Money Multiplier

1
Money Multiplier

• Objectives
• Determine the maximum potential extent to which
  the money supply will change following a Federal
  Reserve purchase or sale of government
  securities.
• Discuss the ways in which the Federal Reserve
  conducts monetary policy.

2
Money Multiplier

• Say
• A banks reserves are 100.
• The required reserve ratio is 10.
• How much can that banks deposits be?
• 1000!
• Ten times as much as their reserves.
• Are you sensing a multiplier?
• Money Multiplier 1/Req. Res. Ratio

3
Money Multiplier II

• The Money Multiplier tells us
• For each dollar the Fed increases reserves by,
  how much can deposits, and so the money supply,
  increase
• If the Required Reserve Ratio is 20
• the money multiplier is 5
• each dollar the Fed injects into the system can
  cause deposits to increase by 5.

4
Money Multiplier III

• In the real world, the money multiplier is
  smaller, because
• People keep cash on hand!
• Banks keep excess reserves above zero!
• The more of either that happens, the smaller the
  impact of an increase in reserves on the money
  supply!

5
Monetary Policy Tools

• The Federal Reserve has three tools for
  conducting monetary policy
• The Required Reserve Ratio
• The Discount Rate
• The rate that the Fed charges to banks for
  overnight loans to cover reserve requirements
• If the bank cant get any on the fed funds market
• The Fed frowns on too many visits to the
  Discount Window
• Open Market Operations
• Buying and selling bonds and other government
  securities