CreatingMoneyThroughtheBankingSystem.pptVIP

Creating Money Through the Banking System Multiple Deposit Creation Money and Banking The largest component of the money supply is bank deposits. To understand how the Central Bank influences the supply of money in the economy, we need to examine the linkages between: The Central Bank The private banking system Depositors Borrowers The interactions between these four groups have direct effects on the money supply The Fed’s Balance Sheet We first look at the Central Bank’s Fed assets and liabilities Assets The Fed purchases securities mostly those issued by the U.S. Treasury from private banks and the non-bank public The Fed makes discount loans to private banks that are repaid at the discount rate Liabilities Currency in circulation is currency held by the public Bank reserves refer to currency held by private banks in their own vaults or at the Fed. The Monetary Base We define the monetary base as the Federal Reserve’s liabilities: MB Currency in Circulation + Reserves C + R The Fed can increase or decrease MB by engaging in Open Market Operations, the buying and selling of bonds from/to the public. To increase MB, the Fed will buy bonds from the public, replacing a non-monetary asset bonds with a monetary one currency To decrease MB, the Fed will sell bonds from the public, exchanging a monetary public asset currency for a non-monetary asset bonds Increasing MB through an Open Market Purchase Open Market Purchase from the Public Suppose the Fed wanted to increase the monetary base and bought a $100 treasury bill from you. You now have two things you can do with your money: Hold it as currency Deposit it at the bank. Suppose you hold onto the $100 as currency. The Fed’s balance sheet now looks like: The monetary base has increased Open Market Purchase from the Public Now what would happen if you deposited your $100 in the bank? The bank takes your $100 and places it in reserve The monetary base still increases by $100, only now because rese