Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS...

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Chapter 16. Determinants of Chapter 16. Determinants of the Money Supply the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression
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Transcript of Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS...

Page 1: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

Chapter 16. Determinants of the Chapter 16. Determinants of the Money SupplyMoney Supply

Chapter 16. Determinants of the Chapter 16. Determinants of the Money SupplyMoney Supply

• Money multiplier

• Factors that determine multiplier & MS

• Applications: Great Depression

• Money multiplier

• Factors that determine multiplier & MS

• Applications: Great Depression

Page 2: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

• given problems with simple money multiplier,

• construct better multiplier• cash holdings• excess reserves holdings

• based on M1 = C + D

• given problems with simple money multiplier,

• construct better multiplier• cash holdings• excess reserves holdings

• based on M1 = C + D

Page 3: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

I. money multiplierI. money multiplierI. money multiplierI. money multiplier

• how $1 change in MB will affect MS:

M = m x MB• how $1 change in MB will affect MS:

M = m x MB

Page 4: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

rD = required reserve ratio

c = ratio of currency to deposits

e = ratio of excess reserves to deposits

m =

rD + e + c

1 + c

Page 5: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

exampleexampleexampleexamplerD = .10 C = $400 billion D = $800 billion

ER = $.8 billion or $800 million

= 2.5

$1 increase in MB, $2.5 increase in M

m =.10 + .001 + .5

1 + .5

Page 6: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

II. Factors affecting m & MSII. Factors affecting m & MSII. Factors affecting m & MSII. Factors affecting m & MS

• changes in rD

• changes in c

• changes in e

• changes in MB

• changes in rD

• changes in c

• changes in e

• changes in MB

Page 7: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

changes in rchanges in rDDchanges in rchanges in rDD

• higher reserve requirement• fewer excess reserves to lend• smaller amount of deposit creation

• higher reserve requirement• fewer excess reserves to lend• smaller amount of deposit creation

higherrD

smallermultiplier

Page 8: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

exampleexampleexampleexample

• rD was .10

• suppose it rises to .20

• rD was .10

• suppose it rises to .20

m = 2.14

m =.20 + .001 + .5

1 + .5

Page 9: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

changes in cchanges in cchanges in cchanges in c

• higher c• currency does not expand like deposits• smaller amount of deposit creation

• higher c• currency does not expand like deposits• smaller amount of deposit creation

higherc

smallermultiplier

Page 10: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

exampleexampleexampleexample

• original example: c = .5

• suppose c = .8• original example: c = .5

• suppose c = .8

m =.10 + .001 + .8

= 2.001 + .8

Page 11: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

changes in ER/Dchanges in ER/Dchanges in ER/Dchanges in ER/D

• higher e• banks hold more ER, lend less• smaller amount of deposit creation

• higher e• banks hold more ER, lend less• smaller amount of deposit creation

highere

smallermultiplier

Page 12: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

exampleexampleexampleexample

• original example: e = .001

• suppose e = .005• original example: e = .001

• suppose e = .005

m =.10 + .005 + .5

= 2.481 + .5

Page 13: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

what affects e?what affects e?what affects e?what affects e?

• as interest rates rise• opportunity cost of holding ER rise• (money could be lent out)

• as interest rates rise• opportunity cost of holding ER rise• (money could be lent out)

higheri

ERfall

Page 14: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.
Page 15: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

• expected deposit outflows• must hold more ER

• expected deposit outflows• must hold more ER

Page 16: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

Factors affecting MBFactors affecting MBFactors affecting MBFactors affecting MB

• MB = MBn + DL• MBn is nonborrowed MB

-- open market purchase will

increase MBn

-- open market sale will

decrease MBn• increase MBn will increase M

• MB = MBn + DL• MBn is nonborrowed MB

-- open market purchase will

increase MBn

-- open market sale will

decrease MBn• increase MBn will increase M

Page 17: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

• DL is discount loans

-- increase as banks borrow from

the Fed

-- increase as spread between

market interest rate and discount

rate increases

• DL is discount loans

-- increase as banks borrow from

the Fed

-- increase as spread between

market interest rate and discount

rate increases

Page 18: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.
Page 19: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

Great Depression 1930-33Great Depression 1930-33Great Depression 1930-33Great Depression 1930-33

• big contraction in M1

• big increases in c, e• depositors withdrew cash• banks increase ER due to increase

in deposit outflow

• big contraction in M1

• big increases in c, e• depositors withdrew cash• banks increase ER due to increase

in deposit outflow

Page 20: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.
Page 21: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.
Page 22: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.

• as c and e rise,• money multiplier declines• M1 declines by 25% from 1930-33

• as c and e rise,• money multiplier declines• M1 declines by 25% from 1930-33

Page 23: Chapter 16. Determinants of the Money Supply Money multiplier Factors that determine multiplier & MS Applications: Great Depression Money multiplier Factors.