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Central Bank

central bank demand = currency demand plus reserve demand by banks  

  • currency - more convenient for small/illegal transactions
    • CUd = cMd
  • checks (checkable deposits) - better for large transactions, safer than currency
    • Dd = (1-c)Md
    • c = fraction of money held in currency
  • R = reserves = (reserve ratio)(D) = (reserve ratio)(1-c)(Md)
    • reserve ratio - fraction of money that banks hold in reserve to cover withdrawals, loans, etc >> always reserve ratio < 1
  • Hd = central bank demand = CUd+Rd
    • Hd = cMd + (reserve ratio)(1-c)Md = Md[c+(reserve ratio)(1-c)]
    • Hd / [c+(reserve ratio)(1-c)] = Md
  • interest rate adjusts to set Hd and CUd+Rd equal
    • Hd = $Y L(i) [c+(reserve ratio)(1-c)]
  • money multiplier - 1 / [c+(reserve ratio)(1-c)]
    • augments the effect of change in central bank supply
    • ppl hold more currency (money demand increases) >> money multiplier decreases >> central bank has less impact
    • central bank has largest effect when ppl hold the least money
    • equal to 1 when either bank puts everything into reserves (reserve ratio = 1) or ppl hold all their money in currency

federal funds market - market for bank reserves  

  • interest rates move so supply/demand for reserves remain equal
  • banks w/ too much reserve lend to banks w/ not enough
  • federal funds rate - interest rate determined by market between banks
Subject: 
Economics
Subject X2: 
Economics

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