Chapter

Money and Monetary policy

 Chapter objectives

• Money
• Banks and the money supply
• Money market
• Monetary policy

2
2
1. Money
1. Definition of Money
– Set of assets in an economy
– That people regularly use
– To buy goods and services from other people
2. Functions of money
– Medium of exchange
– Unit of account
– Store of value

3
 tiénlhi assets coin dried 3
1. Money otio.car.la
'
D- é functions

dot
• Medium of exchange → trung
gian ,
trao

– Item that buyers give to sellers

• When they want to purchase goods and services
• Unit of account -

. teach toair
– Yardstick people use to post prices and record
debts d-in tiong
lai
hi.in tai
• Store of value :
CÉT tui giatai ,
→
hiutuitieii d-é tiong lai ching
– Item that people can use to transfer
purchasing power
• From the present to the future
4
2. Banks and the money supply
1. Basic concepts •

Ngan liang trung ñong

:
central bank

• The money supply (MS): the quantity of money

available in the economy
• The money supply equals currency plus
demand deposits:
tieiigiieekiho.in
MS = C + D
/ \
balances bank acc
bills and
in
the coins
paper
in the hands g the that depositors can

access on demand
public .

by writing a
check -

5
2. Banks and the money supply
• Reserves : Deposits that banks have received but
have not loaned out. Ichi tui dot ) ra

• Reserve ratio (rr): Fraction of deposits that banks

hold as reserves. It includes reserve requirement
- minimum set by the central bank and excess
↓
reserves - above the legal minimum. = commercial
bank

• T-account which is a simplified accounting

statement that shows changes in a bank’s assets
-

and liabilities. ghisutnayotoiaiatiusauvan.it via commercial bank

-

%ii1
6
2. Banks and the money supply
• 100-Percent-Reserve Banking: a system in
which banks hold all deposits as reserves. D= 12
• Fractional-Reserve Banking: a system in
which banks hold a fraction of their deposits
as reserves. IN gain ha-ugd.li tut phair )
e-

7
2. Banks and the money supply
2.2 How Banks affect money supply
SCENARIO 1: 100 – Percent - Reserve Banking
 Initially C = $100, D = $0, MS = & too
 Now suppose households deposit the $100 at “First
National Bank.”
 After the deposit,
FIRST NATIONAL BANK C = $0,
Assets Liabilities D = $100,
MS = & too
Reserves Deposits
12--4100 D= 'S, too  100% Reserve
Banking has no
impact on size of
money supply.
8
2. Banks and the Money Supply
• SCENARIO 2: Fractional - Reserve Banking
– Reserve ratio = 1/10 (10 percent)

9
2. Banks and the Money Supply
FIRST NATIONAL BANK
Assets Liabilities
Reserves :& 10 Deposits $100
Loans $90i

SECOND NATIONAL BANK

Assets Liabilities
Reserves :{ 9 Deposits $90
Loans :& 81

THIRD NATIONAL BANK

Assets Liabilities
Reserves :& 811 Deposits $81
Loans $72,9
:

10
2. Banks and the Money Supply
• How much money is eventually created in the
economy?
• Original deposit = $100 too 100.10%
-

90 90 10%
• First National lending = $ …90
- .

• Second National lending = $ … 81

• Third National lending = $ … 72,9

•… w
• Total money supply = $...doo ✗ ( 0,9%0,9^-1 0,9)
+
. . .

=
too ✗
Fois
= 100×10

= 1000

11
2. Banks and the Money Supply

- Banks hold only a fraction of deposits in

reserve
– Banks create …money
wealth
– But it doesn’t create …
Tai sao ti & too → & tooo lie phai gian lion ? Bin cnn.hn?ecta.otieii bank t.ae cat
,

loans loans responsibility

→
bi
money mong timing
ho:p
nay
loans doing thot lñ
corresponding
medium og exchange
↓ dat
plniongli.in te ao

12
12
2. Banks and the Money Supply
2.3 A model of the money supply
(Cosmin )
• Monetary base, B = C + R controlled by the
↓ ↓
central bank reserve
currency

• Reserve ratio, rr = R/D

depends on regulations & bank policies
ltiktieiimoittrintiéeigiie )
• Currency-deposit ratio, cr = C/D
depends on households’ preferences

13
2. Banks and the Money Supply
2.3 A model of the money supply
• Solving for money multiplier (m)
• B=C+R
• MS = C + D
• MS / B = C + D / C + R
=

:÷ .

lchiacatimaiicho D)
=

¥÷¥ money
multiplier
-

:-#
m
= =

14
 2. Banks and the Money Supply
• rr < 1, then m > 1
• If monetary base changes by ΔB,
then ΔMS = m × Δ B
• m is the money multiplier,
the increase in the money supply
resulting from a one-dollar increase
in the monetary base.

15
 Question
Suppose households decide to hold more of
their money as currency and less in the form
of demand deposits.
1. Determine impact on money supply.
2. Explain the intuition for your result.

16
2. Banks and the Money Supply
2.4 Central bank and tools of monetary control
• A central bank : an institution designed to
oversee the banking system and regulate the
quantity of money in the economy kieinisoat
• The Federal Reserve System (“the Fed”) serves
as the central bank for the United States.
The state bank Vietnam
of banks make loans more

Ms = m ✗ B
m
change and reserve Kbs
B the amount of currency
depend
✗
= on
r
make loans
the banks reserve or

CR :
§
rr =
5-

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2. Banks and the Money Supply
• Tools of monetary control
a. Open-market operations 10 Mo)

– Purchase and sale of government bonds by

the central bank nghie.pm.mu bair trai phiein
: a

chink phii
– To increase the money supply
buy government bonds
• The central bank …
tea Heir cho naini
ng
– To reduce the money supply grit phial
eai → Bo' m

sell tieiiralñu
• The central bank … government bonds B↑
thing →

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2. Banks and the Money Supply
• Tools of monetary control
b. Reserve requirements
– Regulations on minimum amount of reserves
• That banks must hold against deposits
– An increase in reserve requirement rr ↑→m↓→MS↓
decrease ↓ bank reserve
•…
more
the money supply less loans m↓
→

– A decrease in reserve requirement

•…
increase
the money supply rr↓→m↑→MS↑

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2. Banks and the Money Supply
• Tools of monetary control
c. The discount rate Lai suit chiétkhaii =

– Interest rate on the loans that the central

bank makes to banks
– Higher discount rate bank borrow less increase →
→

[ decrease loans
reserve

• …↓ the money supply ←

m↓ → MS ↓
– Smaller discount rate
• … ↑ the money supply
bank and consequences
Analyze
'
so 2 What is run ? causes
Essay : a

of bank runs .
Give an example .

20
2. Banks and the Money Supply
2.5 Problems in controlling the money supply
• The central bank
– Does not control

• The central bank

– Does not control

21
 Bank runs and the money supply

• Bank runs
– Depositors suspect that a bank may go bankrupt
• “Run” to the bank to withdraw their deposits
– Problem for banks under fractional-reserve banking
• Cannot satisfy withdrawal requests from all depositors
– When a bank run occurs
• The bank - is forced to close its doors
• Until some bank loans are repaid
• Or until some lender of last resort provides it with the
currency it needs to satisfy depositors
– Complicate the control of the money supply
22
• Homework: What is a bank run? Analyze causes
and consequences of bank runs. Give an
example.

23
3. Money market
lhuyétua thick thank khoain
'
:Ly

 The theory of liquidity preference

• Interest rate (denoted r) adjusts to balance supply and
demand for money
laisuiitdanhnghia
:

– The nominal interest rate is the interest rate as

usually reported
– the real interest rate is the interest rate corrected for
the effects of inflation
? chiñi Aoi
?
aia nominal
Chieti dir moi real tri dz tray
tray say
ra

do real -
nominal =
const ?? ?
= IT

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3.1 Money supply
• Money supply: assume fixed by central
bank, does not depend on interest rate
central bank
↳ depend only on

Interest
↳ another components don't
rate

Money supply (MS)

have effect on Ms

Quantity Quantity of Money

Fixed by the central bank

2255
3.2 Money demand nhñt
tieiiwtioihtnanhfan.ca
doing
dei goods and
mua .
..

• The demand for money refers to how much assets

people wish to hold in the form of money
• For simplicity, suppose household wealth includes
only two assets:
– Money – liquid but pays no interest rate
=
-

– Interest - bearing assets – pay interest rate but

not as liquid more risky
-
,

• Interest rate is the opportunity cost of holding

money trade off by interest
we

cause when holding

money ,
rate .

2266
3.2 Money demand
Lai sniit ↑ →
Caiitieii ↓

Interest
rate

Money
Demand (MD)

Quantity of Money

2277
3.3 Equilibrium in the money market
Interest
rate

Money supply (MS)

more
buy
financi al
assets
Ms > MD
surplus →

→ ↓
→
r1
holders og financial assets
-
- . . .

Equilibrium
Interest rate reduceinterest rate
r2 in order to it lai chong mua
'
Giani quoi d-in rz
Demand (MD) Nhñ ne chi tea
Money '

Md1 Quantity Md 2 Quantity of Money

brim this
hiding 'm
ra
Fixed by the central bank 1-
new MD uiañgna got assets

ciinng
'
Ban di
phai
'
ban di →

mua → Taing rate who ñgmua

↓
Avi hi vé Equilibrium
che dieii drink cñubang ?
'

Think baj
'
co
→

28
4. Monetary Policy
• Monetary policy: the supply of money set by the
central bank lthaydoicungtieiiaiauganha-ngteunguo.mg )
• The central bank increases the money supply -
Mii
Expansionary monetary policy i
ring
-0
– Money-supply curve shifts right ↓ I↑

I#
r →

– Interest rate (r) falls

– A fall in r increases I
– At any given price level, AD increases
– Thus, aggregate-demand curve shifts right

tntpt ↑
29
The central bank increases the money
supply
(a) The Money Market (b) The Aggregate-Demand Curve
Interest Price
rate level
MS1 MS2
1. When the central bank
increases the
r1 money supply . . .
P

r2

AD2
MD AD1

0 Quantity 0 Y1 Y2 Quantity of output

2. . . . the equilibrium of money 3. . . . which increases the quantity of goods and
interest rate falls . . . services demanded at a given price level.

30
4. Monetary Policy
• The central bank decreases the money supply –
Contractionary monetary policy

i÷÷÷÷
– Money-supply curve shifts left
– Interest rate increases
– A rise in r decreases I
– At any given price level, AD decrease r↑ → I↓

- Thus, aggregate-demand curve shifts left y ↓

a- ¥+0

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The central bank decreases the money
supply
(a) The Money Market (b) The Aggregate-Demand Curve
Interest Price
rate level
MS2 MS1
1. When the central bank
decreases the
r2 money supply . . .
P

r1

AD1
MD , AD2

0 Quantity 0 Y2 Y1 Quantity of output

2. . . . the equilibrium of money 3. . . . which decreases the quantity of goods and
interest rate rises . . . services demanded at a given price level.

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