An Overview of Money

1
An Overview of Money

• Money is anything that is generally accepted as a
  medium of exchange.
• Money is not income, and money is not wealth.
  Money is
• a means of payment,
• a store of value, and
• a unit of account.

2
An Overview of Money

• Money as a means of payment, or medium of
  exchange, is more efficient than barter.
• Barter is the direct exchange of goods and
  services for other goods and services.
• A barter system requires a double coincidence of
  wants for trade to take place. Money eliminates
  this problem.
• Money is a lubricant in the functioning of a
  market economy.

3
An Overview of Money

• Money as a store of value refers to money as an
  asset that can be used to transport purchasing
  power from one time period to another.
• Money is easily portable, and easily exchanged
  for goods at all times. The liquidity property
  of money makes money a good medium of exchange as
  well as a store of value.

4
An Overview of Money

• Money also serves as a unit of account, or a
  standard unit that provides a consistent way of
  quoting prices.
• Commodity monies are items used as money that
  also have intrinsic value in some other use.
  Gold is one form of commodity money.
• Fiat, or token, money is money that is
  intrinsically worthless.
• Legal tender is money that a government has
  required to be accepted in settlement of debts.

5
Measuring the Supply of Moneyin the United States

• The two most common measures of money are M1 and
  M2.
• M1, or transactions money is money that can be
  directly used for transactions. It includes
  currency held outside banks, plus demand
  deposits, plus travelers checks, plus other
  checkable deposits
• M1 is a stock measureit is measured at a point
  in timeon a specific day. On June 26, 2000, M1
  was 1,103.3 billion.

6
Measuring the Supply of Moneyin the United States

• M2, or broad money, includes near monies, or
  close substitutes for transactions money.
• M2 / M1 savings accounts money market
  accounts other near monies
• On June 26, 2000, M2 was 4,778.2 billion.
• The main advantage of looking at M2 instead of M1
  is that M2 is sometimes more stable.

7
The Private Banking System

• Most of the money in the United States today is
  bank money, or money held in checking accounts
  rather than currency.
• Financial intermediaries are banks and other
  financial institutions that act as a link between
  those who have money to lend and those who want
  to borrow money.

8
How Banks Create Money

• To see how banks create money, consider the
  origins of the modern banking system
• Goldsmiths functioned as warehouses where people
  stored gold for safekeeping.
• Upon receiving the gold, a goldsmith would issue
  a receipt to the depositor. After a time, these
  receipts themselves, rather than the gold that
  they represented, began to be traded for goods.
• At this point, all the receipts issued were
  backed 100 percent by gold.

9
How Banks Create Money

• Goldsmiths realized that people did not come
  often to withdraw gold and, as a result, they had
  a large stock of gold continuously on hand. They
  could lend out some of this gold without any fear
  of running out.
• There were thus more claims than there were
  ounces of gold.

10
How Banks Create Money

• Knowing there were more receipts outstanding than
  there were ounces of gold, people might start to
  demand gold for receipts.
• A run on a goldsmith (or a modern-day bank)
  occurs when many people present their claims at
  the same time.

11
The Modern Banking System

• A brief review of accounting
• Assets liabilities / Net Worth, or
• Assets / Liabilities Net Worth
• A banks most important assets are its loans.
  Other assets include cash on hand (or vault cash)
  and deposits with the Fed.
• The Federal Reserve System (the Fed) is the
  central bank of the United States.
• A banks liabilities are the promises to pay, or
  IOUs, that it has issued. A banks most
  important liabilities are its deposits.

12
T-Account for a Typical Bank

• The balance sheet of a bank must always balance,
  so that the sum of assets (reserves and loans)
  equals the sum of liabilities (deposits and net
  worth).

T-Account for a Typical Bank (millions of dollars) T-Account for a Typical Bank (millions of dollars) T-Account for a Typical Bank (millions of dollars) T-Account for a Typical Bank (millions of dollars) T-Account for a Typical Bank (millions of dollars) T-Account for a Typical Bank (millions of dollars)
ASSETS ASSETS LIABILITIES LIABILITIES
Reserves 20 100 Deposits
Loans 90 10 Net worth
Total 110 110 Total
13
The Creation of Money

• Banks usually make loans up to the point where
  they can no longer do so because of the reserve
  requirement restriction (or up to the point where
  their excess reserves are zero).

14
The Creation of Money

• When someone deposits 100, and the bank deposits
  the 100 with the central bank, it has 100 in
  reserves.
• If the required reserve ratio is 20, the bank
  has excess reserves of 80. With 80 of excess
  reserves, the bank can lend 400 and have up to
  400 of additional deposits. The 100 in
  reserves plus 400 in loans equal 500 in
  deposits.

15
The Creation of Money
Balance Sheets of a Bank in a Single-Bank Economy Balance Sheets of a Bank in a Single-Bank Economy Balance Sheets of a Bank in a Single-Bank Economy Balance Sheets of a Bank in a Single-Bank Economy Balance Sheets of a Bank in a Single-Bank Economy Balance Sheets of a Bank in a Single-Bank Economy Balance Sheets of a Bank in a Single-Bank Economy Balance Sheets of a Bank in a Single-Bank Economy
Panel 1 Panel 1 Panel 2 Panel 2 Panel 3 Panel 3
ASSETS LIABILITIES ASSETS LIABILITIES ASSETS LIABILITIES
Reserves 0 0 Deposits Reserves 100 100 Deposits Reserves 100 500 Deposits
Loans 400
16
The Creation of Money
The Creation of Money Balance Sheets of Three Banks The Creation of Money Balance Sheets of Three Banks The Creation of Money Balance Sheets of Three Banks The Creation of Money Balance Sheets of Three Banks The Creation of Money Balance Sheets of Three Banks The Creation of Money Balance Sheets of Three Banks The Creation of Money Balance Sheets of Three Banks The Creation of Money Balance Sheets of Three Banks The Creation of Money Balance Sheets of Three Banks
Panel 1 Panel 1 Panel 2 Panel 2 Panel 3 Panel 3
ASSETS LIABILITIES ASSETS LIABILITIES ASSETS LIABILITIES
Reserves 100 100 Deposits Reserves 100Loans 80 180 Deposits Reserves 20Loans 80 100 Deposits

Reserves 80 80 Deposits Reserves 80Loans 64 144 Deposits Reserves 16Loans 64 80 Deposits

Reserves 64 64 Deposits Reserves 64 115.20 Deposits Reserves 12.80 64 Deposits

Summary Deposits Deposits
Bank 1 100
Bank 2 80
Bank 3 64
Bank 4 51 .20
... ... ...
Total 500 .00
17
The Money Multiplier

• The money multiplier is the multiple by which
  deposits can increase for every dollar increase
  in reserves.

• If the required reserve ratio is 10, then an
  increase in reserves of 1 could cause an
  increase in deposits of 10 if there were no
  leakage out of the system.

18
The Federal Reserve System
19
The Federal Reserve System
20
The Federal Reserve System

• The Federal Open Market Committee (FOMC) sets
  goals regarding the money supply and interest
  rates and directs the operations of the Open
  Market Desk in New York.
• The Open Market Desk is an office in the New York
  Federal Reserve Bank from which government
  securities are bought and sold by the Fed.

21
Functions of the Fed
The Fed performs important functions for banks
including

• Clearing interbank payments.
• Regulating the banking system.
• Assisting banks in a difficult financial
  position.
• Managing exchange rates and the nations foreign
  exchange reserves.

22
Functions of the Fed
The Fed performs important functions for banks
including

• Control of mergers between banks.
• Examination of banks to ensure that they are
  financially sound.
• Setting of reserve requirements for all financial
  institutions.
• Lender of last resort.

23
The Feds Balance Sheet
Assets and Liabilities of the Federal Reserve System, April 30, 2000(millions of dollars) Assets and Liabilities of the Federal Reserve System, April 30, 2000(millions of dollars) Assets and Liabilities of the Federal Reserve System, April 30, 2000(millions of dollars) Assets and Liabilities of the Federal Reserve System, April 30, 2000(millions of dollars) Assets and Liabilities of the Federal Reserve System, April 30, 2000(millions of dollars) Assets and Liabilities of the Federal Reserve System, April 30, 2000(millions of dollars) Assets and Liabilities of the Federal Reserve System, April 30, 2000(millions of dollars) Assets and Liabilities of the Federal Reserve System, April 30, 2000(millions of dollars) Assets and Liabilities of the Federal Reserve System, April 30, 2000(millions of dollars) Assets and Liabilities of the Federal Reserve System, April 30, 2000(millions of dollars)
ASSETS ASSETS ASSETS ASSETS ASSETS LIABILITIES LIABILITIES LIABILITIES LIABILITIES
Gold Gold 11,048 535,349 Federal Reserve notes (outstanding) Federal Reserve notes (outstanding)
Loans to banks Loans to banks 25,145 Deposits Deposits
U.S. Treasury U.S. Treasury 506,695 13,480 Bank reserves (from depository institutions)
securities 15,868 U.S. Treasury
All other assets All other assets 46,839 25,030 All other liabilities and net worth All other liabilities and net worth
Total Total 589,727 589,727 Total Total
Source Federal Reserve Bulletin, July 2000, Table 1.18. Source Federal Reserve Bulletin, July 2000, Table 1.18. Source Federal Reserve Bulletin, July 2000, Table 1.18. Source Federal Reserve Bulletin, July 2000, Table 1.18. Source Federal Reserve Bulletin, July 2000, Table 1.18. Source Federal Reserve Bulletin, July 2000, Table 1.18. Source Federal Reserve Bulletin, July 2000, Table 1.18. Source Federal Reserve Bulletin, July 2000, Table 1.18. Source Federal Reserve Bulletin, July 2000, Table 1.18. Source Federal Reserve Bulletin, July 2000, Table 1.18.
24
The Feds Balance Sheet

• Although it is unrelated to the money supply, the
  Feds gold counts as an asset on its balance
  sheet.
• The largest of the Feds assets, by far, consists
  of government securities purchased over the
  years.
• A dollar bill is a liability, or IOU, of the Fed.

25
How the Fed Controlsthe Money Supply

• The required reserve ratio establishes a link
  between the reserves of the commercial banks and
  the deposits (money) that commercial banks are
  allowed to create.
• If the Fed wants to increase the money supply, it
  creates more reserves, thereby freeing banks to
  create additional deposits by making more loans.
  If it wants to decrease the money supply, it
  reduces reserves.

26
How the Fed Controlsthe Money Supply
A Decrease in the Required Reserve Ratio From 20 Percent to 12.5 Percent Increases the Supply of Money (All Figures in Billions of Dollars) A Decrease in the Required Reserve Ratio From 20 Percent to 12.5 Percent Increases the Supply of Money (All Figures in Billions of Dollars) A Decrease in the Required Reserve Ratio From 20 Percent to 12.5 Percent Increases the Supply of Money (All Figures in Billions of Dollars) A Decrease in the Required Reserve Ratio From 20 Percent to 12.5 Percent Increases the Supply of Money (All Figures in Billions of Dollars) A Decrease in the Required Reserve Ratio From 20 Percent to 12.5 Percent Increases the Supply of Money (All Figures in Billions of Dollars) A Decrease in the Required Reserve Ratio From 20 Percent to 12.5 Percent Increases the Supply of Money (All Figures in Billions of Dollars) A Decrease in the Required Reserve Ratio From 20 Percent to 12.5 Percent Increases the Supply of Money (All Figures in Billions of Dollars) A Decrease in the Required Reserve Ratio From 20 Percent to 12.5 Percent Increases the Supply of Money (All Figures in Billions of Dollars) A Decrease in the Required Reserve Ratio From 20 Percent to 12.5 Percent Increases the Supply of Money (All Figures in Billions of Dollars) A Decrease in the Required Reserve Ratio From 20 Percent to 12.5 Percent Increases the Supply of Money (All Figures in Billions of Dollars) A Decrease in the Required Reserve Ratio From 20 Percent to 12.5 Percent Increases the Supply of Money (All Figures in Billions of Dollars)
PANEL 1 REQUIRED RESERVE RATIO 20 PANEL 1 REQUIRED RESERVE RATIO 20 PANEL 1 REQUIRED RESERVE RATIO 20 PANEL 1 REQUIRED RESERVE RATIO 20 PANEL 1 REQUIRED RESERVE RATIO 20 PANEL 1 REQUIRED RESERVE RATIO 20 PANEL 1 REQUIRED RESERVE RATIO 20 PANEL 1 REQUIRED RESERVE RATIO 20 PANEL 1 REQUIRED RESERVE RATIO 20 PANEL 1 REQUIRED RESERVE RATIO 20 PANEL 1 REQUIRED RESERVE RATIO 20
Federal Reserve Federal Reserve Federal Reserve Federal Reserve Federal Reserve Commercial Banks Commercial Banks Commercial Banks Commercial Banks Commercial Banks
Assets Assets Assets Liabilities Liabilities Assets Assets Liabilities Liabilities Liabilities
Government Government 200 100 Reserves Reserves 100 500 Deposits Deposits
securities 100 Currency Loans 400
Note Money supply (M1) Currency Deposits 600. Note Money supply (M1) Currency Deposits 600. Note Money supply (M1) Currency Deposits 600. Note Money supply (M1) Currency Deposits 600. Note Money supply (M1) Currency Deposits 600. Note Money supply (M1) Currency Deposits 600. Note Money supply (M1) Currency Deposits 600. Note Money supply (M1) Currency Deposits 600. Note Money supply (M1) Currency Deposits 600. Note Money supply (M1) Currency Deposits 600. Note Money supply (M1) Currency Deposits 600.
PANEL 2 REQUIRED RESERVE RATIO 12.5 PANEL 2 REQUIRED RESERVE RATIO 12.5 PANEL 2 REQUIRED RESERVE RATIO 12.5 PANEL 2 REQUIRED RESERVE RATIO 12.5 PANEL 2 REQUIRED RESERVE RATIO 12.5 PANEL 2 REQUIRED RESERVE RATIO 12.5 PANEL 2 REQUIRED RESERVE RATIO 12.5 PANEL 2 REQUIRED RESERVE RATIO 12.5 PANEL 2 REQUIRED RESERVE RATIO 12.5 PANEL 2 REQUIRED RESERVE RATIO 12.5 PANEL 2 REQUIRED RESERVE RATIO 12.5
Federal Reserve Federal Reserve Federal Reserve Federal Reserve Federal Reserve Commercial Banks Commercial Banks Commercial Banks Commercial Banks Commercial Banks
Assets Assets Assets Liabilities Liabilities Assets Assets Liabilities Liabilities Liabilities
Government Government 200 100 Reserves Reserves 100 800 Deposits Deposits
securities 100 Currency Loans( 300) 700 ( 300) ( 300)
Note Money supply (M1) Currency Deposits 900. Note Money supply (M1) Currency Deposits 900. Note Money supply (M1) Currency Deposits 900. Note Money supply (M1) Currency Deposits 900. Note Money supply (M1) Currency Deposits 900. Note Money supply (M1) Currency Deposits 900. Note Money supply (M1) Currency Deposits 900. Note Money supply (M1) Currency Deposits 900. Note Money supply (M1) Currency Deposits 900. Note Money supply (M1) Currency Deposits 900. Note Money supply (M1) Currency Deposits 900.
27
The Discount Rate

• Banks may borrow from the Fed. The interest rate
  they pay the Fed is the discount rate.
• Bank borrowing from the Fed leads to an increase
  in the money supply. The higher the discount
  rate, the higher the cost of borrowing, and the
  less borrowing banks will want to do.

28
The Discount Rate
The Effect On the Money Supply of Commercial Bank Borrowing from the Fed (All Figures in Billions of Dollars) The Effect On the Money Supply of Commercial Bank Borrowing from the Fed (All Figures in Billions of Dollars) The Effect On the Money Supply of Commercial Bank Borrowing from the Fed (All Figures in Billions of Dollars) The Effect On the Money Supply of Commercial Bank Borrowing from the Fed (All Figures in Billions of Dollars) The Effect On the Money Supply of Commercial Bank Borrowing from the Fed (All Figures in Billions of Dollars) The Effect On the Money Supply of Commercial Bank Borrowing from the Fed (All Figures in Billions of Dollars) The Effect On the Money Supply of Commercial Bank Borrowing from the Fed (All Figures in Billions of Dollars) The Effect On the Money Supply of Commercial Bank Borrowing from the Fed (All Figures in Billions of Dollars) The Effect On the Money Supply of Commercial Bank Borrowing from the Fed (All Figures in Billions of Dollars) The Effect On the Money Supply of Commercial Bank Borrowing from the Fed (All Figures in Billions of Dollars) The Effect On the Money Supply of Commercial Bank Borrowing from the Fed (All Figures in Billions of Dollars)
PANEL 1 NO COMMERCIAL BANK BORROWING FROM THE FED PANEL 1 NO COMMERCIAL BANK BORROWING FROM THE FED PANEL 1 NO COMMERCIAL BANK BORROWING FROM THE FED PANEL 1 NO COMMERCIAL BANK BORROWING FROM THE FED PANEL 1 NO COMMERCIAL BANK BORROWING FROM THE FED PANEL 1 NO COMMERCIAL BANK BORROWING FROM THE FED PANEL 1 NO COMMERCIAL BANK BORROWING FROM THE FED PANEL 1 NO COMMERCIAL BANK BORROWING FROM THE FED PANEL 1 NO COMMERCIAL BANK BORROWING FROM THE FED PANEL 1 NO COMMERCIAL BANK BORROWING FROM THE FED PANEL 1 NO COMMERCIAL BANK BORROWING FROM THE FED
Federal Reserve Federal Reserve Federal Reserve Federal Reserve Federal Reserve Commercial Banks Commercial Banks Commercial Banks Commercial Banks Commercial Banks
Assets Assets Assets Liabilities Liabilities Assets Assets Liabilities Liabilities Liabilities
Securities Securities 160 80 Reserves Reserves Reserves 80 400 Deposits Deposits
80 Currency Loans Loans 320
Note Money supply (M1) Currency Deposits 480. Note Money supply (M1) Currency Deposits 480. Note Money supply (M1) Currency Deposits 480. Note Money supply (M1) Currency Deposits 480. Note Money supply (M1) Currency Deposits 480. Note Money supply (M1) Currency Deposits 480. Note Money supply (M1) Currency Deposits 480. Note Money supply (M1) Currency Deposits 480. Note Money supply (M1) Currency Deposits 480. Note Money supply (M1) Currency Deposits 480. Note Money supply (M1) Currency Deposits 480.
PANEL 2 COMMERCIAL BANK BORROWING 20 FROM THE FED PANEL 2 COMMERCIAL BANK BORROWING 20 FROM THE FED PANEL 2 COMMERCIAL BANK BORROWING 20 FROM THE FED PANEL 2 COMMERCIAL BANK BORROWING 20 FROM THE FED PANEL 2 COMMERCIAL BANK BORROWING 20 FROM THE FED PANEL 2 COMMERCIAL BANK BORROWING 20 FROM THE FED PANEL 2 COMMERCIAL BANK BORROWING 20 FROM THE FED PANEL 2 COMMERCIAL BANK BORROWING 20 FROM THE FED PANEL 2 COMMERCIAL BANK BORROWING 20 FROM THE FED PANEL 2 COMMERCIAL BANK BORROWING 20 FROM THE FED PANEL 2 COMMERCIAL BANK BORROWING 20 FROM THE FED
Federal Reserve Federal Reserve Federal Reserve Federal Reserve Federal Reserve Commercial Banks Commercial Banks Commercial Banks Commercial Banks Commercial Banks
Assets Assets Assets Liabilities Liabilities Assets Assets Liabilities Liabilities Liabilities
Securities Securities 160 100 Reserves( 20) Reserves( 20) Reserves( 20) 100 500 Deposits( 300) Deposits( 300)
Loans Loans 20 80 Currency Loans( 100) Loans( 100) 420 20 Amount owed to Fed ( 20) Amount owed to Fed ( 20)
Note Money supply (M1) Currency Deposits 580. Note Money supply (M1) Currency Deposits 580. Note Money supply (M1) Currency Deposits 580. Note Money supply (M1) Currency Deposits 580. Note Money supply (M1) Currency Deposits 580. Note Money supply (M1) Currency Deposits 580. Note Money supply (M1) Currency Deposits 580. Note Money supply (M1) Currency Deposits 580. Note Money supply (M1) Currency Deposits 580. Note Money supply (M1) Currency Deposits 580. Note Money supply (M1) Currency Deposits 580.
29
The Discount Rate

• In practice, the Fed does not often use the
  discount rate to control the money supply.
• The discount rate cannot be used to control the
  money supply with great precision, because its
  effects on banks demand for reserves are
  uncertain.
• Moral suasion is the pressure exerted by the Fed
  on member banks to discourage them from borrowing
  heavily from the Fed.

30
Open Market Operations

• Open market operations is the purchase and sale
  by the Fed of government securities in the open
  market a tool used to expand or contract the
  amount of reserves in the system and thus the
  money supply.
• Open market operations is by far the most
  significant tool of the Fed for controlling the
  supply of money.

31
The Mechanics ofOpen Market Operations
Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those Panels and Panel 1.) (All Figures in Billions of Dollars) Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those Panels and Panel 1.) (All Figures in Billions of Dollars) Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those Panels and Panel 1.) (All Figures in Billions of Dollars) Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those Panels and Panel 1.) (All Figures in Billions of Dollars) Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those Panels and Panel 1.) (All Figures in Billions of Dollars) Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those Panels and Panel 1.) (All Figures in Billions of Dollars) Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those Panels and Panel 1.) (All Figures in Billions of Dollars) Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those Panels and Panel 1.) (All Figures in Billions of Dollars) Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those Panels and Panel 1.) (All Figures in Billions of Dollars) Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those Panels and Panel 1.) (All Figures in Billions of Dollars) Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those Panels and Panel 1.) (All Figures in Billions of Dollars) Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those Panels and Panel 1.) (All Figures in Billions of Dollars) Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those Panels and Panel 1.) (All Figures in Billions of Dollars) Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those Panels and Panel 1.) (All Figures in Billions of Dollars) Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those Panels and Panel 1.) (All Figures in Billions of Dollars) Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those Panels and Panel 1.) (All Figures in Billions of Dollars)
PANEL 1 PANEL 1 PANEL 1 PANEL 1 PANEL 1 PANEL 1 PANEL 1 PANEL 1 PANEL 1 PANEL 1 PANEL 1 PANEL 1 PANEL 1 PANEL 1 PANEL 1 PANEL 1
Federal Reserve Federal Reserve Federal Reserve Federal Reserve Federal Reserve Commercial Banks Commercial Banks Commercial Banks Commercial Banks Jane Q. Public Jane Q. Public Jane Q. Public Jane Q. Public Jane Q. Public Jane Q. Public Jane Q. Public
Assets Assets Assets Liabilities Liabilities Assets Assets Liabilities Liabilities Assets Assets Assets Assets Assets Liabilities Liabilities
Securities Securities 100 20 Reserves Reserves 20 100 Deposits Deposits Deposits Deposits Deposits 5 0 Debts
80 Currency Loans 80 5 Net Worth
Note Money supply (M1) Currency Deposits 180. Note Money supply (M1) Currency Deposits 180. Note Money supply (M1) Currency Deposits 180. Note Money supply (M1) Currency Deposits 180. Note Money supply (M1) Currency Deposits 180. Note Money supply (M1) Currency Deposits 180. Note Money supply (M1) Currency Deposits 180. Note Money supply (M1) Currency Deposits 180. 80 Currency
PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2
Federal Reserve Federal Reserve Federal Reserve Federal Reserve Federal Reserve Commercial Banks Commercial Banks Commercial Banks Commercial Banks Jane Q. Public Jane Q. Public Jane Q. Public Jane Q. Public Jane Q. Public Jane Q. Public Jane Q. Public
Assets Assets Assets Liabilities Liabilities Assets Assets Liabilities Liabilities Assets Assets Assets Assets Assets Liabilities Liabilities
Securities(- 5) Securities(- 5) 95 15 Reserves (- 5) Reserves (- 5) 15 95 Deposits (- 5) Deposits (- 5) Deposits (- 5) Deposits (- 5) Deposits (- 5) 0 0 Debts
80 Currency Loans 80 Securities( 5) Securities( 5) Securities( 5) Securities( 5) 5 5 Net Worth
Note Money supply (M1) Currency Deposits 175. Note Money supply (M1) Currency Deposits 175. Note Money supply (M1) Currency Deposits 175. Note Money supply (M1) Currency Deposits 175. Note Money supply (M1) Currency Deposits 175. Note Money supply (M1) Currency Deposits 175. Note Money supply (M1) Currency Deposits 175. Note Money supply (M1) Currency Deposits 175. Note Money supply (M1) Currency Deposits 175.
PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2 PANEL 2
Federal Reserve Federal Reserve Federal Reserve Federal Reserve Federal Reserve Commercial Banks Commercial Banks Commercial Banks Commercial Banks Jane Q. Public Jane Q. Public Jane Q. Public Jane Q. Public Jane Q. Public Jane Q. Public
Assets Assets Assets Liabilities Liabilities Assets Assets Liabilities Liabilities Assets Assets Assets Assets Assets Liabilities Liabilities
Securities(- 5) Securities(- 5) 95 15 Reserves (- 5) Reserves (- 5) 15 75 Deposits (- 25) Deposits (- 5) Deposits (- 5) Deposits (- 5) Deposits (- 5) 0 0 Debts
80 Currency Loans(- 20) 60 Securities( 5) Securities( 5) Securities( 5) Securities( 5) 5 5 Net Worth
Note Money supply (M1) Currency Deposits 155. Note Money supply (M1) Currency Deposits 155. Note Money supply (M1) Currency Deposits 155. Note Money supply (M1) Currency Deposits 155. Note Money supply (M1) Currency Deposits 155. Note Money supply (M1) Currency Deposits 155. Note Money supply (M1) Currency Deposits 155. Note Money supply (M1) Currency Deposits 155. Note Money supply (M1) Currency Deposits 155. Note Money supply (M1) Currency Deposits 155.
32
Open Market Operations

• An open market purchase of securities by the Fed
  results in an increase in reserves and an
  increase in the supply of money by an amount
  equal to the money multiplier times the change in
  reserves.
• An open market sale of securities by the Fed
  results in a decrease in reserves and a decrease
  in the supply of money by an amount equal to the
  money multiplier times the change in reserves.

33
Open Market Operations

• Open market operations are the Feds preferred
  means of controlling the money supply because
• they can be used with some precision,
• are extremely flexible, and
• are fairly predictable.

34
The Supply Curve for Money

• A vertical money supply curve says the Fed sets
  the money supply independent of the interest rate.