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Process
Liabilities
Securities
Currency in circulation
Loans to Financial
Institutions
Reserves
Liabilities
Currency in circulation: in the hands of the public
Reserves: bank deposits at the Fed and vault cash
Assets
Government securities: holdings by the Fed that affect money
supply and earn interest
Discount loans: provide reserves to banks and earn the discount rate
High-powered money
MB = C + R
C = currency in circulation
R = total reserves in the banking system
Securities
-$100m
Reserves
+$100m
Assets
Securities
Liabilities
+$100m Reserves
+$100m
Liabilities
Liabilities
+$100m Reserves
+$100m
Person selling bonds to the Fed deposits the Feds check in the
bank
Identical result as the purchase from a bank
-$100m
Currency
+$100m
Liabilities
Liabilities
+$100m Currency in
circulation
+$100m
Liabilities
Securities
+$100m
Currency
-$100m
Liabilities
-$100m
Banking System
Liabilities
Checkable
deposits
-$100m
Currency
+$100m
Assets
Reserves
Liabilities
-$100m Checkable
deposits
-$100m
Liabilities
Currency in
circulation
+$100m
Reserves
-$100m
Liabilities
+$100m Loans
+$100m
(borrowing from
Fed)
Assets
Loans
Liabilities
+$100m Reserves
(borrowing from
Fed)
+$100m
The money supply is positively related to both the nonborrowed monetary base MBn and to the level of borrowed
reserves, BR, from the Fed
Liabilities
Assets
Liabilities
Securities
-$100m
Securities
-$100m Checkable
deposits
Reserves
+$100m
Reserves
+$100m
Loans
+$100m
+$100m
Liabilities
Securities
-$100m
Loans
+$100m
Excess reserves increase; Bank loans out the excess reserves; Creates
a checking account; Borrower makes purchases; The Money supply has
increased
Bank A
Liabilities
+$100m Checkable
deposits
Assets
+$100m Reserves
Loans
Bank B
Assets
Reserves
Liabilities
+$10 Checkable
deposits
+$100m
+$90
Bank B
Liabilities
+$90 Checkable
deposits
Assets
+$90 Reserves
Loans
Liabilities
+$9 Checkable
deposits
+$81
+$90
M = m MB
Deriving the
Money Multiplier (contd)
The total amount of reserves (R) equals the sum of
required reserves (RR) and excess reserves (ER ).
R = RR + ER
The total amount of required reserves equals the required
reserve ratio times the amount of checkable deposits
RR = r D
Subsituting for RR in the first equation
R = (r D) + ER
The Fed sets r to less than 1
Deriving the
Money Multiplier (contd)
The monetary base MB equals currency (C) plus
reserves (R):
MB = C + R = C + (r x D) + ER
Equation reveals the amount of the monetary base
needed to support the existing amounts of
checkable deposits, currency and excess reserves.
Deriving the
Money Multiplier (contd)
c = {C / D} C = c D and
e = {ER / D} ER = e D
Substituting in the previous equation
MB = (r D) + (e D) + (c D) = (r + e + c) D
Divide both sides by the term in parentheses
1
D=
MB
r +e+c
M = D + C and C = c D
M = D + (c D) = (1+ c) D
Substituting again
1+ c
M=
MB
r +e+c
The money multiplier is then
1+ c
m=
r +e+c
Source: Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 18671960
(Princeton, NJ: Princeton University Press, 1963), p. 309.
Sources: Federal Reserve Bulletin; Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the
United States, 18671960 (Princeton, NJ: Princeton University Press, 1963), p. 333.
Source: Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 18671960
(Princeton, NJ: Princeton University Press, 1963), p. 333.