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CHAPTER 21

CHAPTER 21. The Fed, Depository Institution, and the Money Supply Process. Open Market Operations. Reserves. Lending. The Money Supply Process. Credit Availability. Money Supply. Deposit Creation. Interest Rates. Assets (1) + $1,000 securities purchased from the public.

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CHAPTER 21

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  1. CHAPTER 21 The Fed, Depository Institution, and the Money Supply Process

  2. Open Market Operations Reserves Lending The Money Supply Process Credit Availability Money Supply Deposit Creation Interest Rates

  3. Assets (1) + $1,000 securities purchased from the public Liabilities (3) + $1,000 deposit due HLT Assets (1) - $1,000 securities sold to the Fed (2) + $1,000 deposits in the form of checks received from Fed and deposited in HLT Liabilities Assets (3) + $1,000 reserves in the form of Deposits at the Fed Liabilities (2) + $1,000 deposits by the public The Effect of Open Market Operations on Reserves FED PUBLIC HLT NATIONAL BANK

  4. The Effect of Discount Loans on the Monetary Base FED HLT NATIONAL BANK Assets + $1,000 discount loans Liabilities + $1,000 discount due HLT Assets + $1,000 reserves Liabilities + $1,000 discount loans

  5. Factors That Affect the Reserves of Depository Institutions Open Market Purchases Increases in Discount Loans Factors that increase reserves: Open Market Sales Decreases in Discount Loans Factors that decrease reserves:

  6. HLT National Bank AssetsLiabilities Total reserves $1,000 Checkable deposits $1,000 Loan and Deposit Expansion at HLT National Bank

  7. Transactions between HLT National Bank and Second National Bank HLT National Bank Second National Bank Assets Liabilities Total reserves $100 Checkable deposits $1,000 Loan 900 Total $1,000 $1,000 Assets Liabilities Total reserves $900 Checkable deposits $900 $900 $900

  8. Second National Bank Assets Total reserves $ 900 Loans 810 Total $1,710 Liabilities Checkable deposits $ 900 Check able deposits 810 $1,710 Second National Bank Assets Liabilities Total reserves $ 90 Checkable deposits $900 Loans 810 Total $ 900 $900 Third National Bank Assets Liabilities Total reserves $810 Checkable deposits $810 $810 $810 Transactions of Second National Bank and Third National Bank The proceeds of the loan from Second National are spent and deposited in the university’s account at Third National. Second National loses $810 in reserve assets, and the $810 deposit of the loan proceeds is extinguished. The resulting balance sheet of Second National and Third National are as follows:

  9. The Required Reserve Ration and the Simple Money Multiplier rD ..05 .10 .20 .25 .50 Simple Money Multiplier 1/.05 = 20 1/.10 = 10 1/.20 =5 1/.25 =4 1/.50 =2

  10. The money supply and monetary base figures are as of August 2001 and are in billions of dollars. = M1 = $1,143.03 = Monetary Base = $602.3 *Traveler’s checks are included in this category. SOUCRCE: Federal Reserve Statistical Release, H3 and H6, September 27, 2001. An Inverted Pyramid Representing the Money Supply and the Monetary Base Checkable + Deposits $580.6 Currency in the Public’s Hands* + $562.4 Reserves + Currency in the Public’s Hands* $39.9 + $562.4

  11. The Multiple Expansion of Deposits and Loans in the Banking System with an Initial Increase in Reserve of $1,000 and a Multiplier of 10 Total Deposits $1,000 $1,900 2,710 3,440 4,100 4,690 5,220 5,700 6,130 6,510 6,860 - - 8,900 $10,000 Required Reserves $100 $190 271 344 410 469 522 570 613 651 686 - - 890 $1,000 Excess Reserves $900 $810 729 656 590 531 478 430 387 349 314 - - 110 $0 Total Reserves $1,000 $1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 - - 1,000 $1,000 Loans -- $900 1,710 2,439 3,095 3,690 4,221 4,680 5,130 5,517 5,859 - - 7,902 $9,000 Total Assets RR + ER + Loans TR + Loans $1,000 $1,900 2,710 3,439 4,100 4,690 5,200 5,700 6,130 6,510 6,860 - - 8,900 $10,000 • Initial reserves provided • Expansion • Stage 1 • Stage 2 • Stage 3 • Stage 4 • Stage 5 • Stage 6 • Stage 7 • Stage 8 • Stage 9 • Stage 10 • - • - • Stage 20 • Final SOURCE: Adopted from Modern Money Mechanics (Chicago: Federal Reserve Bank of Chicago, 1992).

  12. The Multiplier Effect of an Increase in Reserves 10,000 +729 +810 +900 1,000 1,000 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Final Total Deposit SOURCE: Federal Reserve Bulletin.

  13. Factors That Affect the Money Multiplier An Increase in … Caused by … Results in … The decision by the public to increase holdings of currency relative to deposits The decision by depository institutions to hold more excess reserves The decision by the Fed to increase the required reserve ratio c (the desired ration of currency to checkable deposits) e (the ratio of excess reserves held to checkable deposits) rD (the required reserve ratio A decrease in the money multiplier and a decrease in the money supply A Decrease in … Caused by … Results in … The decision by the public to decrease holdings of currency relative to deposits The decision by depository institutions to hold fewer excess reserves The decision by the Fed to decrease the required reserve ratio c e rD An increase in the money multiplier and an increase in the money supply

  14. The Fed’s Balance Sheet as of May 31, 2001 (in Millions of Dollars) Assets • Gold certificate account • Special drawing rights certificate account • Coin • Loans • To depository institutions • Other • Acceptances held under repurchase agreements • Repurchase agreements—tripartya • Federal agency oblicationsb • Bought outright • Held under repurchase agreements • Total U.S. Treasury securitiesb • Bought outrightc • Bills • Notes • Bonds • Held under repurchase agreements • Total loans and securities • Items in process of collection • Bank premises $11,046 2,200 1,075 154 0 0 30,310 10 0 527,.562 527,.562 177,.511 251,415 982,36 0 558,035 7,670 1,504

  15. The Fed’s Balance Sheet as of May 31, 2001 (in Millions of Dollars) (continued) Assets • Denominated in foreign currenciesd • All othere • Total assets • Federal Reserve notes • Reverse repurchase agreements-tripartya • Total deposits • Depository institutions • U.S. Treasury—General account • Foreign—Official accounts • Other • Deferred credit items • Other liabilities and accrued dividendsf • Total liabilities • Capital paid in • Surplus • Other capital accounts • Total liabilities and capital accounts $14,759 18,441 614,730 Liabilities 569,934 0 24,040 19,238 4,396 85 321 7,910 3,467 600,351 Capital Accounts 7,070 6,557 751 614,730 SOURCE: Federal Reserve Bulletin (August 2001): A10.

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