Microsoft Word - Money, Banking, and Int Finance(scribd).docx

Money, Banking, and International Finance

Your Bank
Assets Liabilities
Required Reserves $1,000 – 200
Excess Reserves 0

Loan 9,000

Deposits $10,000 – 200

Bank pays your $200 from required reserves. Bank does not have any excess reserves
because it loaned the excess reserves out. Consequently, your deposit becomes $9,800, and the
bank must hold $980 in required reserves. However, it only has $800, so the bank is short $180.
Bank calls in loans, causing other banks to lose deposits. Thus, the money supply contracts by
Equation 8.

1,800

0.10

1

180

1

Deposits Reserves = $ = $

r

Δ = Δ

r

   ^ (^8 )^

We do not include your $200 because you converted $200 from a checkable deposit into
currency. Remember the M1 definition of money, as defined by Equation 9. We start at the $180
because you switched the first $200 from a checkable deposit into currency, and unfortunately,
we cannot count the same money twice.

M1 = checkable deposits + currency ( 9 )

The Money Supply Multipliers

People, who hold more currency and fewer deposits, can cause bank reserves to fall,
contracting the money supply. Thus, the public determines the level currency to hold relative to
the bank deposits. Economists examine the proportion of cash (C) to checkable deposits (D) as
the currency-deposit ratio (C/D). Consequently, four factors influence this ratio over time,
which are:

 Higher wealth causes the currency-deposit ratio to fall. When a country becomes wealthier,

people have greater income. Thus, people would deposit their money into banks because

holding large amounts of currency is risky.

 Higher interest rates lower the currency-deposit ratio. Banks pay interest rates on deposits

while currency does not. When interest rates rise, people begin depositing money into

banks to earn the greater interest rate.