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