little loss ofvalue)Risk element. Risky assets provide a higherinterest rate

When we speak of THE INTEREST RATE, we refer generally tothe interest rate on a short term security (eg. TB rate).MOSTOTHER RATES RISE & FALL IN STEP WITH IT


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7-Demand for money?Why the public desires to hold some money (cash)

1-Transactions demand for money: the demand formoney as a medium of exchange by household &business sectors( to pay for their needs)Transactions demand for money=f(GDP,GPL) +2-Asset demand for money( demand for money as astore of value)ie people try to diversify their wealthamong a broad group of investments eg bonds, timedeposits

Asset demand for money= f( interest rate) - As interest rate on financial assets increases, cost ofholding money without investing it is high, thus quantitydemanded of holding money(& not investing it) falls,&vise versa.


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Total demand for money:Demand for money=f( I, GDP,GPL)-------------------------------- --------------

otherfactors

that shiftthe curve

Money demand curve


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7-Demand curve for moneyShows the desires of the public to hold money asinterest rate changes is negatively sloping.

I

Quantity Demand of money

Demand for money


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8-Money MarketIs the market where short term funds are lent &borrowed eg TBs,gov. short term bonds. It consists of money demand & supply

I

Quantity of money

Money Supply curve (M s)

Money Demand curve (M d)Eq. I


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Graphs of a free money market

I

Quantity of money

Ms

Md

Equilibrium interest rateThe interest rate


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Case 2: show how the interest rate is

affected if GDP or GPL increase

I

Quantity of money

I0

I1

Ms Md Md1

Note: INTEREST RATEincreased.

Money Commercial Banking Final Diagram Version

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