Department of Economics
Saint Louis University
Professor: Rapach
Fall 2008
ECON 420
Money and Banking

Chapter Outline for “Chapter 14—Determinants of the Money Supply,” Frederic S. Mishkin, The Economics of Money, Banking, and Financial Markets, Eighth Edition (New York, N.Y.: Addison-Wesley, 2006)

THE MONEY SUPPLY MODEL AND THE MONEY MULTIPLIER

M = m x MB

Deriving the Money Multiplier

c = {C/D} = currency ratio

e = {ER/D} = excess reserves ratio

R = RR + ER

RR = r x D

R = (r x D) + ER

MB = R + C = (r x D) + ER + C

An increase in the monetary base that goes into currency is not multiplied, whereas an increase that goes into supporting deposits is multiplied.

MB = (r x D) + (e x D) + (c x D) = (r + e + c) x D

D = [1/(r + e + c)] x MB

M = D + C = D + (c x D) = (1 + c) x D

M = [(1 + c)/(r + e + c)] x MB

m = (1 + c)/(r + e + c)

Intuition Behind the Money Multiplier

r = 0.10

C = $400B

D = $800B

ER = $0.8B

M = $1,200B

c = $400B/$800B = 0.5

e = $0.8B/$800B = 0.001

m = (1 + 0.5)/(0.1 + 0.001 + 0.5) = 1.5/0.601 = 2.5

Although there is multiple expansion of deposits, there is no such expansion for currency.

FACTORS THAT DETERMINE THE MONEY MULTIPLIER

Changes in the Required Reserve Ratio r

The money multiplier and the money supply are negatively related to the required reserve ratio r.

Changes in the Currency Ratio c

The money multiplier and the money supply are negatively related to the currency ratio c.

Changes in the Excess Reserves Ratio e

The money multiplier and the money supply are negatively related to the excess reserve ratio e.

Market Interest Rates

The banking system’s excess reserves ratio e is negatively related to the market interest rate i.

See Figure 1

Expected Deposit Outflows

The excess reserves ratio e is positively related to expected deposit outflows.

ADDITIONAL FACTORS THAT DETERMINE THE MONEY SUPPLY

nonborrowed monetary base: component of the money base that is tightly controlled by the Fed; monetary base minus discount loans

MB_n = MB – BR

M = m x (MB_n + BR)

Changes in the Nonborrowed Monetary Base MB_n

The money supply is positively related to the nonborrowed monetary base MB_n.

Changes in Discount Loans DL from the Fed

The money supply is positively related to the level of borrowed reserves, BR, from the Fed.

OVERVIEW OF THE MONEY SUPPLY PROCESS

See Table 1

APPLICATION Explaining Movements in the Money Supply, 1980-2005

See Figure 2

See Figure 3

Over long periods, the primary determinant of movements in the money supply is the nonborrowed monetary base MB_n, which is controlled by Federal Reserve open market operations.

APPLICATION The Great Depression Bank Panics, 1930-1933

See Figure 4

See Figure 5

See Figure 6

QUESTIONS AND PROBLEMS: 2, 4, 8, 10, 12, 14