THE SUPPLY OF MONEY: PART ONE

RELATED CONCEPTS :|CHECKABLE DEPOSITS| COMMODITY MONEY| DISCOUNT RATE| DOUBLE COINCIDENCE OF WANTS| EXCESS RESERVES| FLAT MONEY| LIQUIDITY| M1| M2| MONETARY BASE | MONEY | OPEN MARKET OPERATION| REQUIRED RESERVE RATIO (R)|

How does money make it easier for people to trade?

• With money, people don’t have to sell their goods and services only to those who have goods and services they want.

Why is income not money?

• Income is the goods and services one earns; money is only a measure of its value.

What is it that is really “borrowed” when people borrow “money”?

• A borrower is actually borrowing real goods and services.

Are credit cards money?

• No. Credit cards are a means of spending money. Money is what people use to pay their credit card bills.

How does the lending of excess reserves by banks create money?

• The lending of excess reserves creates money 91) instantly when the borrower’s checkable deposit is increased (this is how banks give people loans), and (2) later, when the lent money is redeposited by the people from whom the borrower buys goods and services, and this is relent and so on.

If the legal reserve requirement is 20%, what is the most the banking system can lend out if an individual deposits $1,000?

• $4,000.

How does the Fed’s buying government securities add to monetary base? How does this change the money supply?

• This increases the monetary base, and through the money multiplier process, the money supply is increased even more.

Why does lowering of the discount rate add to the monetary base?

• A lower discount rate encourages banks to run down their excess reserves, since it is then cheaper to get some extra cash from the Fed when needed. Banks run down their excess reserves by lending them: This creates money.

What factors make the actual money multiplier smaller than 1/R?

• The two main factors are (1) banks don’t lend all their excess reserves and (2) the public does not redeposit all the funds it has been lent.

How does increasing the monetary base change the money supply?

• The bigger the monetary base, the more money that can be created through the money multiplier process.

Copyright 2008 by Sujanto Rusli
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