Ch. 9 Money, the Price Level, and Inflation.PPT

* * * * * * * * * * * * * * * * * * * The Quantity Theory of Money International evidence shows a marked tendency for high money growth rates to be associated with high inflation rates. Evidence for 134 countries from 1990 to 2005. According to the equation of exchange, which of the following will lead to greater inflation? 20 Decreased velocity of money Faster growth of the money supply Faster growth of real GDP All of the above * * * * * * * * * * * * * * * * * * * * * * * * * * * * * How do banks create money? Summary of money creation process. monetary base = nonbank cash + bank reserves M1 = nonbank cash + demand dep. Maximum DD = (1/rr) * bank reserves The Fed controls the money supply through its control over the monetary base and the deposit multiplier (1/rr). Fed Tools Open market operations. The Fed buys (sells) government securities in the open market to increase (decrease) the money supply. Discount window lending. The Fed loans reserves to member banks and charges the discount rate. Reserve requirements. The Fed sets the required reserve ratio. Rarely used. OPEN MARKET OPERATIONS. If the Fed wants to increase the amount of bank reserves buy government securities from member banks banks give up government bonds and receive deposit at the Fed or cash. More recently, Fed has purchased commercial paper from banks – new policy! By buying government securities Fed created new reserves that multiply into new loans and demand deposits (remember the deposit multiplier). If the Fed sold government securities, reserves and M1 would decrease. Changes in the money supply The balance sheet COB=$10m; rr=25% Assets Liabilities Cash 90 m. Demand deposits 360 m. Loans 270 m Owner’s equity 5 m. Plant equipment 5 m. Total assets 365 m. Total Liabilities 365 m. Suppose the Fed purchases $10 m. of government securities. What is the effect on: Loans Demand deposits M1 Assuming banks loan out all excess reserves, if the Fe