THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 453

CHAPTER 16 The Money Supply Process 421 Recall that in Chapter 13, the primary benefit to a bank of holding reserves is that they provide insurance against losses due to deposit outflows; that is, they enable the bank experiencing deposit outflows to escape the costs of calling in loans, selling securities, borrowing from the Bank of Canada or other corporations, or bank failure If banks fear that deposit outflows are likely to increase (that is, if expected deposit outflows increase), they will want more insurance against this possibility and desired reserves will increase Changes in Currency Holdings As shown before, chequable deposits undergo multiple expansions while currency does not Hence, when chequable deposits are converted into currency, holding the monetary base and other variables constant, there is a switch from a component of the money supply that undergoes multiple expansion to one that does not The overall level of multiple expansion declines and the money supply falls On the other hand, if currency holdings fall there is a switch into chequable deposits, which undergo multiple deposit expansion, so the money supply rises This analysis suggests the following result: The money supply is negatively related to currency holdings OVE RVI E W O F T HE M O NE Y SUP P LY P ROCE SS We now have a model of the money supply process in which all three of the players the Bank of Canada, depositors, and banks directly influence the money supply As a study aid, Table 16-2 charts the money supply response to the three factors discussed above and gives a brief synopsis of the reasoning behind them The variables are grouped by the player or players who are the primary influence behind the variable The Bank of Canada, for example, influences the money supply by controlling the first two variables (called tools of the Bank of Canada) Depositors influence the money supply through their decisions about their holdings of currency, while banks influence the money supply by their decisions about desired reserves However, because depositors behaviour influences bankers expectations about deposit outflows, which as we have seen affects banks decisions to hold reserves, depositors are also listed as a player determining desired reserves TA B L E 16 - Money Supply Response Change in Variable Money Supply Response Nonborrowed monetary base, MBn * * More MB for deposit creation Borrowed reserves, BR * * More MB for deposit creation Depositors Currency holdings * + Less multiple deposit expansion Depositors and banks Desired reserves * + Less loans and deposit creation Player Variable Bank of Canada Reason Note: Only increases (*) in the variables are shown The effects of decreases on the money supply would be the opposite of those indicated in the Response column