Economics Chapter 15: Money Supply Process
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Questions and Answers

Which of the following is NOT one of the three players that influence the money supply?

  • Financial analysts (correct)
  • Depositors
  • Banks
  • The central bank

What is included in the Bank of Canada's liabilities?

  • Loans to financial institutions
  • Securities
  • Vault cash
  • Currency in circulation (correct)

Which term describes the deposits held at the Bank of Canada for managing liquidity?

  • Asset holdings
  • Reserve requirements
  • Settlement balances (correct)
  • Currency reserves

What best describes the effect of open market operations on the monetary base?

<p>It adjusts the level of reserves in the banking system. (B)</p> Signup and view all the answers

How is currency in circulation best defined?

<p>Bank notes in the hands of the public. (B)</p> Signup and view all the answers

What defines the monetary base in the context of banking?

<p>The sum of currency in circulation and total reserves (C)</p> Signup and view all the answers

What are desired reserves primarily used for by banks?

<p>To handle possible deposit outflows (B)</p> Signup and view all the answers

How is the desired reserve ratio determined for an individual bank?

<p>As a fraction of the deposits entrusted to the bank (B)</p> Signup and view all the answers

Which of the following is considered an asset for the Bank of Canada?

<p>Securities issued by the Government of Canada (B)</p> Signup and view all the answers

What is the immediate effect on the monetary base when the Bank of Canada purchases $100M of bonds from a bank?

<p>Monetary base increases by $100M (D)</p> Signup and view all the answers

What are excess reserves?

<p>Reserves in addition to desired reserves (C)</p> Signup and view all the answers

Which action is performed by the Bank of Canada to control the monetary base?

<p>Conducting open market operations (C)</p> Signup and view all the answers

What does the monetary base exclude?

<p>Consumer deposits at banks (D)</p> Signup and view all the answers

Which of the following best describes open market operations?

<p>Buying and selling government securities (D)</p> Signup and view all the answers

What is the immediate effect of an open market purchase by the Bank of Canada?

<p>An increase in reserves in the banking system (D)</p> Signup and view all the answers

Which statement about the control of the monetary base by the Bank of Canada is true?

<p>The control over the monetary base is complicated by external factors. (C)</p> Signup and view all the answers

What does 'MBn' represent in the context of the monetary base?

<p>Non-borrowed monetary base (C)</p> Signup and view all the answers

How does lending by banks affect the money supply?

<p>Lending increases the money supply through the creation of deposits. (B)</p> Signup and view all the answers

Which of the following does not directly affect the monetary base?

<p>Sentiment in the bond market (B)</p> Signup and view all the answers

Which factor complicates the Bank of Canada's ability to manage the monetary base?

<p>Banks have the final say in agreeing to loans. (C)</p> Signup and view all the answers

What happens to the monetary base when a $100 million bond is purchased by the Bank of Canada?

<p>The monetary base increases by $100 million. (A)</p> Signup and view all the answers

Which statement about borrowed reserves (BR) is correct?

<p>Control of borrowed reserves is influenced by multiple factors. (D)</p> Signup and view all the answers

What effect does an open market purchase have on the reserves of a bank?

<p>Reserves increase, leading to potential lending. (C)</p> Signup and view all the answers

What impact does a $100M loan from the Bank of Canada to a Canadian bank have on the liabilities of the Bank of Canada?

<p>Increase by $100M in loans (C)</p> Signup and view all the answers

What happens to the reserves in the banking system after depositors shift $100M from chequable deposits into currency?

<p>Decrease by $100M (C)</p> Signup and view all the answers

How does a $100M open market purchase affect the monetary base?

<p>Increases the monetary base by $100M (D)</p> Signup and view all the answers

If depositors prefer to keep additional funds in the form of currency, what is the immediate consequence on chequable deposits?

<p>They decrease by $100M (C)</p> Signup and view all the answers

What is the net effect on reserves after an open market purchase is executed, assuming depositors withdraw $100M into currency?

<p>Reserves remain unchanged (A)</p> Signup and view all the answers

Which of the following accurately describes the nature of reserves during a $100M loan to a bank?

<p>Reserves increase only for the Canadian bank and decrease for the Bank of Canada (C)</p> Signup and view all the answers

If a $100M open market operation is executed, which effect accurately describes its impact on the banking system's reserves before any depositor behavior changes?

<p>Reserves increase by $100M (C)</p> Signup and view all the answers

What can be inferred about the relationship between currency in circulation and monetary base after a shift of funds from deposits into currency?

<p>Currency in circulation increases while monetary base remains unchanged (C)</p> Signup and view all the answers

What is indicated by a money multiplier of 2.5 in relation to the monetary base?

<p>A $1 increase in the monetary base leads to a $2.50 increase in the money supply. (A)</p> Signup and view all the answers

What key factor limited the increase in the money supply despite a significant growth in the monetary base from 2008 to 2014?

<p>An increase in excess reserves offset the potential gain in money supply. (D)</p> Signup and view all the answers

What happens to the money multiplier when the currency ratio decreases?

<p>It increases the money multiplier and thus the money supply. (C)</p> Signup and view all the answers

During the quantitative easing periods, how did the monetary base grow in the US?

<p>By more than 350%. (B)</p> Signup and view all the answers

What effect did the extraordinary rise in excess reserves have during the global financial crisis?

<p>It limited the effectiveness of the money multiplier. (C)</p> Signup and view all the answers

What was a common observation regarding the money supply and monetary base during the 2020 coronavirus pandemic?

<p>The monetary base increased significantly, but the money supply rose only slightly. (B)</p> Signup and view all the answers

Which of the following directly affects the bank's ability to lend money?

<p>The excess reserves ratio. (D)</p> Signup and view all the answers

How did the Fed's asset purchases during the crisis influence banking operations?

<p>It increased the liquid assets available to banks. (C)</p> Signup and view all the answers

What is one result of ineffective monetary policy tools during economic downturns?

<p>Inefficient transmission of monetary policy. (D)</p> Signup and view all the answers

Flashcards

Loan from BoC to bank

The Bank of Canada provides a loan to a bank, increasing their assets and liabilities by equal amounts.

Open Market Purchase Effect

Similar to a bank loan, an open market purchase by the BoC increases the bank's ability to lend.

Currency in circulation

The physical money held by the public, not in a bank account.

Reserves in Banking System

Funds held by banks at a central bank, or in other reserve accounts, to meet withdrawal demands.

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Shifts to Currency

When the public moves money from bank deposits into cash.

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Monetary Base

The central bank's liability that includes currency and reserves.

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Depositor Behavior

How individuals choose to hold their money: as deposits or as physical cash.

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Open market purchase impact on reserves

The effect on reserves depends on how depositors choose to hold their money (as deposit or cash).

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Reserves

The amount of money that banks hold in their accounts at a central bank.

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Open Market Operations

The buying and selling of securities by the central bank to control the monetary base.

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Desired Reserves

The amount of reserves a bank wants to hold to manage potential deposit outflows.

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Desired Reserve Ratio

A bank's desired reserves expressed as a fraction of its deposits.

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Excess Reserves

Reserves held by a bank beyond its desired reserve.

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Bank Rate

The rate charged by the central bank (BoC) for loans to financial institutions.

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Open Market Purchase

The Bank of Canada (BoC) buys securities (bonds) from a bank.

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Open Market Sale

The Bank of Canada (BoC) sells securities (bonds) to a bank.

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Monetary Base (MB)

The sum of currency in circulation and reserves held by banks.

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Non-borrowed Monetary Base (MBn)

Part of the monetary base that the central bank directly controls by open market operations.

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Borrowed Reserves (BR)

Part of the monetary base that banks borrow from the central bank.

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Multiple Deposit Creation

Banks lending out excess reserves, leading to an increase in the money supply.

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Deposit Creation (Single Bank)

A single bank's reserves increase, leading to loans and a new deposit (checking account).

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Money Supply (M1+)

The total amount of money available in the economy; includes currency, checking accounts.

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Bank Reserves

Deposits a bank has at the central bank or holds as vault cash.

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Float

The difference between the amount of checks deposited and the amount cleared and credited to a bank's account.

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Bank of Canada's Balance Sheet

A financial statement showing the Bank of Canada's assets (what it owns) and liabilities (what it owes). Assets include securities and loans, while liabilities include currency in circulation and bank reserves.

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Reserves (Bank of Canada's Balance Sheet)

Deposits of commercial banks held at the Bank of Canada, which banks maintain to manage their liquidity and meet potential deposit outflows.

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Three Players in the Money Supply Process

The Bank of Canada, banks (depository institutions), and depositors all influence the amount of money in circulation.

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Money Multiplier

A measure of how much the money supply expands for every dollar increase in the monetary base.

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Simple Deposit Multiplier

The theoretical increase in the money supply resulting from a new deposit, assuming no excess reserves.

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Quantitative Easing

A monetary policy used by central banks to increase the money supply by purchasing assets.

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Currency Ratio

The proportion of the money supply held as currency by the public.

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Increase in Monetary Base Impact

An increase in the monetary base leads to a greater increase in the money supply, but the multiplier effect is influenced by the currency ratio and excess reserves ratio.

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Impact of Excess Reserves on Money Multiplier

Higher excess reserves reduce the money multiplier as banks have less available funds to lend.

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Application of Money Multiplier in Real World

The money multiplier is a theoretical concept and the actual money supply expansion can be much less due to factors like excess reserves and shifts in currency holding.

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Money Multiplier vs. Real World

The money multiplier is a theoretical tool used to understand the potential for money supply expansion, but the real world is more complex due to factors like bank behavior and shifts in public preferences.

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Study Notes

Chapter 15: The Money Supply Process

  • Three Players:
    • Central bank: Oversees the banking system, responsible for monetary policy.
    • Banks (depository institutions): Financial intermediaries, accept deposits, make loans.
    • Depositors: Individuals/institutions holding bank deposits.

Bank of Canada's Balance Sheet

  • Assets:

    • Securities (primarily government securities).
    • Loans to financial institutions (loans/advances to banks; bank rate is the interest charged).

  • Liabilities:

    • Currency in circulation (bank notes held by public).
    • Reserves (deposits of banks with the Bank of Canada).

  • Reserves (settlement balances): Deposits of banks with the Bank of Canada, their vault cash. Banks hold reserves to manage liquidity.

  • Monetary base (high-powered money): Reserves + currency in circulation = reserves + notes in circulation + coins in circulation

  • Desired reserves: Reserves banks maintain to handle potential deposit outflows. Expressed as a fraction (desired reserve ratio) of entrusted deposits.

  • Excess reserves: Reserves in excess of desired reserves.

Control of the Monetary Base

  • MB: Monetary base = C + R (currency circulation + total reserves)
  • The Bank of Canada controls the monetary base through open market operations and advances to banks.

Open Market Purchase from a Bank

  • Bank of Canada purchasing bonds from a bank increases the bank's reserves.
  • If there's no change in currency circulation, the Monetary Base increases by the amount purchased.
  • Open market sale has the opposite effect.

Loans to Financial Institutions

  • Immediate effect of bank loans to financial institutions is an increase in reserves for both the borrowing bank and the lending (Bank of Canada).
  • From here, the process is similar to open market purchases.

Shifts From Deposits into Currency

  • The ultimate effect of open market purchases on reserves depends on depositor behavior.
  • If depositors prefer to hold more cash, bank reserves fall, cancelling the initial increase. Yet the overall monetary base remains unchanged.

Open Market Policies and Advances

  • The immediate effect of an open market purchase or advance is an increase in banking system reserves.
  • The ultimate effect on reserves depends on how the injected liquidity is held.
  • The ultimate effect on the monetary base is clear: It increases by the amount of the purchase or advance, irrespective of preferences for cash.

Other Factors Affecting the Monetary Base

  • Money supply is positively related to the monetary base
  • The Bank of Canada doesn't fully control all monetary base elements (e.g. deposits at the bank, "float")

Overview of the Bank of Canada's Ability to Control the Monetary Base

  • Monetary base can be divided into non-borrowed and borrowed reserves.
  • Non-borrowed reserves are easier to control.
  • External factors complicate monetary base control.

Multiple Deposit Creation: A Simple Model

  • Due to open market purchases, a bank's reserves increase, and it's able to loan out the excess. New loans become deposits in other banks, creating new money and further expansion in the money supply.
  • The ultimate effect of the $100 million injection is an increase in the money supply by more than $100 million.
  • It is determined by the desired reserve ratio.

Deposit Creation: The Banking System

  • New deposits are created when banks loan out excess reserves.
  • The size of the deposit increase depends on the desired reserve ratio.

Critique of the Simple Model

  • Several factors may disrupt simple deposit expansion.
  • A desire of the public to hold extra cash and banks unwillingness to loan out all excess reserves can dampen the total multiple increase.

Factors That Determine the Money Supply

  • Changes in the non-borrowed monetary base positively relate to money supply.
  • Changes in borrowed reserves from the Bank of Canada positively relate to the money supply.
  • Changes in the desired reserves ratio negatively relate to the money supply.
  • Changes in currency holdings negatively relate to the money supply.
  • Changes in excess reserves negatively relate to the money supply.

Money Supply Response

  • Summary Table of Money Supply Responses shows how various factors affect the Money Supply.

The Money Multiplier

  • Money is defined as currency plus chequable deposits (M1+).
  • The money supply (Money = M1+) is linked to the monetary base (MB) through a money multiplier.
  • The relationship is expressed as M = m x MB

Deriving The Money Multiplier

  • Assumptions on currency, excess reserves etc, lead to a formula for the money multiplier.
  • The money multiplier (m) is determined by the desired reserve ratio (rd), the currency ratio (c), and the excess reserves ratio (e). An equation is given that summarizes this.

Intuition Behind the Money Multiplier

  • For a reserve ratio of 10%, a $1 increase in the monetary base leads to a $2.50 increase in the money supply. This is less than the "simple" deposit multiplier

Application: Quantitative Easing and the Money Supply, 2007-2020

  • During quantitative easing, the monetary base increased dramatically but the money supply didn’t rise proportionally
  • This is because, the factors such as currency and excess reserves ratios held back the rise.

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The Economics of Money, Banking, and Financial Markets PDF

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Explore Chapter 15 on the Money Supply Process that delves into the roles of the central bank, banks, and depositors. Understand the balance sheet of the Bank of Canada, its assets and liabilities, and the concept of reserves. This quiz will test your comprehension of the monetary base and the liquidity management by banks.

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