CHAPTER 14 - The Money Supply Process.

Increase in Discount Loans effects

$1 million of discount loans increases bank reserves and the monetary base by $1 million EFFECT: on the FED t-acct = increase on DL(A) and increase on reserves(L) on the banking system t-acct = increase on reserves(A) and increase on DL(L) As a result of the Fed's making $1 million of discount loans, bank reserves and the monetary base increase by $1 million.

Monetary Base (part 2) (section)

= Currency in circulation (C) + Reserves (R) OR = Fed notes + Treasury currency − coins + bank deposits

Float

= cash items in the process of collection − deferred availability cash items

New MS formula (The Money Supply Process for M1 section)

MS = [ (C/D) + 1 + (S/D) ] / [ (C/D) + rD + (ER/D) ] times MB

m2 multiplier

MS2 = m2 * MB m2 = (the same formula as before but add (T/D) and (MMF/D))

How a Single Bank Responds to an Increase in Reserves? (part 2)

Wells Fargo earns only a low interest rate from the Fed on the additional reserves obtained from the T-bill sale and therefore has an incentive to loan out or invest these funds. Suppose that Wells Fargo loans $100,000 to Rosie's Bakery to enable it to buy two new ovens. We will assume that Wells Fargo makes the loan by creating a checking account for Rosie's and depositing the $100,000 principal of the loan in the account. 1. Wells Fargo t-acct = decrease in sec. and increase in R and loans(A) increase in check.dep.(L)

Multiple Deposit Expansion

What happens to the money supply when the Fed increases bank reserves through an open market purchase? To answer this question, we first analyze the changes that occur at a single bank and then look at the changes for the whole banking system.

The Money Supply, the Money Multiplier, and the Monetary Base During the 2007-2009 Financial Crisis (3)

Why did the monetary base increase significantly more than M1 during and after the 2007-2009 financial crisis? 3. Provided is a graph that shows the movement of C/D and ER/D over time. We can observe a sharp increase (or better a beginning) of ER/D and C/D slightly decreased - While the currency-to-deposit ratio had been gradually trending upward since 2000, it fell during the 2007-2009 financial crisis and again during the 2020 Covid-19 pandemic. The decline was the result of households and firms shifting funds into checkable deposits from money market mutual funds and other assets whose riskiness they believed had increased and, in 2020, households receiving federal government payments under the CARES Act. - With deposits increasing faster than currency, C/D fell.

Monetary Base (MB) formula for balance sheet

[ (Securities) + (Discount loans) + (Gold &SDRs) + (Floats) + (Other Fed assets) ] [ − (Treasury deposits) − (Treasury currency) - (Foreign &other deposits) − (Other Fed liabilities) ]

Deferred availability cash items

the funds of the check that the Fed is processing but soon will credit to the bank that receives the check.

Simple deposit multiplier (1)

change in deposits = $100,000 + 0.9×$100,000 + [(0.9×0.9)×$100,000] + [(0.9×0.9×0.9)×$100,000 + ⋯ OR change in deposits = $100,000 ×[ 1 + 0.9 + 0.92 + 0.93 + ⋯].

The Banking System (2nd actor)

creates the checking accounts that are a major component of M1.

Money Multiplier

determined by all three actors. links the monetary base to the money supply. amount of money that the banking system can generate with each dollar of reserves.

Monetary Base (MB; High-Powered-Money)

determined by the FED (1st actor). the sum of bank reserves and currency in circulation.

Discount Rate

the interest rate the Fed charges on discount loans.

Reserves (R)

includes: 1. Bank reserves are are defined as: Reserves = Bank deposits with the Fed + Vault cash (currency held by banks.) 2. Required reserves + Excess reserves(on top of what the FED requires).

Revised m formula

m = [ (C + D + S) / (C + RR + ER) ] * [ (1/D) / (1/D) ] => m = [ (C/D) + 1 + (S/D) ] / [ (C/D) + (RR/D) OR rD + (ER/D) ]

Excess reserves-to-deposit ratio (ER/D)

measures banks' holdings of excess reserves relative to their checkable deposits

Bank pays the DL(discount loan)

opposite effect that the increase had. everything on that card decreases for both the fed and the banking system

Currency in circulation (C)

paper money and coins held by the nonbank public.

Multiple deposit creation

part of the money supply process in which an increase in bank reserves results in rounds of bank loans and creation of checkable deposits. - The money supply is growing with each loan. The initial increase in bank reserves and the monetary base results in the money supply growing by a multiple of the initial increase in reserves. (slide: an increase in the money supply is a multiple of the initial increase in reserves.)

The Money Supply, the Money Multiplier, and the Monetary Base During the 2007-2009 Financial Crisis (4)

- Because both in the fall of 2008 and the spring of 2020, the increase in ER/D was significantly larger than the decline in C/D, the value of the money multiplier declined, and the increase in the monetary base resulted in a much smaller increase in M1 than would have occurred if the value of the money multiplier had not declined - We've already discussed why banks continue to hold large quantities of reserves more than 10 years after the end of the 2007-2009 financial crisis. To briefly recap, (1) although the interest rate the Fed pays on reserves is low, the investment is risk-free; (2) historically high levels of uncertainty in the financial system have led many banks to increase their liquidity; (3) large banks are required to be more liquid than prior to 2007, which they achieve by keeping substantial balances in their reserve accounts with the Fed.

How a Single Bank Responds to an Increase in Reserves? (part 3)

- By lending money to Rosie's, Wells Fargo creates checkable deposits and, therefore, increases the money supply (currency + check.dep). Suppose that Rosie's then spends the loan proceeds by writing a check for $100,000 to buy ovens from Bob's Bakery Equipment. Bob's deposits the check in its account with PNC Bank. - Once the check has cleared and PNC Bank has collected the funds from Wells Fargo 1. Wells Fargo t-acct = decrease in sec, increase in loans, and R = $0(A) check.dep = $0(L) - Wells Fargo is now satisfied because it has exchanged some of its low-interest Treasury bill holdings for a higher-interest loan. But the effect of the open market purchase on the banking system is not finished.

The Federal Reserve (1st actor) (how the money supply is determined includes the behavior of three groups)

responsible for controlling the money supply and regulating the banking system.

REPOS (Reverse Repurchase Agreement)

sell securities and agree to buy them back at a later date (short-term loan).

Simple deposit multiplier (3) - required reserve ratio(rD)

simple deposits multiplier = 1 / rD

Simple deposit multiplier (2)

simplify the above equation to = 1 / (1 − 0.9) = 1 / (0.10) = 10. SO => change in deposits(D) = = $100,000×10 = $1,000,000.

Open Market PURCHASE

the Fed's purchase of securities. raises the monetary base by the dollar amount of an open market purchase.

Currency-to-deposit ratio (C/D)

the ratio of currency held by the nonbank public, C, to checkable deposits, D.

Savings-to-deposit ratio (S/D)

the ratio of savings deposits held by the nonbank public, S, to checkable deposits, D.

Simple Deposit Multiplier (section)

the ratio of the amount of deposits created by banks to the amount of new reserves. (there is a table that shows the process for the effect of an increase in R, which shows what ends up resulting from the multiple times) (FROM BOOK) There are two ways to answer this question. First, each bank in this process is keeping reserves equal to 10% of its deposits because we are assuming that no bank holds excess reserves. For the banking system as a whole, the increase in reserves is $100,000—the amount of the Fed's open market purchase. Therefore, the system as a whole ends up with $1,000,000 in deposits because $100,000 is 10% of $1,000,000.

Comparing Open Market Operations and Discount Loans (OMO part)

- The Fed has greater control over open market operations because it initiates purchases or sales of securities by having the trading desk at the New York Fed place orders with the primary dealers. - The Fed is willing to buy and sell securities at whatever price is needed to carry out its open market operations successfully.

The Non-bank public (3rd actor)

(all households and firms): decides the form in which they wish to hold money (e.g., currency vs. checking deposits).

Explaining the Explosion in the Monetary Base (section | part 1)

(there is a graph where you can observe a sharp increase of reserves(most importantly) and currency after 2008; the question is WHY??) 1. until the fall of 2008, about 98% of the monetary base consisted of currency because banks held very low levels of reserves. 2. currency in circulation increased, reserves increased much more, rising from 2% of the base in August 2008 to 47% in December. 3. In this case, though, the Fed's holdings of Treasury securities actually fell during the first months when the base was exploding. The Fed held $779 billion in Treasury securities of all types in January 2007 but only $475 billion in January 2009. The Fed's holdings of Treasury bills plunged from $277 billion in January 2007 to only $18 billion in January 2009.

The Money Supply, the Money Multiplier, and the Monetary Base During the 2007-2009 Financial Crisis (3.1)

- Changes in C/D on the money multiplier that a decrease in C/D, holding all else constant, will cause the value of the money multiplier to increase and the value of M1 to also increase for any given value of the monetary base. We know from Figure 2 that, in fact, the value of the money multiplier decreased. - The reason is that the value of ER/D soared, increasing from almost zero in August 2008—because banks were holding very few excess reserves—to about 1.3 in the fall of 2009. In other words, banks began to hold more excess reserves than they had checkable deposits, causing ER/D to rise above 1, where it remained until early 2018. - With banks already holding substantial excess reserves, the increase in ER/D was less dramatic during the Covid-19 pandemic—rising from 0.65 in December 2019 to 0.99 in May 2020.

The Effect of Increases in Currency Holdings and Increases in Excess Reserves (PART 4)

- Funds deposited in banks are subject to the multiple deposit creation process, while funds held as currency are not. (result from part 2, point 2) - Now suppose that when Bob's Bakery deposits the $100,000 in its account at PNC Bank, the bank decides that instead of holding $10,000 as required reserves and loaning out the other $90,000, it will hold the entire $100,000 as excess reserves. If PNC takes this action, the process of multiple deposit creation comes to an immediate stop because no more loans are made, and no more deposits are created. - Rather than resulting in a $1,000,000 increase in deposits, the Fed's $100,000 open market purchase will have resulted in only a $100,000 increase in deposits. The deposit multiplier will have declined from 10 to 1 (example for part 2, point 3)

More Info from the book for the Simple Deposit Multiplier (1)

- If a bank decides to invest all or some of its excess reserves in municipal bonds or other securities rather than make loans, the deposit creation process will be the same as if the bank had made loans. - Suppose that PNC decided to purchase $90,000 worth of municipal bonds from a bond dealer instead of extending the $90,000 loan to Santiago's. PNC would write the bond dealer a check in the amount of $90,000, which the bond dealer would deposit in its bank. The dealer's bank would then have excess reserves, which it could lend or invest, and so on. - The effect on multiple deposit creation is the same whether banks use excess reserves to make loans or buy securities.

The Effect of Increases in Currency Holdings and Increases in Excess Reserves (PART 3)

- In our account of the money supply process in Section 14.2, once Wells Fargo had acquired $100,000 in excess reserves as a result of selling Treasury bills to the Fed, the bank loaned the entire amount to Rosie's Bakery. Rosie's then spent the loan proceeds by writing a check for $100,000 to Bob's Bakery Equipment, and Bob's deposited the entire $100,000 check in its account with PNC Bank. - Once the check cleared, PNC Bank gained $100,000 in reserves. But suppose that instead of depositing the whole $100,000, Bob's had deposited $90,000 and taken $10,000 in cash. In that case, PNC would have a gain in reserves of $90,000, not $100,000, thereby reducing the amount PNC had available to lend.

The Money Supply Process for M2 (PART 1)

- M2 is a broader monetary aggregate than M1, including not only everything in M1 but also non-transaction accounts. - Non-transaction accounts consist of small-denomination time deposits, which we will call T, and money market mutual fund accounts and similar accounts, MMF

More Info from the book for the Simple Deposit Multiplier (2)

- Note that just as the Fed can expand the volume of checkable deposits in the banking system by increasing reserves, it can also contract the volume of deposits by reducing reserves. - The Fed reduces reserves by selling government securities in an open market sale. This action has a ripple effect that is similar to deposit creation in the banking system but in the opposite direction. The result of the open market sale is multiple deposit contraction. - Suppose that the Fed sells $100,000 in Treasury securities to Wells Fargo, thereby reducing that bank's reserves by $100,000. With a simple deposit multiplier of 10, we know that a decline in reserves of $100,000 will eventually lead to a decline in checkable deposits of $1,000,000.

How a Single Bank Responds to an Increase in Reserves? (part 6)

- SunTrust faces the same decisions that Wells Fargo and PNC faced. SunTrust wants to use the increase in reserves to expand its loans, but it can safely lend only the increase in excess reserves. With a required reserve ratio of 10%, SunTrust must add to its required reserves and can lend only $81,000. Suppose that SunTrust lends the $81,000 to Malik's Barber Shop to use for remodeling. Initially, SunTrust's assets (loans) and liabilities (checkable deposits) rise by $81,000. But when Malik's spends the loan proceeds and a check for $81,000 clears against it, the changes in SunTrust's balance sheet are as follows: 1. SunTrust t-acct = R = +$9kand Loans = +$81k(A) and Check.Dep = +$90k(L) - To this point, the $100,000 increase in reserves supplied by the Fed has increased the level of checkable deposits by . - This process can go on and on and it is called Multiple deposit creation (this process is going with the assumption that the FED requires the 10% of RR ratio from bank.

Example of OM purchase

- Suppose the Fed buys $1 million worth of Treasury bills from Wells Fargo. Wells Fargo electronically transfers ownership of the bills to the Fed, and the Fed pays for them by depositing $1 million in Wells Fargo's reserve account at the Fed. - In practice, the Fed typically buys securities from multiple banks at the same time

Comparing Open Market Operations and Discount Loans (DL part)

- The Fed's control over discount lending is much less complete than its control over open market operations because banks decide whether to borrow from the Fed. - The Fed has some control over discount loans because it sets the discount rate. - Note that the discount rate differs from most other interest rates because it is set by the Fed, whereas most other interest rates are determined by demand and supply in financial markets.

New MB after the FED control over OMO and DL revelation

- The monetary base (B) includes: the nonborrowed monetary base (Bnon) and borrowed reserves (BR) (same as discount loans). MB = Bnon + BR. - The Fed has control over the nonborrowed monetary base. - Although decisions by both the Fed and banks determine the volume of discount loans, the Fed by itself can control the nonborrowed monetary base

Explaining the Explosion in the Monetary Base (part 4 | from slides) (similar info but summarized differently)

- The monetary base increased sharply in the fall of 2008 and stayed at high levels through 2016. - Most of the increase occurred because of an increase in the bank reserves component, not the currency in circulation component. - The Fed's holdings of Treasury securities actually fell while the base was exploding. - As the Fed began to purchase assets connected with Bear Stearns and AIG, the asset side of its balance sheet expanded, and so did the monetary base.

The Money Multiplier

- The money multiplier is determined by the actions of three actors in the economy: the Fed, the nonbank public, and banks. - The money multiplier helps us understand the factors that determine the money supply. MS = MB * m => m = MS/MB

More Info about OM (Example: Households and firms decide to withdraw $1 million from their checking accounts.)

- The public's preference for currency relative to checkable deposits does not affect the monetary base. - CAUSES - 1. on the non-banking public t-acct = dec. of check.dep. and increase of currency(A) 2. on the banking system t-acct = decrease on reserves(A) and decrease on check.dep.(L) 3. on the FED t-acct = increase in currency in circulation and decrease of reserves(L) - The monetary base is unaffected. This result is important because it means that the Fed can increase and decrease the monetary base through open market operations without the changes being affected by how much currency the nonbank public wishes to hold relative to checkable deposits. Discount Loans

The Effect of Increases in Currency Holdings and Increases in Excess Reserves (PART 5)

- To find a stable money multiplier that will link the monetary base to the money supply. We have seen that the Fed can control the size of the monetary base through open market operations. Provided that the money multiplier is stable, the Fed's control over the monetary base allows it to also control the money supply. - The simple deposit multiplier is useful in understanding how reserve creation leads to increases in loans and deposits, which is the heart of the money supply process. But we need to elaborate on the simple deposit multiplier in three ways: 1. Rather than a link between reserves and deposits, we need a link between the monetary base and the money supply. 2. We need to include the effects on the money supply process of changes in the nonbank public's desire to hold currency relative to checkable deposits. 3. We need to include the effects of changes in banks' desire to hold excess reserves relative to deposits.

The Money Supply, the Money Multiplier, and the Monetary Base During the 2007-2009 Financial Crisis (1)

- provides 2 graphs(figures) of 1. the MB and M1 and 2. the money multiplier(m) 1. we can observe a sharp increase in MB after 2008 but M1 still is growing 'steadily' but after 2008 it does so in a faster rate. - in the fall of 2008, in response to the financial crisis, the Fed bought huge amounts of financial assets, including mortgage-backed securities. Figure 1 shows that, as a result, the size of the monetary base soared.

Liabilities / Capital of the FED

1. Federal Reserve Notes Outstanding 2. Reserve Repurchase Agreement (currency in circulation) 3. Bank deposits (as reserves) 4. Treasury deposits, General Account 5. Deposits of foreign governments and international organizations, and other deposits

The Money Supply Process for M1 (part 1)

1. MS = MB * m 2. MB = Bnon + BR 3. The money multiplier(m) depends on rD, ER/D, C/D, and S/D 4. (FROM THE BOOK) We stated earlier that the Fed controls the money supply. We now know that this statement is not quite correct. The Fed can set the value of the nonborrowed base at whatever level it chooses. But the behavior of the nonbank public influences the money supply through the currency-to-deposit ratio, and the behavior of banks influences the money supply through the volume of discount loans and the excess reserves-to-deposit ratio.

Open Market operations

the Fed's purchases and sales of U.S. Treasury securities in the financial market. are carried out electronically with primary dealers by the Fed's trading desk. there are 24 primary dealers (commercial banks, investment banks, and securities dealers).

Explaining the Explosion in the Monetary Base (part 3)

1. Although QE was ended in October 2014, the monetary base didn't significantly decrease until June 2017, when then Fed Chair Janet Yellen announced that the Fed would shrink its balance sheet by no longer buying new Treasury notes and mortgage-backed securities to replace those it held that were maturing. 2. As the Fed's holdings of securities declined, so did bank reserves, shrinking the monetary base. This process ended in mid-2019, when U.S. economic growth slowed. Fed Chair Jerome Powell responded by expanding the Fed's securities purchases. During the Covid-19 pandemic, the Fed revived some of the lending facilities it had used during the 2007-2009 financial crisis and also started new programs. 3. note that the response involved the Fed purchasing, among other assets, corporate bonds, municipal bonds, and commercial paper. These purchases increased bank reserves and caused the monetary base to soar more than 60% by June 2020.

The Money Supply Process for M1 effects (PART 2)

1. An increase in S/D causes the value of the money multiplier and the money supply to increase 2. An increase in ER/D causes the value of the money multiplier and the money supply to decline. Economically, an increase in ER/D means that banks are holding relatively more excess reserves, so they are not using these funds to make loans as part of the process of multiple deposit creation. 3. An increase in rD causes the value of the money multiplier and the money supply to decline. Economically, an increase in rD means that for any increase in reserves that banks receive, a larger fraction must be held as required reserves, which are therefore not available to be loaned out as part of the process of multiple deposit creation. 4. For today the equation would exclude rD bc there is no RR.

Assets of the FED

1. Securities (US Treasury Sec., Federal agency debt Sec., Mortgage-backed Sec., and other) 2. Discount Loans to Banks 3. Gold&SDR certificate acounts 4. Coins 5. Cash items in the process of collection 6. Other: Accounts at other central banks, Physical assets; Art works

The Money Supply Process for M1 effects (PART 1)

1. The money supply will increase if either the monetary base or the money multiplier increases in value, and it will decrease if either the monetary base or the money multiplier decreases in value. 2. An increase in the currency-to-deposit ratio (C/D) causes the value of the money multiplier to decline and, if the monetary base is unchanged, it causes the value of the money supply to decline. 3. If households and firms increase their holdings of currency relative to their holdings of checkable deposits, banks will have a relatively smaller amount of funds they can lend out, which reduces the multiple creation of deposits.

Explaining the Explosion in the Monetary Base (part 2)

1. the increase in the monetary base during the fall of 2008 was not a result of typical open market purchases. Instead, the increase reflected the Fed's innovative policy measures. As the Fed began to purchase mortgage-backed securities, commercial paper, and assets connected with the investment bank Bear Stearns and the insurance company AIG, the asset side of its balance sheet expanded, and so did the monetary base 2. mportant lesson about the mechanics of increases in the monetary base: Whenever the Fed purchases assets of any kind, the monetary base increases. 3. beginning in 2009, the Fed engaged in several rounds of quantitative easing (QE). QE involved the Fed purchasing long-term Treasury securities—particularly 10-year Treasury notes—and mortgage-backed securities in an attempt to drive down long-term interest rates to increase spending by firms on machinery, equipment, factories, and office buildings and by households on new houses.

The Money Supply, the Money Multiplier, and the Monetary Base During the 2007-2009 Financial Crisis (2)

2. we can observe that m had been decreasing and it declined sharply after 2008 - The value of the money multiplier had been trending down, declining from a value of about 1.9 at the beginning of 2000 to about 1.7 at the beginning of 2007. The value then declined by more than 50% during the financial crisis, dropping below 1 by late 2008. - In fact, with the value of the monetary base having risen above the value of the money supply, the money multiplier had turned into a money divider! The value of the money multiplier eventually rose above 1 in May 2018 and stayed there until again slipping below 1 in 2020, during the Covid-19 pandemic.

FED BALANCE SHEET (section)

Assets, Liabilities, Equities (Capital)

(Practice Question 2) Suppose the Federal Reserve Bank of Atlanta buys a painting from a local art store for $1,000. This painting is used to grace the walls of its conference room. This purchase will cause ________ in the monetary base, everything else held constant.

B. increase of $1,000

Open Market SALE

the Fed's sale of securities. the monetary base decreases by the dollar amount of an open market sale.

(Practice Question 1) Suppose the currency-to-checkable deposit ratio decreases while, at the same time, the excess reserve-to-checkable deposit ratio also decreases. Everything else held constant, these changes would_______the money supply.

C. increase

Coins (FED assets)

Coins not in circulation are under the Fed's assets.

The Money Multiplier (more about the formula)

MS = C(currency) + D(deposits) + S(savings) MB = C(currency) + RR(required reserves) + ER(excess R) m = (C + D + S) / (C + RR + ER)

The Money Supply Process for M2 (PART 2)

MS = C(currency) + D(deposits) + S(savings) + T + MMF

Example of Explosion in the Monetary Base from part 2

For instance, if the Federal Reserve Bank of Dallas buys a computer system from a local information technology company for $10 million, it pays for the computers with a check. When the company deposits the check into the company's bank, the bank sends the check to the Fed, which increases the bank's reserves by $10 million. The result is an increase in the monetary base of $10 million. If the computer company decided to cash the check, the result would be the same: Currency in circulation would rise by $10 million, while the reserves of the computer company's bank would be unchanged, so the monetary base would still rise by $10 million.

How a Single Bank Responds to an Increase in Reserves? (part 5)

Initially, PNC's assets (loans) and liabilities (checkable deposits) rise by $90,000. But this is temporary because Santiago's spends the loan proceeds by writing a $90,000 check to buy equipment from Computer Universe, which has an account at SunTrust Bank. When SunTrust clears the $90,000 check against PNC, PNC's balance sheet changes as follows: 1. PNC t-acct = R = $10k and Loans = +$90k (A) and Check.Dep = +$100k (L) [all +] 2. SunTrust t-acct = R = +$90k(A) and Check.Dep = +$90k(L) checkable deposits in the banking system have risen by $190,000 as a result of the Fed's $100,000 open market purchase.

The Effect of Increases in Currency Holdings and Increases in Excess Reserves (PART 1)

Key assumptions for deriving the simple deposit multiplier: - Banks hold no excess reserves. - The nonbank public does not increase its holdings of currency. (we assumed in the previous section that whenever banks have excess reserves, they lend them all out. We also assumed that if households or firms receive a check, they deposit the whole amount in a checking account and keep none of the funds as cash. Neither of these assumptions is correct)

Roles of the FED

Lender of last resorts Banker of banks Government's bank (Treasury's general account) Partners with other countries' central banks

The Effect of Increases in Currency Holdings and Increases in Excess Reserves (PART 2)

Need to relax the assumptions of the simple deposit multiplier : 1. To show a link between the monetary base and the money supply. 2. To include the effects of changes in the nonbank public's desire to hold currency relative to checkable deposits. - The more currency the nonbank public holds relative to checkable deposits, the smaller the multiplier deposit creation process. 3. To include the effects of changes in banks' desire to hold excess reserves. - The more excess reserves banks hold relative to their checkable deposits, the smaller the multiplier deposit creation process.

Items in the Fed's Liabilities (sub-section)

Reverse repurchase agreement, Deferred availability cash items

Items in the Fed's Assets (sub-section)

SDR, Coins, Cash items for collection

How a Single Bank Responds to an Increase in Reserves? (part 1)

Suppose that the Fed purchases $100,000 in Treasury bills (or T-bills) from Wells Fargo: 1. Wells Fargo t-acct = increase in (excess)reserves and decrease in securities(A) [Required reserves don't increase because they are determined as a percentage of the bank's checkable deposits, and because this transaction has no immediate effect on Wells Fargo's checkable deposits, it doesn't change the amount of reserves the bank is required to hold.]

How the Fed Changes the Monetary Base (section)

The Fed changes the monetary base by changing the levels of its assets: Open market operations Discount loans

From FED's balance sheet

[ Fed notes + Bank deposits ] = [ (Securities) + (Discount loans) + (Gold &SDRs) + (Cash items in the process of collection) + (Coins) + (Other Fed assets) ] [ − (Treasury deposits) − (Foreign &other deposits) − (Deferred availability cash items) − (Other Fed liabilities) ]

Discount Loans

a loan made by the Federal Reserve typically to a commercial bank this change in bank reserves changes the monetary base. Discount loans alter bank reserves.

An increase excess reserves-todeposit ratio (ER/D)

based on the actions of banks => causes the money supply(MS) to decrease => because the value of the money multiplier falls, reducing deposit expansion.

An increase in required reserve ratio, rD

based on the actions of the Fed through changes in reserve requirements => causes the money supply(MS) to decrease => because fewer reserves can be lent out, and the value of the money multiplier falls.

An increase in nonborrowed base, Bnon

based on the actions of the Fed through open market operations => causes the money supply(MS) to increase => because the monetary base increases, and more reserves are available for deposit expansion.

An increase currency-to-deposit ratio (C/D)

based on the actions of the nonbank public => causes the money supply(MS) to decrease => because the value of the money multiplier falls, reducing deposit expansion.

An increase Savings-to-deposit ratio (S/D)

based on the actions of the nonbank public => causes the money supply(MS) to increase => because the value of the money multiplier rises, increasing deposit expansion.

Cash items in the process of collection

funds of the check that the Fed is processing but for which the Fed has not yet collected the payment.

SDR (Special Drawing Rights)

international type of monetary reserve created by IMF to supplement member countries' official reserves.

How a Single Bank Responds to an Increase in Reserves? (part 4)

trace the further effect of the open market operation by considering the situation at PNC Bank after it has received the check for $100,000 from Bob's Bakery Equipment. After PNC has cleared the check and collected the funds from Wells Fargo, PNC's balance sheet changes as follows: 1. PNC t-acct = increase in R(A) and increase in check.dep(L) - For simplicity, let's assume that when it received Bob's deposit, PNC had no excess reserves. 10% of that $100k went to RR and $90k went to ER (looks like an inc. of loans by $90k and a dec. of R by $90k) So with that $90k in ER it uses to make a loan to Santiago's Printing to purchase new office equipment.