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ECON 3430 (64)
Lecture 15

ECON 3430 Lecture 15: CH15 book powerpoint notes

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York University
ECON 3430
Brenda Spotton- Visano

The Money Supply Process Chapter 15 Three Players in the Money Supply Process 1. The central bank The government agency that oversees the banking system and is responsible for the conduct of monetary policy 1. Banks (depository institutions) The financial intermediaries that accept deposits from individuals and institutions and make loans 1. Depositors Individuals and institutions that hold deposits in banks The Bank of Canada’s Balance Sheet Liabilities Currency in circulation: in the hands of the public Reserves: deposits (settlement balances) at the Bank of Canada and vault cash – these are particularly important for our analysis Assets Government securities: holdings by the Bank of Canada that affect money supply and earn interest Loans to financial institutions: provide loans (advances) to banks and charge the bank rate Reserves Banks (LVTS participants), have an account at the Bank of Canada in which they hold deposits (also called settlement balances) Reserves consist of settlement balances at the Bank of Canada plus vault cash Banks hold reserves in order to manage liquidity Reserves (cont’d) Desired reserves Reserves that are held to meet the central bank’s requirement that for every dollar of deposits at a bank, a certain fraction must be kept as reserves Desired reserve ratio The fraction of deposits that the bank desires be kept as reserves Excess reserves Reserves in excess of desired reserves Control of the Monetary Base MB = C + R MB: monetary base (high-powered money) C: currency in circulation (notes and coins held by the public outside banks) R: total reserves in the banking system (vault cash + settlement balances) The Bank of Canada controls the monetary base through open market operations and advances to banks Open Market Purchase from a Bank Bank of Canada purchases $100m of bonds from a bank and pays them with a $100m cheque Net result is that reserves have increased by $100m No change in currency Monetary base has risen by $100m Open Market Sale to a Bank Bank of Canada sells $100 of bonds to a bank No change in currency Reduces the monetary base by the amount of the sale Open Market Purchase: Summary The effect of an open market purchase on reserves depends on whether the seller of the bonds keeps the proceeds from the sale in currency or in deposits The effect of an open market purchase on the monetary base always increases the monetary base by the amount of the purchase Shifts from Deposits into Currency The non-bank public withdrawals $100 million in cash The banking system loses $100 million in deposits and therefore $100 million in reserves Shifts from Deposits into Currency (cont’d) For the Bank of Canada, the public’s action means $100 million more currency is in circulation Reserves in the banking system falls Net effect on the monetary base is zero Loans to Financial Institutions When the Bank makes a $100m loan to a bank, the bank is credited with $100m of reserves (settlement balances) from the proceeds of the loan Monetary liabilities of the Bank of Canada have increased by $100m Monetary base also increases by this amount Other Factors that Affect the Monetary Base Two important items that affect the monetary base but are not controlled by the Bank of Canada Float Government deposits at the Bank of Canada Interventions in the foreign exchange market Although technical and external factors complicate control of the monetary base, they do not prevent the Bank of Canada from accurately controlling it Overview of the Bank of Canada's Ability to Control the Monetary Base Open market operations are controlled by the Bank of Canada The Bank of Canada cannot determine the amount of borrowing by banks from the Bank of Canada Split the monetary base into two components MB n MB - BR The money supply is positively related to both the non-borrowed monetary base MB nnd to the level of borrowed reserves, BR, from the Bank of Canada Multiple Deposit Creation: A Simple Model Multiple Deposit Creation: A Simple Model But the $100 reserves to not remain there for long Borrowers didn’t take a loan just to increase their deposits They will purchase goods and services Over time, First
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