4. Monetary Aggregates
Central Bank
Assets Liabilities
Bonds Bank Reserves Monetary
Other Currency in Circ. Base
Other
Banking System Non-Bank Public
Assets Liabilities Assets Liabilities
Bank Reserves Deposits M2 Currency in Circ. Loans
Bank Money
Reserves • Vault Cash Other
Supply
Bank Deposits Other
• Deposits at CB Other Net Worth
Loans
6. The Money Multipliers
M2 Money Supply = M2 Money Multiplier Monetary Base
• How much money banks create (by making loans) depends on:
– Central Bank’s Required Reserve Ratio (rr)
– Households’ Currency to Checking Deposits ratio (Cc/D)
– Households’ Near Money to Checking Deposits ratio (N/D)
– Banks’ Excess Reserves to Checking Deposits ratio (U/D)
(Excess Reserves = Customary Reserves)
7. How Does the Fed Control the Money Supply?
M2 Money Supply = M2 Money Multiplier Monetary Base
• Required Reserve Ratio (Fed)
• Preferred Asset Ratios (Others)
• Open Market Operations (Fed)
• Foreign Exchange Interventions (Fed)
• Discount Loans (Fed)
8. How Does the Fed Create Money “Out of Thin Air”?
Banking System Central Bank
Assets Liabilities Assets Liabilities
Reserves $10 Deposits $20 Bonds $10 Bank Reserves $10
Loans $10 Currency in Circ $0
M2 Money Supply Currency in Circ. + Deposits $20
Monetary Base Currency in Circ. + Reserves $10
9. How Does the Fed Create Money “Out of Thin Air”?
Banking System Central Bank
Assets Liabilities Assets Liabilities
Reserves $10+$5 Deposits $20+$5 Bonds $10+$5 Bank Reserves $10+$5
Loans $10 Currency in Circ $0
• Fed buys $5 Treasury bond from “primary dealer”
• Fed pays with new bank reserves
M2 Money Supply Currency in Circ. + Deposits $20+$5
Monetary Base Currency in Circ. + Reserves $10+$5
10. Takeaway Points
• Central Bank can change money supply by changing
monetary base or by changing required reserve ratio
• Only the central bank can change the monetary base
• Money supply can also change if preferred asset ratios
change
Editor's Notes
This is an example of open market purchasePrimary dealers are about 20 large securities firms (banks or broker-dealers) authorized to trade with the FedTypically banks will use the new excess reserves to make additional loans money supply will eventually rise by more than $5
Savings accounts are also referred to as “near money”Excess reserves are also referred to as “customary reserves”In previous example, with those two extreme assumptions, the money multiplier equals 1/(reserve ratio)= 1/(10%) = 10. Under normal circumstances it is smaller than that.
Required reserve ratio and preferred asset ratios determine how much banks can lend
This is an example of open market purchasePrimary dealers are about 20 large securities firms (banks or broker-dealers) authorized to trade with the FedTypically banks will use the new excess reserves to make additional loans money supply will eventually rise by more than $5
