THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 460

428 PA R T V Central Banking and the Conduct of Monetary Policy S U M M A RY There are three players in the money supply process: the central bank, banks (depository institutions), and depositors The monetary base consists of currency in circulation and reserves Eight factors affect the monetary base: (1) the Bank of Canada s holdings of securities and investments, (2) advances, (3) foreign currency assets, (4) securities purchased under resale agreements, (5) currency outstanding, (6) other Bank of Canada assets (net), (7) government deposits with the Bank of Canada, and (8) securities sold under repurchase agreements Increases in the first six factors add to the monetary base; increases in the last two factors reduce the monetary base The Bank of Canada controls the monetary base through open market operations and has better control over the monetary base than over reserves A single bank can make loans up to the amount of its excess reserves, thereby creating an equal amount of deposits The banking system can create a multiple expansion of deposits because as each bank makes a loan and creates deposits, the reserves find their way to another bank, which uses them to make loans and create additional deposits In the simple model of multiple deposit creation in which banks not hold on to excess reserves and the public holds no currency, the multiple increase in chequable deposits (simple deposit multiplier) equals the reciprocal of the desired reserve ratio The simple model of multiple deposit creation has serious deficiencies Decisions by depositors to increase their holdings of currency or of banks to hold excess reserves will result in a smaller expansion of deposits than the simple model predicts All four players the Bank of Canada, banks, depositors, and borrowers from banks are important in the determination of the money supply The money supply is positively related to the nonborrowed monetary base MBn, which is determined by open market operations, and the level of borrowed reserves (advances) from the bank of Canada, BR The money supply is negatively related to the desired reserve ratio, r, and holdings of currency The model of the money supply process takes into account the behaviour of all three players in the money supply process: the Bank of Canada through open market operations and lending; depositors through their decision about their holding of currency; and banks through their decisions about desired reserves, which are also influenced by depositors decisions about deposit outflows The monetary base is linked to the money supply using the concept of the money multiplier, which tells us how much the money supply changes when there is a change in the monetary base KEY TERMS borrowed reserves, p 407 high-powered money, monetary base, p 408 p 405 money multiplier, p 422 multiple deposit creation, p 414 nonborrowed monetary base, p 414 open market purchase, open market sale, p 408 required reserves, p 407 simple deposit multiplier, p 418 p 408 QUESTIONS You will find the answers to the questions marked with an asterisk in the Textbook Resources section of your MyEconLab *3 During the Great Depression years 1930 1933, the currency ratio c rose dramatically What you think happened to the money supply? Why? *1 The money multiplier is necessarily greater than Is this statement true, false, or uncertain? Explain your answer During the Great Depression, the desired reserves ratio r rose dramatically What you think happened to the money supply? Why? If the desired reserve ratio on chequable deposits were set at zero, the amount of multiple deposit expansion would go on indefinitely Is this statement true, false, or uncertain? Explain *5 Suppose that travellers cheques were included in the M1* measure of the money supply and had no reserve requirements When people travel during the summer and convert some of their chequing account deposits into travellers cheques, what would happen to the money supply? Why?