Printing Money
and Spending it.
The Federal Reserve
And the Money Supply
s
M
MV=PQ
V=PQ
This is the equation of exchange, which
defines V and hence always holds true.
?
d
M =kPQ=(1/V)PQ
The demand for money (Md) is some
proportion (k) of the expenditures (PQ)
that people expect to be making.
?
k=(1/V)
s
M V=PQ
The M in the equation exchange is the
money supply, i.e., Ms.
?
d
M =kPQ=(1/V)PQ
Hence, k = 1/V only when Ms = Md. If
people are demanding more money than
currently exists then Ms < Md.
?
k=(1/V)
The Money Supply
M =C+D
Where C is currency and coin
And D is checking account balances
The Money Supply
M =C+D
C = is currency and coin
Currency is produced by the Bureau
of Engraving and Printing:
Washington, D. C., and Fort Worth
The Money Supply
M =C+D
C = is currency and coin
Coins are produced by the U.S. Mints:
Philadelphia and Denver
San Francisco and West Point
The Money Supply
M =C+D
R = rD
Where R is total bank reserves,
The coefficient r is the reserve ratio,
and rreq is the required reserve ratio.
The Money Supply
M =C+D
D = R/r
M = C + R/r
Suppose that at some future date:
C = $800 billion;
R = $240 billion;
and rreq = 20%, or 0.20.
How large would the money supply be?
M = C + R/r
Assume the banks are “fully loaned up,”
and plug the numbers into the equation:
M = C + R/r
M = $800 + $240/0.20
C = $800
R = $240
r = 0.20
M = $800 + $1200
M = $2000
M = C + R/r
C = $800
R = $240
r = 0.20
What would happen to the money
supply if the reserve requirement were
cut in half (i.e., from 0.20 to 0.10)?
M = C + R/r
Plug the numbers into the equation:
C = $800
R = $240
M = $800 + $240/0.10 r = 0.10
What
would+ happen
M = $800
$2400 to the money
supply if the reserve requirement were
M = $3200 So, D doubles (from $1200 to $2400)
cut in half (i.e.,
from 0.20
0.10)?
increasing
M fromto$2000
to $3200.
M = C + R/r
M = C + R/r
Ultimately, C would be doubled from $800 to $1600,
so that M would be doubled from $2000 to $4000.
=
r
(
)C
M
+
R
Can you rearrange these symbols to produce
an equation that expresses the money supply
M as a function of C, R, and r?
D
And why isn’t D included in the mix?
FEDERAL RESERVE POLICY TOOLS:
Required Reserve Ratio: “rreq” –which
determines the maximum volume of demand
deposits that can be supported by a given
level of reserves.
R
M=C+ r
( )
Required Reserve Ratio
R
M=C+ r
( )
Required Reserve Ratio
FEDERAL RESERVE POLICY TOOLS:
Required Reserve Ratio: “rreq” –which
determines the maximum volume of demand
deposits that can be supported by a given
level of reserves.
Discount Policy (Primary Credit Policy):
“id”which encourages (or discourages)
borrowing from the Fed to meet the
reserve requirement, thus increasing (or
decreasing) R.
Discount Policy
R
M=C+ r
( )
Discount Policy
R
M=C+ r
( )
The Primary Credit Rate
a.k.a. the Discount Rate
is an administered rate.
0.75%
0.750000000000000000000000000000000000%
The “Required Reserve Ratio” is a blunt policy
tool. Even a small change in “r” can cause large
and abrupt changes in the money supply. And
besides, changing “r” attracts press attention.
“Discount Policy” caters to overly aggressive
banks. It encourages banks to get caught short of
reserves and have to borrow from the Federal
Reserve. Better to use the discount rate, a.k.a, the
“Primary Credit Rate” for dealing with troubled
banks.
Is there some other way of increasing Reserves
generally (and daily) without attracting press
attention and without putting those reserves in the
hands of overly aggressive or troubled banks?
Open Market Operations
“Open Market Operations” is a term that refers to
the Fed’s buying Treasury bills from commercial
banks as a means of directly increasing the level of
reserves.
Treasury bills in the portfolio of a commercial bank
represent “funds lent out.” That is, when the bank
bought the Treasury bill (i.e., the IOU) from the
Treasury, it lent funds to the Treasury.
When the Fed buys the Treasury bill from the bank,
it replaces “funds lent out” with Reserves, which
enables the bank to engage in further lending.
FEDERAL RESERVE POLICY TOOLS:
Required Reserve Ratio: “rreq” –which
determines the maximum volume of demand
deposits that can be supported by a given
level of reserves.
Discount Policy (Primary Credit Policy): --“id”
which encourages (or discourages) banks
from borrowing from the Fed to meet the
reserve requirement, thus increasing (or
decreasing) R.
Open Market Operations: “T-bills” –which the
Fed can buy from banks (or sell to banks),
directly affecting R.
The Federal Reserve’s buying of Treasury bills
has an effect on the rate of return that holders
of those bills receive.
More significantly, the Fed’s buying of T-bills
has a direct effect on the total amount of bank
reserves and hence on the interest rate (the
federal-funds rate) at which banks can borrow
from one another.
The Fed can increase the money supply by
buying T-bills, and can gauge the magnitude of
the increase by watching the federal funds
rate. This is called “interest rate targeting.”
fed-funds rate
Price of T-bills
S
D
S
S’
D’
D
Q
Market for Treasury Bills
Market for Reserves
Q
S + M
I
New money is lent
into existence. It
enters the economy
through the market
for loanable funds.
Query: How does the
increased investment
(the I) show up in the
monetarists’ equation
of exchange?
Open Market Operations
Discount Policy
R
M=C+ r
( )
Required Reserve Ratio
Open Market Operations
Discount Policy
R
M=C+ r
( )
Required Reserve Ratio
Open Market Operations
Discount Policy
R
M=C+ r
( )
Required Reserve Ratio
Effective Federal Funds Rate:
2006-2011
Press Release
March 15, 2011
The Committee will maintain the target range for the federal
funds rate at 0 to 1/4 percent and continues to anticipate that
economic conditions, including low rates of resource utilization,
subdued inflation trends, and stable inflation expectations, are
likely to warrant exceptionally low levels for the federal funds
rate for an extended period.
….the Committee is maintaining its existing policy of
reinvesting principal payments from its securities holdings and
intends to purchase $600 billion of longer-term Treasury
securities by the end of the second quarter of 2011.
Bank Reserves:
1959-2011
Pre-crisis level: $45 billion
Current level: $1,263 billion
Percentage increase:
$1,263/$45 = 28.1 = 2810%
Feb 2008: r = 43.4 / 291.5 = 14.9 %
Feb 2011: r = 1,263 / 537 = 235 %
Deposits:
2005-2011
The Fed increased the required reserve ratio in 1937-38
The Fed increased the required reserve ratio in 1937-38
According to the Fed’s “Regulation Q,” which was imposed on
the banking system from the mid 1930s until the early 1980s,
no bank account could be both checkable and interest bearing.
Checking accounts,
i.e., demand deposits
can bear no interest.
Savings accounts
bear interest but are
not checkable.
In the early 1980s---after a bout with double-digit inflation,
“Regulation Q” was phased out, after which the distinction
between checking accounts and saving accounts was blurred.
Checking accounts,
i.e., demand deposits
can bear no interest.
Savings accounts
bear interest but are
not checkable.
In the early 1980s---after a bout with double-digit inflation,
“Regulation Q” was phased out, after which the distinction
between checking accounts and saving accounts was blurred.
Checking accounts,
i.e., demand deposits
can now bear interest.
Savings accounts
bear interest and
are effectively
checkable.
In the early 1980s---after a bout with double-digit inflation,
“Regulation Q” was phased out, after which the distinction
between checking accounts and saving accounts was blurred.
Well, we just don’t
know what money is,
anymore.
$$
Even if the Fed knew
just how much money $$$$$
it had created, it
wouldn’t know where
$$
in the world it all is.
The equation of exchange was
most useful when most US
dollars were in the US.
$$
$$
$$
Printing Money
and Spending it.
The Federal Reserve
And the Money Supply