March 17, 2015
Key principles
- A single bank can create money (through loans) by the amount of excess reserves.
- The banking system as a whole can create money by a multiple (deposition money multiplier) of the initial reserves.
Initial deposit
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New or existing money
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Bank reserves
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Immediate change in MS
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Cash- money is created in the banking system only
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Existing $
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Increases
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No; but composition of money charges. Cash to currency.
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FED purchase of a bond from the public
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New
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Increases
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Yes; money coming from the Fed puts new dollars in circulation
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Bank purchase of a bond from public
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New
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Increase
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Yes; money is coming from reserves which puts new money in circulation.
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Factors that weaken the effectiveness of the deposit multiplier
- If banks fail to loan out all of their ER.
- If banks customers take loans in cash, rather than in new checking account deposits it creates a cash or currency drain.
The Money Market (Supply & Demand)
- Demand of money has an inverse relationship between nominal interest rates and the quantity of money demanded.
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