ECON 2000 Lecture Notes - Lecture 95: Monetary Base, Reserve Requirement, Money Multiplier

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14 May 2018

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ECON 2000

Lecture 95

A model of money supply

- Three exogenous variables

- Monetary base B – total number of dollars held by public as currency

C and by the banks as reserves R. can be directly controlled by the

BoC

- Reserve-deposit ratio rr – fraction of deposits that banks hold in

reserve. Determined by business policies of banks and laws

regulating banks. By mid-1994, phasing out of reserve requirement

laws was complete and Canadian banks were no longer subject to

any minimum reserve requirement

- Currency-deposit ratio cr – amount of currency C people hold as a

fraction of their holdings of deposits D. reflects the preferences of

households about the form of money they wish to hold

- M = C + D

- B = C +R

- M/B = (C/D + 1) / (C/D + R/D)

- C/D = currency deposit ratio cr, and R/D = reserve-deposit ratio rr

- M = (cr + 1) / (cr + rr) x B

o Money supply depends on the three exogenous variables

- Money supply proportional to monetary base

- Factor of proportionality (cr + 1)/(cr + rr) denoted by m and called the

money multiplier

- M = m x B

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Document Summary

Monetary base b total number of dollars held by public as currency. C and by the banks as reserves r. can be directly controlled by the. Reserve-deposit ratio rr fraction of deposits that banks hold in reserve. Determined by business policies of banks and laws regulating banks. By mid-1994, phasing out of reserve requirement laws was complete and canadian banks were no longer subject to any minimum reserve requirement. Currency-deposit ratio cr amount of currency c people hold as a fraction of their holdings of deposits d. reflects the preferences of households about the form of money they wish to hold. M/b = (c/d + 1) / (c/d + r/d) C/d = currency deposit ratio cr, and r/d = reserve-deposit ratio rr. M = (cr + 1) / (cr + rr) x b: money supply depends on the three exogenous variables. Factor of proportionality (cr + 1)/(cr + rr) denoted by m and called the money multiplier.

Related Questions

In a country the monetary base is 1000. People hold one-fourth of their money in the form of currency (and thus three-fourths as bank deposits). Banks hold a third of their deposits in reserve.

a) What is reserve-deposit ratio, currency-deposit ratio, the money multiplier, and the money supply?

b) One day, Government passed a new rule that people needs to pay tax on their currency holdings, and people now want to hold one-fifth their money in the form of currency (and thus four-fifths as bank deposits). If the central bank does nothing, what is the money supply?

c) The central bank wants to conduct an open market operation to keep the money supply at its original level, does it buy or sell government bonds? Calculate how much the central bank needs to transact.

Explain completely the mechanism through which a change in the following will change the money supply, M1.

A) an increase in c

B) an increase in rd

C) a decrease in e

D) an increase in the federal funds rate

Refer to following: M1 = (m) * [MB] = m * (MBn + BR)

Where,

m = [(1 + c)/(rd + c + e)]

And MB = MBn + BR

Where MB = Monetary base = C + R

C = Currency in Circulation

R = Bank Reserves

MBn = Non-borrowed Monetary Base

BR = Borrowed Reserves = Borrowed Reserves from the Federal Reserve System

m = money multiplier

c = C/D = currency ratio

rd = required reserve ratio against deposits

e = ER/D = Bank precautionary reserve ratio

taupesheep43

Suppose households hold $0.30 in currency for every $1 they have as demand deposits (checking accounts). Also, banks hold 20% of their deposits as reserves.

A. If the Federal Reserve system buys $10 of government bonds from banks, by how much would the following change (include a minus sign if the value falls)?

i. The money supply (MI)

ii. The monetary base

B. Instead of the bonds being sold, suppose that households chose to hold less in currency and more in demand deposits. Explain how that would change:

i. The money supply (MI)

ii. The monetary base

C. Suppose the money supply increases by 3%, the real GDP rises by 2%, and velocity is constant. By how much do prices rise? Explain why or show your work

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ECON 2000 Lecture Notes - Lecture 95: Monetary Base, Reserve Requirement, Money Multiplier

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