Chapter 5
CENTRAL BANKS
AND THE
CREATION OF
MONEY
The Federal Reserve
System
Board of Governors
Federal Reserve Banks
Member Banks
Federal Open Market Committee
Tools of Monetary Policy
Reserve Requirements
Open Market Operations
Open Market Repurchase Agreements
Discount Rate
Reserve Requirements
Fractional Reserve Banking System
Required reserve ratio
Demand deposits
Time deposits
Total reserves
Required reserves
Excess reserves
Open Market Operations
Fed purchases and sales of government
securities
Fed purchases
Increase excess reserves
Increase new loans
Increase money supply
Fed sales
Decrease excess reserves
Decrease loans
Decrease money supply
Open Market Repurchase
Agreements
Repurchase Agreement
Fed buys securities from a seller who agrees to
repurchase them at a higher price on a certain date
in the future. (Temporary increase in excess
reserves.)
Reverse Repurchase Agreement
Fed sells securities and agrees to repurchase them at
a higher price on a certain date in the future.
(Temporary decrease in excess reserves.)
Discount Rate
Rate charged on loans from the Fed’s discount
window.
Administratively set by Board of Governors
An increase in the discount rate discourages
banks from borrowing from the Fed
A decrease in the discount rate encourages
banks to borrow from the Fed
Different Uses of Money
Unit of Account
Numeraire
Medium of Exchange
Currency and demand deposits
Store of Value
Time deposits
Monetary Aggregates
Monetary Base: Currency in circulation
Currency and coins plus total reserves
M1 Money Supply
Currency plus demand deposits
M2 Money Supply
M1 plus short-term time deposits
M3 Money Supply
M2 plus long-term time deposits
Money Multiplier
Process by which changes in bank
reserves generate larger changes in the
money supply.
Size of Multiplier Influenced by:
Reserve requirement ratio
Public’s demand for cash
Banks’ willingness to make loans
Level of interest Rates
The Money Supply Process
in an Open Economy
Foreign Exchange Market Intervention
The Fed’s purchase and sale of foreign
currencies
Purchase of foreign currencies
Increases monetary base
Reduces value of the U.S. currency
Sale of foreign currencies
Decreases monetary base
Increases value of the U.S. currency
Central Banks Around the
World
European Central Bank
Bank of England
Bank of Japan
European Central Bank
(ECB)
Replaced central banks in the 11 countries
participating in the European Economic
Community
Structure of ECB is decentralized
Major Issues: Weakness of Euro
Major Aspects: Transparency
Policy objective: price stability
England: Bank of England
Primary Roles: Monetary Policy and
Stability of Financial System
Bank of England Act (1998)
No longer under control of Exchequer
Management of Government debt
Policy objective: price stability
Independence
Transparency
Japan: Bank of Japan
Ministry of Finance
Bank of Japan Law (1998)
Independence
Transparency
Policy objective: price stability
Policy Board
TanKan Report