The Federal Reserve and the Money Supply

 

Chapter 5

 

Responsibilities of the Fed

Supervise and Regulate Banks

Servicing Banks

Holding U.S. Treasury Funds

Implement Monetary Policy

 

The Fed Controls the Money Supply By:

Open market operations

Adjusting the discount rate

Adjusting reserve requirements

 

≠ ≠

money supply†† ř†† ŖIRř investments

ř†††

employmentř economic activity

 

 

 

 

 

 

 

 

 

Fedís political independence

Long terms, although no re-appointment

Own source of funding

 

How do we measure the money supply?

With monetary aggregates

 

Table 5.1†††† Measures of the Monetary Aggregates

 

†††††††††††††††††††††††††††† ††††††††††††††††††††††††††††††††††††††††††††† Value as of December 1996

††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††† ††††††††† ($ billion)

M1†††† =†††††† Currency†††† ††††† †††††††††††††††††††††† †††376.2

††††††††† +†††††† Travelerís checks††††††††† †††††††††††††††††† †††††††8.5

††††††††† +†††††† Demand deposits†† ††††† †††††††††††† †††408.0

††††††††† +†††††† Other checkable deposits ††††† ††† †††358.0

†††††††††††††††††† Total M1†††† ††† †††††††††††††††††††††††† 1,150.7

 

 

M2†††† =†††††† M1

+†††††† Savings deposits including MMDAs†† ††††††††† 1,134.5

+†††††† Small time deposits†††††††† ††† ††††† †††††††††††††††††† †††929.3

+†††††† Money market mutual funds (retail)†††††††††††††† ††465.4

Total M2††††††††††††††††††††††††††††††††† †††††††††††††††††††††††††††††††††††† 3,679.9

 

M3†††† =†††††† M2

†††††††††††††††††† +†††††† Large time deposits††††††††††††††††††††††††††††††††††††† †† 417.3

†††††††††††††††††† +†††††† Money market mutual funds
†††††††††††††††††††††††††††† (institutional)†††††††††††††††††††††††††††††††††††† †† †††††† †††228.6

†††††††††††††††††† +†††††† Repurchase agreements††††††††††††††††††††† †††††††††††† 175.8

†††††††††††††††††† +†††††† Eurodollars††††††††††† ††† ††††††††††††††††††††††††††††††††† †††††92.1

Total M3†††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††† 4,593.7

 

L†††††††††††††††† =†††††† M3††††

 

†††††††††††††††††††††††††††† +†††††† Nonbank public holdings of U.S. savings bonds,

††††††††††††††††††††††††††††††††††††† short-term Treasury securities, commercial paper,

††††††††††††††††††††††††††††††††††††† and bankersí acceptances

††††††††††††††††††††††††††††††††††††† †††††††††††††††††††††††††††††††††††††††††††††††††††††††† 1,118.9

Total L††††††††††††††††† ††††††††††††††††††††††††††††††††††††††††††††††††††††††† 5,712.6

How is Money Created?

By banks lending funds placed on deposit

†††††††††††††††††† Assets†††††††††††††††††††††††††††††††††††††††††††††††††††††††††† Liabilities

 

Cash†††††††††††††††††††††††††††††††† $1,000††††††††† Deposits†††† ††††††††††††††††††††† †††$900

Gov. securities††††††††††††††††† 1,000††††††††† Capital††††††††††††††† †††††††††††† ††1,100

 

Total†††††††††† †††††††††† †††††††††† $2,000††††††††† Total†††† †††††††††††††††††††††††††† $2,000

 

 

†††††††††††††††††† Assets†††††††††††††††††††††††††††††††††††††††††††††††††††††††††† Liabilities

 

 

Cash††††††††††††† ††††††††††††††††††††††$90†††††† Deposits†††††††††††† ††††††††††††††††$900

Gov. securities††††† †††††† ††††1,000†††††† Capital†††††††††† ††††††††††††††††††††1,100

Loan to Joe Smith ††††††††††††††††910

 

Total†††††††††† ††††††††††††††† ††$2,000†††††† Total††††††††††† †††††††††††††††††††††$2,000

 

 

†††††††††††††††††† Assets†††††††††††††††††††††††††††††††††††††††††††††††††††††††††† Liabilities

 

 

Cash††††† †††††††††††††††††††††† ††$1,000 ††††† †††Demand deposit†††††††††††††††† $900

Loan to Joe S.†††††† †††††††† †††††910 †††††† †††Demand deposit to Joe S.††910

Gov. securities††† ††††††††††††1,000††††††††† Capital††††††††††††††† ††††††††††††† 1,100

 

Total †††††††††††††††††††††††††††† †††$2,910††† †††††Total††††††††††††††††††††††††††† $2,910

 

 

†††††††††††††††††† Assets†††††††††††††††††††††††††††††††††††††††††††† ††††††††††††††Liabilities

 

 

Cash††††††††††††††††††††††††††††††††††† $1,000††††††† Original demand deposits†††††† 900

Loan to Joe S.††††††††††††††††††††††††† 910††††††† Demand deposit for Joe S††††††† 910

Loan to Mary Cate†††††††††††††††††† 819 ††††††† Demand deposit for Mary C.819

Gov. securities††††††††††††††††††††† 1,000 ††††††† Capital††††† ††††††††††††††††††††††††††† 1,100

 

Total†††††††††††††††††††††††††††††††††† $ 3,729††††††† Total†† ††††††††††††††††††††††††††††††$3,729