key principles of unit 4

Key principles:

A single bank can create money (through loans) by the amount of excess reserves

The banking system as a whole can create money by a multiple (depositor money multiplier) of the initial Excess reserves

Initial deposit	New or existing $	Bank reserves	Immediate change in MS
Cash	Existing	Increase	No, composition of M1 money changes (cash to currency)
*FED purchase of a bond from public	New	Increase	Yes, money coming from the FED puts new dollars in circulation
*Bank purchase of a bond from the public	New	Increase	Yes, b/c money is coming from the reserve which puts new money in circulation

*= Deposit + money created in the banking system

Factors that weaken the effectiveness of the deposit multiplier:

                If banks fail to loan out all of their excess reserves

                If bank customers take their loans in cash rather than in new checking account deposits, it creates a cash or currency drain

Money Market

Demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded

MD or DM increase then interest rate decrease, DM or MD decreases then interest rate increases