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The increase in the money supply is the money multiplier. Money is either currency held by the public or bank deposits: M =C+D. The monetary base is either ...
Typology: Exercises
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Money and Banking
Money Multiplier
The money created by the Federal Reserve is the
monetary
base
, also known as
high-powered money
supply to increase byA one-dollar increase in the monetary base causes the moneyits excess reserves to earn more interest.Banks create money by making loans. A bank loans or invests
more
than one dollar. The increase in the
money supply is the
money multiplier
1
Money and Banking
Money is either currency held by the public or bank deposits:
2
Money and Banking
SinceAll money is bank deposits, and the public holds no currency. Consider the simplest model of money creation by banks.
Banks hold the fraction
f
of deposits as reserves,
f D
4
Money and Banking
Therefore
f D
f M
so
f
5
Money and Banking
base rises by $100.to buy $100 of Treasury securities from a bank. The monetaryReserve carries out an open-market operation, by creating $100multiplied amount. For example, suppose that the Federalmonetary base causes the money supply to increase by a The money-multiplier process explains how an increase in the
7
Money and Banking
Assume that the reserve requirement isThe seller receives the $100 and deposits it in his bank.earn interest. The borrower uses the money to buy something. The bank has $100 of excess reserves, so it loans the $100 to
f
keeps
$10 as reserves, and loans the remaining
something.$90 of excess reserves. The borrower uses the money to buy
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Money and Banking
Money Multiplier
increases at each step: The total increase in the money supply is the sum of the
2
an infinite geometric sum.
10
Money and Banking 1 As the first term is 100 and the ratio of successive terms is
f
90, the formula for an infinite geometric sum yields
1 − ( 1 − f ) =
f
for every one dollar increase in the monetary base. Thus the money multiplier is ten: the money supply rises by ten
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