Topic Notes – 4

Supply of Money (Money Supply)

 Related to Money Authority (Central Bank, In Vietnam: State Bank of Vietnam – SBV)
How do Money Authority can manage the Money Supply?
+ Print money (Cash) => There is more available cash in the economy, then Money Authority
will pump by distributing it through the commercial banks (e.g: Techcombank, VP Bank)
+ Manage Money Circulation (Reserves) => The higher the required reserve is, the lower the
commercial bank can make loan => Total amount of money in circulation will decrease
High Powered Money => Whenever SBV changes Monetary Policy, M1 and Reserves are
directly affected.
+ M1 (frequently used): cash hold by people + demand deposit in the Banking System (have a
low interest rate and withdraw whenever you want)
+ Reserves in the State Bank of Vietnam from the Commercial Banks
Explaination: if the commercial banks have so many deposits from households, they do not
keep all of it and deposit a part of them into the SBV
Fractional reserves and money creation
1. Reserves
Definition: The amount of deposits that are kept in the “vault” (=big safe box) of the commercial
banks
Deposits = Liabilities from the bank

Amount of Reserves
Reserve ratio =
Amount of Deposits

Ex: Amount of Reserves = 10; Amount of Deposits = 100

 Reserve ratio = 10 %
Note: if the reserve ratio is reqired by SBV, this is called “ required reserve ratio”
2. Money creation
Money category:
When we discuss about money creation, we do not talk about whether money is created.
Instead, we will talk about the total in maximum of the addtional loans from the initial
deposit.
Money Multiplier Formula:

1
Money Multiplier =
Required Reserve Ratio( RR)

Ex:
Explaination: The lower the required reserve ratio, the higher the additional credibility available
in the economy is.

Explanation: regardless of the interest rate, the SBV will decide the MS in the economy
depending on the economic situation.
Demand of Money (Money Demand)
 Cash holding

Transactional purpose: payment (depending on national output – Y (+))

 Shift the Money Deman curve
Explaination: The higher money income, the more transactions for goods and services in the
economy, and the higher the transactional demand for money.

“Speculative purpose (Asset demand for money – r (-))

 Move along Money Demand curve
Definition: It tells us that why people want to hold cash depending on the changes of the interest
rate
- “asset” means financial assets, which brings interest gains from holding it
Explaination: people will compare the benefits from holding cash and the benefits from holding
the financial assets.
+ if the benefits from holding from the financial assets (interest gains is really big). > the benefits
from holding cash => People will hold less and less cash
+ if the benefits from holding from the financial assets (interest gains is very small) < the
benefits from holding cash => People will hold more and more cash
Question: What does the benefits from holding cash bring to us?
+ High liquidity
+ Lack of risk
Plot on a graph
Money demand formula

Md = MT + MA

Question: What does make money demand shift?

The main shift factor for real Md is income(Y).
Additional shift factors include:
+ Wealth: If people become wealthier, some of the additional wealth may be held as money, so
Md rises.
+ Expected future inflation: If people expect P to rise quickly in the future, they will try to
hold as little money as possible.
+ Payment technologies: Any technological development that alters how people pay for goods
and services, or the ease of switching between money and non-money assets can change Md
(Examples: Credit Cards and ATM’s)

Equilibrium


Required reserve ratio changes
When Required Reserve Ratio decreases
 

When Required Reserve Ratio increases,


National Output changes:
When the national output increases,
Question: Why are there so many interest rates?
+ Reference interest rate (focus on this) => the interest rate that State Bank of Vietnam applies
to the commercial banks

Ex:
+ Deposit rate
+ Loan rate