Monetary Policy- Changes in the Money supply

Презентация с 20 слайда Money Market

The money supply is the quantity of money available in an economy.

The control over the money supply is called monetary policy.

The central bank in the U.S. is called the Federal Reserve, or the Fed.

HOW THE MONEY SUPPLY CAN INCREASE?

ACTIVE TRANSACTIONS

Loans, exchange foreign currency, securities

M1 will iuncrease---->M2 and M3 will increase

PASSIVE TRANSACTIONS

Money- demand deposit-M1, M2, M3 are same

WHO DETERMINES OUR MONEY SUPPLY?

MNB influences the total money supply, but not the fraction of money between currency and demand deposits which is determined by public preferences

MNB implements monetary policy by altering the money supply and influencing bank behavior

The quantity of money in circulation is controlled by the central bank in real value, does not depend on interest rate!

Banks are required by law to hold a percentage of all deposits with the FED to be able to return the deposits:

R = reserves: deposits

RR = required reserves: reserves held by the FED

rr = reserve-deposit ratio: percentage determined by the FED (rr = R/D)

ER = excess (избыток) reserves: reserves used by banks to lend or investment

R = RR + ER

RR = rr*R

ER = (1 – rr)R

A Model of Money Supply

The monetary base (B) is money held by the public in currency and by banks as reserves R

B = C + R

The currency-deposit ratio (cr) is the amount of currency people hold as a fraction of their demand deposits

cr = C / D

Divide M = C + D by B = C + R:

M/B = (C + D) / (C + R)

Divide the numerator and denominator by D:

M/B = (C/D + 1) / (C/D + R/D)

M/B = (cr + 1) / (cr + rr)

M = [(cr + 1) / (cr + rr)]B = m Í B

Define money multiplier m = (cr + 1) / (cr + rr),so far any $1 increase in the monetary base, money supply increases by $m.

= $500 billion, cr = 0.6 and rr = 0.1:

m=(0.6 + 1) / (0.6 +0.1) = 2.3

M = 2.3(500) = $1,150 billion

The money supply is proportional to the monetary base. So, an increase in B increases M m-fold.

The lower the reserve-deposit ratio, the more loans banks make and the higher is the money multiplier

The lower the currency deposit ratio, the fewer dollars of the monetary base the public holds as currency and the lower is the money multiplier

Open-Market Operations

The purchase and sale of U.S. Treasury Bonds

To expand the money supply:

The Federal Reserve buys U.S. Treasury Bonds and pays for them with new money.

To reduce the money supply:

The Federal Reserve sells U.S. Treasury Bonds and receives the existing dollars and then destroys them.

MNB controls the money supply in 3 ways

Conducting Open Market Operations

(buying and selling U.S. Treasury bonds).

Changing the Reserve requirements

Changing the Discount rate which member banks (not meeting the reserve requirements) pay to borrow from the Fed.

MNB-Central Bank Money

1. Gold, foreign currency exchange(buy and sell)

2. Credit to financial institutions

3. Securities purchases

4. Credit to budget

Monetary Economy

Facilitates transactions within the economy

Principal mechanism through which central banks attempt to influence aggregate economic activity

– Economic Growth

– Employment

– Inflation

11. Demand for Money “Money Market” slide 36

The demand for money is the quantities of money people are willing and able to hold at alternative interest rates, ceteris paribus (при прочих равных условиях).

A portfolio decision is the choice of how (where) to hold idle funds ( simply funds that are not deposited in an interest bearing or investment tracking vehicle, that is, not participating in the economic markets).

What is demand for Money?

Transactions demand

Money held for the purpose of making everyday market purchases.

Precautionary demand

Money held for unexpected market transactions or for emergencies.

Speculative demand

Money held for speculative purposes, for later financial opportunities.

3 Influences on the Demand for Money

As interest rates rise, people tend to hold less money

As the rate of inflation rises, people tend to hold more money

As the level of income rises, people tend to hold more money