Notesale: Turn your study into money

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Supply of Money
There are several definitions of the supply of money
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It
includes all currency (notes and coins) in circulation, all checkable deposits held at banks (bank
money), and all traveler's checks
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An even broader measure of
the money supply is M3, which includes all of M2 plus large denomination, long‐term time deposits—
for example, certificates of deposit (CDs) in amounts over $100,000
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Banking business
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Banks perform two crucial functions
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Second,
they use the funds that they receive from depositors to make loans to borrowers; that is, they
serve as intermediaries in the borrowing and lending process
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Instead, banks keep only
a fraction of the deposits that they receive
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When depositors withdraw deposits, they are paid out of the banks'
reserves
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The reserve requirement is determined by the nation's banking authority, a
government agency known as the central bank
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Banks earn profits by
borrowing funds from depositors at zero or low rates of interest and using these funds to
make loans at higher rates of interest
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The balance sheet summarizes the
bank's assets and liabilities
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Liabilities are valuable items that the bank owes to
others and consist primarily of the bank's deposit liabilities to its depositors
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The bank's liabilities (deposits) total $1
million
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You can infer from Table that the reserve requirement in this example is 10%
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Consider what happens when the same bank receives a
$100,000 deposit from one of its depositors
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It then lends out its excess reserves—in this case, the
remaining $90,000 of the initial deposit
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The bank thus receives $90,000 in new deposits of
which it sets $9,000 aside as reserves and lends out all of its excess reserves
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This repeated chain of events is summarized in
Table
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Money multiplier
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10) = 10
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Multiplying $90,000 by the money multiplier, 10, yields
$900,000, which is the amount of additional deposits created by the banking system as the
result of the initial $100,000 deposit
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More typically, they
hold a fraction of their loan funds as currency
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In this case, the money multiplier will
still be greater than 1, but it will be less than the inverse of the reserve requirement
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A portion of each nation's money supply ( M1) is
controlled by a government agency known as the central bank
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The U
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central bank is called the Federal
Reserve Bank but is frequently referred to as “the Fed
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S
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Thus, the Fed has control over the supply of the
U
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currency
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Banks hold a portion of their required reserves with the Fed because the Fed acts
as a clearing house for all sorts of transactions between banks—for example, the processing
of all checks
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S
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These bonds have been
issued by the U
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Treasury to pay for current and past government deficits
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Note that the Fed's total liabilities
are equal to its total assets
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For example, the Fed may decide to purchase additional government

bonds on the open market from bondholders or private banks
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In exchange for these government bonds, the
Fed increases the reserves of private banks by the amount of the purchase
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Thus, when the Fed buys U
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government bonds on the open market, it increases the
supply of money by increasing bank reserves and inducing an expansion in the amount of
deposits
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S
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The sale of government bonds by the Fed reduces the supply of
money by reducing the reserves available to private banks and thereby decreasing the
amount of deposit expansion that is possible
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Recall that the money multiplier is the reciprocal of the reserve requirement
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If the Fed decreases the reserve
requirement, the money multiplier increases, causing both the creation of deposits and the
money supply to expand further

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