Lecture 28: Money supply

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Lecture 28 Money supply

• Mishkin Ch14 part B
• page 351- 369

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Introduction

• What affect money supply?
• Money supply
• monetary multiplier money base
• Monetary multiplier
• Money base

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What affect monetary base?

• Open market operations are controlled by the Fed.
• The Fed cannot determine the amount of borrowing
  by banks from the Fed (discount loans).
• Split the monetary base into two components
• Discount loans borrowed reserves, BR
• Remainder non-borrowed monetary base, MBn, (MBn
  MB - BR )
• M m(MBn BR)

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Factors that determine the money supply

• Previously we knew that required reserve ratio
  (r), currency ratio (c), and excess reserves
  ratio (e) negatively affect monetary multiplier
  (m) and thus negatively affect money supply.
• The money supply is positively related to
  nonborrowed monetary base (MBn).
• The money supply is positively related to
  borrowed reserve from the Fed (MR).

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Changes in the nonborrowed monetary base (MBn )

• M m(MBn BR)
• The Feds open market purchase ? increase in
  nonborrowed monetary base (MBn) ? increase in
  monetary base (MB) ? support more currency and
  deposits ? increase money supply (M).
• The money supply (M) is positively related to the
  nonborrowed monetary base (MBn).
• How about open market sale?

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Changes in the borrowed reserves (MR) from the Fed

• M m(MBn BR)
• If discount loans increase ? borrowed reserves
  (BR) increase ? monetary base (MB) increase ?
  support more currency and deposits and thus a
  higher money supply.
• The money supply is positively related to the
  level of borrowed reserves, BR, from the Fed.

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Overview of the money supply process
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Application I explain money supply movements
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• change in MB (mainly MBn) is important for
  long-term movements.
• change in m (currency ratio c) is important for
  short-term movements.

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Explain money supply movements contd

• Over long periods, the primary determinant of
  movements in the money supply is the nonborrowed
  monetary base, which is controlled by the Feds
  open market operations.

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Application II bank panics and reduction in
money supply
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Application bank panics and money supply contd

• Bank panics ? relative risks of deposits
  increase, relative expected return of deposits
  decrease ? demand for deposits decrease ? people
  shift to holding cash ? currency ratio c increase
  ? money multiplier m decrease ? money supply
  decrease.
• In times of uncertainty ? expected deposit
  outflow increases ? banks would increase excess
  reserves ratio e ? money multiplier m decrease ?
  money supply decrease.

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Application bank panics and money supply contd

• Although the Fed tried its best to increase
  monetary base, it can not fully offset the
  negative effect of money multiplier on money
  supply.

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Recap

• The relationship between money supply and
• excess reserve ratio ? interest rate, expected
  deposit outflow
• currency ratio (short-term effects)
• Nonborrowed monetary base ? open market operation
  (long-term effects)