finalized econ report
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8/8/2019 Finalized Econ Report
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Other Factors that affect the Money Base
Two important factors that affect the
monetary base, but are not controlledby the Fed, are:
Float
Treasury deposits at the Fed
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Overview of the Fed¶s Ability toControl the Monetary Base
Two primary features that determine
the monetary base:Open market operations
Discount lending
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Overview of the Fed¶s Ability toControl the Monetary Base
Hence, we can split the monetary
base into two components :One that the Fed can completely control(Non-borrowed Monetary Base)
One that is less tightly controlled(Borrowed Reserves)
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Overview of the Fed¶s Ability toControl the Monetary Base
The money supply is positively related to boththe non-borrowed monetary base MB
nand to
the level of borrowed reserves, BR, from theFed
Float and Treasury deposits at the FederalReserve which are not in control of the Fedcan cause short-term fluctuations in monetarybase, but the Fed can offset these short-termfluctuations by its open market operationsmaintain its control over monetary base.
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Multiple Deposit Creation: a SimpleModel
When the Fed supplies the banking
system with $1 of additional reserve,deposits increase by a multiple of thisamount ± a process called multipledeposit creation.
Deposit Creation: the Single Bank
Deposit Creation: the Banking System
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Simple Deposit Multiplier
The multiple increase in deposits
generated from an increase in thebanking system¶s reserves
Equals the reciprocal of the required
reserve ratio:
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Critique of the Simple Model
Our simple model assumes that:
1. Banks never hold excess reserves.2. Individuals and non-bank corporationsnever hold currency.
Since neither of these assumptions is
particularly realistic, we must modify andextend our model to take the behavior of banks and the non-bank public into account.
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Critique of the Simple Model
Fed is not the only player whose behavior influence the level of deposits, andtherefore, the money supply.
Depositors¶ decisions regarding how muchcurrency to hold and banks¶ decision
regarding the amount of excess reservesto hold can cause the market supply tochange.
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Factors that Determine the Money Supply
Changes in the Nonborrowed Monetary Base(MBn)
Changes in the Borrowed Reserves (BR)from the Fed
Changes in the Required Reserve Ratio, r
Changes in the Currency HoldingsChanges in Excess Reserves
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Changes in the Nonborrowed Monetary Base (MBn )
The money supply is positively related
to nonborrowed monetary base (MBn).
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Changes in the Borrowed Reserves (BR) from the Fed
The money supply is positively related
to borrowed reserve, BR, from the Fed.
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Changes in the Required Reserve Ratio, r
Required reserve ratio (r ), negatively
affect monetary multiplier (m) and thusnegatively affect money supply.
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Changes in the Currency Holdings
The money supply is negatively related
to currency holdings.
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Changes in Excess Reserves
The money supply is negatively related
to the amount of excess reserves.
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Float When the Fed clears checks for banks, itoften credits the amount of the check to a
bank that has deposited it (increases thebank¶s reserves) but only later debits(decreases the reserves of) the bank onwhich the check is drawn.
The resulting temporary net increase in thetotal amount of reserves in the bankingsystem (and hence in the monetary base)occurring from the Fed¶s check-clearing
process is called float.
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Float
Float is affected by random events such asthe weather, which affects how quickly
checks are presented for payment, is notcontrolled by the Fed, but affects themonetary base.
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U.S. Treasury deposits
When the U.S. Treasury moves deposits fromcommercial banks to its account at the Fed,
leading to a rise in Treasury deposits at theFed, it causes a deposit outflow at these banksand thus causes reserves in the bankingsystem and the monetary base to fall.
Thus Treasury deposits at the Fed isdetermined by the U.S. Treasury¶s actions andaffects the monetary base but are not fullycontrolled by the Fed.
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Open market Operations
Open market operations are controlled bythe Fed.
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Discount Lending
The Fed cannot determine the amount of borrowing by banks from the Fed (discountloans).
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Non-borrowed Monetary Base(MBn )
Results primary from open market
operationsFormally defined as the monetary baseminus banks¶ borrowings from the Fed(discount loans) :
MBn= MB - BR
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Borrowed Reserves (BR)
The amount of the monetary base that
is created by discount loans from theFed.
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D
eposit Creation: the Single Bank
First National Bank
Securities -$100Reserves $100
Assets Liabilities
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First National Bank
Securities -$100Loans $100
Assets Liab
First National Bank
Securities -$100
Reserves $100
Loans $100
Assets Liabilities
Checkable Deposits +$100
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D
eposit Creation: the Banking System
Bank A
Reserves $100
Assets Lia
Checkable Deposits $100
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Bank A
Reserves +$10Loans +$90
Assets Lia
Checkable Deposits +$100
Bank A
Reserves +$10Securities +$90
Assets Liabilities
Checkable Deposits +$100
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Bank B
Reserves +$9Loans +$81
Assets Lia
Checkable Deposits +$90
Bank B
Reserves +$90
Assets Lia
Checkable Deposits +$90