Final Eco Money Multiplier
Transcript of Final Eco Money Multiplier
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MONEY MULTIPLIER
PRESENTED BY:
KARAN C 132
SREEJA T 93
LATIKA C 40
YASHRAJ T 108
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The Functions of Money
1. Medium of exchange: It facilitates efficient
trading
2. Unit of account : Breakable into Denominations
3. Store of value: It can be used to make purchasesin the future
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The Banking System
In the past,precious metals (e.g. gold or silver) wereused as a medium of exchange
Later on,paper currency was issued, but only central
banks were allowed to issue paper currency that was
convertible into gold
Abandonment of thegold standard: currencies were
no longer convertible by law into anything valuable
Today almost all currency isfiat money, which is
widely accepted because it is declared by government
to be legal tender
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Money Multiplier Mathematical relationship between the monetary base and
money supply of an economy.
Money supply = money multiplier x monetary base
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Relation between Money Base & Supply
Monetary
Base
Coins, paper
currency
Spending
power in
economy
M0,M1,M2,
M3,M4
MONEY MULTIPLIER
Commercial
banks
reserves withcentral bank
Money
supply
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Cash In Circulation
BANK
Depositors funds
[Mr. A]
BANK
Mr. Bs
securities
Bs
spending
power
New loan
Bank lends it out to
Mr. B
Fractional Reserve
Increase of Cash by a factor that is a multiple of
the initial deposit
Fractional
reserve
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central bank money
(all money created
by the central bank
regardless of its form
(banknotes, coins,
electronic money
through loans to
private banks)
commercial bank
money (money
created in the
banking system
through borrowing
and lending)
sometimes referred
to as checkbookmoney
TERMS
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High Powered MoneyCentral Bank
High powered money
=currency + deposits
- MO
Asset to private sector
Liability to Central
Bank
Monetaryconditions
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Open Market Operations
Central Bank Increases
The amount of
High powered money
purchase of securities
Govt. Guarantees to
Pay a fixed rate
Of interest
Govt. bonds carry less
risk
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The RatiosApproach to
the creation of deposit money
Two ratios are important in the determination of the
level of deposit creation:
Commercial banks reserve ratio
Ratio ofcurrency to deposits held by the public
LetR = cash held in bank reserves
C= cash held by the non-bank public
H= level of high-powered money in the economy
=> then:
(25) C+ R = H
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Banks desired reserve ratio (i.e. reserves as a proportionof deposits, D) of banks is given by r:
(26) R = rD The public hold a fraction c of its bank deposits in cash :
(27) C = cD
Substituting into (25) : cD + rD = H
Solving for D yields :
(28) D = H/(c+r)
ifc=0, and r=0.1, then deposits would be 10 x the cash in theeconomy:
D = H/0.1 D = 10H
as c o, the value of D q: e.g suppose c=0.2, then,
D = H/(0.1+0.1) D = H/(0.2) D = 5H
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An expression for money supply (M) andHcan beobtained by noting that the total supply of money is
the sum of deposits (D) and currency (C). Thus:(29) M= C + D
M= cD + H/(c+r)
M= cH/(c+r) + H/(c+r)
(30) M= H[(c+1)/(c+r)]=> (c+1)/(c+r) is known as the money multiplier
it tells us how much bigger is the money supply (M) withrespect to the cash base of the system (H)
=> Money supply = money multiplier x monetary baseE.g.: In the UK banking system the reserve ratio (r) is 0.005 and
the cash ratio (c) is 0.033
=> the value of the money multiplier is just over 27
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Changing the Money Supply
If the central bank wants to raise money supply, it
can use the following instruments:
a) it can lower the required reserve ratio
b) it can lower its discount rate
a) and b) affect the money multiplier
c) it can engage in open market operations (OMO)
This affects the monetary base (H)
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Thank you!!!!