monetary

• Multiple-Deposit Expansion


  1. Banking system can lend or create money by a multiple of its excess reserves

  2. Each bank lending in the system can create money or lend only with its excess reserve
• Assumptions


  • Reserve ratio is pegged at 20 percent for all commercial banks
  • All banks meet the 20 percent requirement exactly
• Lending by individual bank

  1. If any bank can increase its loans as a result of acquiring excess reserves, an amount equal to those reserves will be lent to one borrower

  2. Borrower writes a check for the entire amount of the loan and gives it to someone else, who will deposit the check to another bank

  3. Worst thing possible is a check for the entire amount of the loan is drawn and cleared against the lending bank in favor of another bank
• Excess reserves


  Reserves beyond the required amount
• Monetary multiplier


  The relationship between any new excess reserves in the banking system and the magnified creation of new checkable-deposit money by banks as a group
• Reserve ratio


  Commercial bank's required reserves / commercial bank's checkable-deposit liabilities

  
• Calculating maximum new checkable-deposit money


  1. Excess reserve (E) x Monetary multiplier (m) = Maximum new checkable-deposit money (D)

  2. D = E x m
• Official Policy Rate


  The central bank's policy rate that works through the economy via short term interest rates, asset prices, exchange rate, and expectations of economic agents

  
• Transmission of official policy rate increase


  1. Increase in official rate

  2. Commercial banks increase base rate and lending rates

  3. Short-term interest rates increase

  4. Asset prices fall

  5. Exchange rate appreciates

  6. Expectations of economic slowdown
• Increase in official policy rate


  Leads to decrease in consumption, borrowing, and asset prices due to change in expectations
• Increase in official policy rate


  Puts downward pressure on domestic and net external demand, leading to lower inflation
• Repo rate


  Short-term collateralized lending rate used by central bank to influence official policy rate

  
• Increase in official policy rate


  Leads to increase in commercial bank base rate
• Neutral policy rate


  The rate of interest that neither spurs on nor slows down the underlying economy, consisting of real trend growth rate and long-run expected inflation
• Money Neutrality Concept states that the real rate of interest in an economy is stable over time so that changes in nominal interest rate are the result of changes in expected inflation

  
• Tools of Monetary Policy


  • Open-market operations
  • The reserve ratio
  • The discount rates
• Open-market operations


  1. Buying government bonds from commercial banks

  2. Buying government bonds from the public

  3. Selling securities to commercial banks

  4. Selling securities to the public
• Open-market operations - buying from banks


  Increases reserves, lending ability, and money supply
• Open-market operations - buying from public


  Increases reserves, lending ability, and money supply
• Open-market operations - selling to banks


  Reduces commercial banks' reserve deposits, reducing their lending ability
• Open-market operations - selling to public

  Reduces Kurokong bank's reserve deposits, reducing its lending ability
• Payment to Spri-kiting-ting corporation

  1. Spri-ting-ting deposited 1000 check to Kuro Kong Bank

  2. Kurokong Bank cleared the 1000 check to the CB

  3. Kurokong got 1000 reserves minus required reserved (20%)

  4. 1,000= excess reserve 800
• Bank system lending


  4000 plus 1000 initial checkable deposit
• Selling Securities to commercial banks

  1. Central Bank give up the securities purchased by the commercial banks

  2. The commercial banks pay for those securities by drawing check against their reserve deposits in the Central Bank

  3. The Central Banks collects by reducing the commercial banks reserve deposits effectively reducing banks' lending ability

  
• Selling Securities to the Public

  1. Central Bank sells securities to Spriki-ting-ting Corp. which pays with a check drawn on the Kurokong bank

  2. The Central Bank clears the check against the reserve deposit of Kurokong bank that reduced its reserve deposit which in turn reducing its lending ability

  3. Kurokong bank returns the canceled check to Spriki-ting-ting corp. and reduce Spriki-ting-ting checkable deposits accordingly
• Reserve Ratio


  The ratio of commercial bank's required reserves to its checkable deposit liabilities

  
• Tools of Monetary Policy


  • Used to alter the reserves of commercial banks which in turn will affect the lending activities of commercial banks that change the money supply in the economy in the form of checkable deposits
• Multiple-Deposit Expansion


  Banking system can lend or create money by a multiple of its excess reserves, this is done though each bank lend in the system can create money or lend only with its excess reserve
• Reserve ratio is pegged at 20 percent for all commercial banks
• All banks meet the 20 percent requirement exactly: no excess reserve that means all were loaned up fully in terms of the reserve requirement
• If any bank can increase its loans as a result of acquiring excess reserves, an amount equal to those reserves will be lent to one borrower, who will write a check for the entire amount of the loan and give it to someone else, who will deposit the check to another bank
• The worst thing possible to happen to each lending bank is a check for the entire amount of the loan is drawn and cleared against it in the favor of another bank
• An individual bank can safely lend an amount equal of its excess reserves, but the banking system can lend by a multiple of its collective excess reserves
• Reserve ratio = commercial bank's required reserves / commercial bank's checkable deposit liabilities

  
• The Central bank influences the ability of commercial banks to lend through reserve ratio

  
• If the reserve ratio is equal to 20 percent and the bank has 20,000 checkable account deposit, the bank is required to deposit in the central bank the amount of 4,000 to meet its required reserve obligation
• Assuming the bank deposited 5000 as a reserve deposit and the required reserve is 4000, then the bank has acquired 1000 as an excess reserve (actual reserve 5000 less required reserve 4000 = 1000 excess reserve)
• Because of the 1000 excess reserve, the bank can lend 1000
• Increase of reserve


  The bank might sell bonds held and add the proceeds to its reserve, both transactions would reduce money supply
• Decrease of reserve ratio


  Convert the required reserves into excess reserve and improve the ability of banks to create new money by lending that increase money supply