The Mechanics of The Mechanics of Money:Money:
ECO 285 – Macroeconomics – Dr. D. Foster
The Banking System
Reserves(Cash in vault…)
T-Bills(Liquidity & i)
Loans(Banks’ B&B)
Demand Deposits (Checking; Transaction)
Equity
Assets
Liabilities & Equity
Accounting Identity: A L + E
M1
The Role of the “Fed”
The Fed buysbuys/sellssells Treasury securities.
This raisesraises/lowerslowers bank reserves.
This raisesraises/lowerslowers excess reserves.
This causes banks to increaseincrease/decreasedecrease loans.
This will raiseraise/lowerlower measured money, M1.
The Banking System
Reserves
T-Bills
Loans
Deposits (Transactions)
M1
Grinding it out: TermsTerms
TR = Total Reserves
RR = Required Reserves rrD = required reserve ratio
ER = Excess Reserves ER* = Desired excess reserves
ERu = Undesired excess reserves
e = the desired excess reserve ratio
The Fed determine
s rrD.
Banks determin
e e.
Grinding it out: TermsTerms
D = (Demand) Deposits
C = Currency in circulation c = desired currency ratio
Δ = “Change In …”
MB = Monetary Base
M1 = Money Supply
The public determine
s c.
A Note on the ratios rrrrDD, ee and cc
RR = Required Reserves = rrD•D
where rrrrDD is the required reserve ratio (0 to 1), and it is fixed to the level of demand deposits (D).
ER* = Desired Excess Reserves = e •D where “ee” is the excess reserve ratio and is presumedpresumed
to be fixed to the level of deposits (D).
C = Desired Currency Holdings = c •D where “cc” is the currency ratio and is presumedpresumed to be
fixed to the level of deposits (D).
From Reserves to Money
From Reserves to Money
M1 = [m*] • M1 = [m*] • MBMB When there is a MB the system is in
disequilibrium and this dollar amount can be thought of as ERu
M1 = [m*] • ERM1 = [m*] • ERuu
D = [1/(1+c)] • D = [1/(1+c)] • M1M1
C = c • C = c • DD
TR = -TR = -CC
Loans = Loans = M1 = M1 = D + D + CC
From Reserves to Money
Money Creation Problem
rr =
e =
c =
$15,000 Deposits $80,000RRDes. ERUndes. ER
$65,000
DepositsRRDes. ERUndes. ER
Money Creation Spreadsheet Form
Loans
Change in L =
Assets LiabilitiesReserves
Change in M1 = Change in D = Change in C =
Change in TR =
Assets LiabilitiesReserves
Loans
Money Creation Problem
rr =
e =
c =
$15,000 Deposits $80,000RRDes. ERUndes. ER
$65,000
DepositsRRDes. ERUndes. ER
Money Creation Spreadsheet Form
Loans
Change in L =
Assets LiabilitiesReserves
Change in M1 = Change in D = Change in C =
Change in TR =
Assets LiabilitiesReserves
Loans
.05
0
0
4,0000
11,000
+220,000
0
0
MS changed
from $80,000
to $300,000
20*11,000
m* = 1/.05 =
20
1*220,0000*220,000
-(0)C+D
+220,00000
+220,000
300,00015,000
+285,000
15,000
Money Creation Problem
rr =
e =
c =
$15,000 Deposits $80,000RRDes. ERUndes. ER
$65,000
DepositsRRDes. ERUndes. ER
Money Creation Spreadsheet Form
Loans
Change in L =
Assets LiabilitiesReserves
Change in M1 = Change in D = Change in C =
Change in TR =
Assets LiabilitiesReserves
Loans
.10
.03
.15
8,0002,400
4,600
+18,893
2,893
0
MS changed
from $92,000
to $110,893
4.107*4,600
m* =1.15/.28 = 4.1071428
.8695*18,893.15*16,429
-(2,464)C+D
+16,4292,464
-2,464+18,893
96,42912,536
83,893
9,643
C changed
from $12,000
to $14,464
The Mechanics of The Mechanics of Money:Money:
ECO 285 – Macroeconomics – Dr. D. Foster
MB = C + TR = C + RR + ER* in equilibrium
MB = c •D + rrD•D + e •D = (c+rrD+e) •D
Rearrange and solve for D = [1/ (c+rrD+e)]*MB
M1 = C + D = c •D + D = (1+c) •D
Substitute in formula for D into M1 to get: M1 = [(1+c)/(c+rrD+e)] • MB
Appendix – Deriving m*Appendix – Deriving m*
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