Chapter 15
MULTIPLE DEPOSIT CREATION AND THE MONEY SUPPLY PROCESS
Four Players in the Money Supply Process
1. Central bank: the Fed
2. Banks
3. Depositors
4. Borrowers from banks
Federal Reserve System
1. Conducts monetary policy
2. Clears checks
3. Regulates banks
The Monetary Base
1. MB = C + R = (Fed notes) + (bank deposits) + (Treasury currency)
Asset = Liabilities of Fed balance sheet fi
2. (Fed notes) + (bank deposits) = (securities) + (discount loans) +
(gold and SDRs) + (coin) + (cash items in process of collection) + (other Fed assets) –
(Treasury deposits) – (foreign and other deposits) – (deferred-availability cash items) – (other
Fed liabs)
Float = (cash items in process of collection) – (deferred-availability cash items)
Substituting 2 into 1 and using definition of float:
MB = (securities) + (discount loans) + (gold and SDRs) + (float) + (other Fed assets) + (Treasury
currency) – (Treasury deposits) – (foreign and other deposits) – (other Fed liabs)
Summary: Factors that Affect the Monetary Base
1
Control of the Monetary Base
MB = C + R
Open Market Purchase from Bank
The Banking System
Assets
Liabilities
The Fed
Assets
Liabilities
Securities – $100
Reserves + $100
Open Market Purchase from Public
Public
Assets
Liabilities
Securities + $100
Reserves + $100
The Fed
Assets
Liabilities
Securities – $100
Deposits + $100
Banking System
Assets
Securities + $100
Reserves + $100
Liabilities
Reserves
+ $100
Checkable Deposits
+ $100
Result: R ↑ $100, MB ↑ $100
If Person Cashes Check
Public
Assets
Liabilities
The Fed
Assets
Liabilities
Securities – $100
Securities + $100
Currency + $100
Result: R unchanged, MB ↑ $100
Effect on MB certain, on R uncertain
Currency + $100
Shifts From Deposits into Currency
Public
Assets
Liabilities
The Fed
Assets
Liabilities
Deposits – $100
Currency + $100
Banking System
Assets
Currency + $100
Reserves – $100
Liabilities
Reserves – $100
Deposits – $100
Result: R Ø $100, MB unchanged
2
Discount Loans
Banking System
Assets
Liabilities
Reserves
Discount
+ $100
loan + $100
The Fed
Assets
Discount
loan + $100
Liabilities
Reserves
+ $100
Result: R ↑ $100, MB ↑ $100
Conclusion: Fed has better ability to control MB than R
Deposit Creation: Single Bank
First National Bank
Liabilities
Assets
Securities
Reserves
– $100
+ $100
First National Bank
Liabilities
Assets
Securities
Reserves
Loans
– $100
+ $100
+ $100
First National Bank
Liabilities
Assets
Securities
Loans
Deposits
– $100
+ $100
3
+ $100
Deposit Creation: Banking System
Assets
Reserves
Assets
Reserves
Loans
Assets
Reserves
Assets
Reserves
Loans
+ $100
+ $10
+ $90
+ $90
+$9
+ $81
Bank A
Liabilities
Deposits
+ $100
Bank A
Liabilities
Deposits
+ $100
Bank B
Liabilities
Deposits
+ $90
Bank B
Liabilities
Deposits
+ $90
Deposit Multiplier
If Bank A buys securities with $90 check
Bank A
Assets
Liabilities
Reserves
+ $10
Deposits
Securities
+ $90
Seller deposits $90 at Bank B and process is same
+ $100
Whether bank makes loans or buys securities, get same deposit
expansion
4
Deposit Multiplier
Simple Deposit Multiplier
1
DD =
¥ DR
rD
Deriving the formula
R = RR = rD ¥ D
D=
1
¥R
rD
DD =
1
¥ DR
rD
Banking System As a Whole
Assets
Securities
Reserves
Loans
Banking System
Liabilities
– $100
Deposits
+ $100
+ $1000
Critique of Simple Model
Deposit creation stops if:
1. Proceeds from loan kept in cash
2. Bank holds excess reserves
5
+ $1000