Quiz 16: Monetary Control


The Federal Reserve's major assets are securities, Loans, other assets. Its major liabilities are monetary base, other current liabilities. The current (September 2013) relative amounts of assets and liabilities of Fed are as follows: all figures are in billions of dollars. img

Fed can increase the money supply by engaging open market operations. By purchasing government securities, increasing making many more loans to financial institutions such as AIG and Bear Stearns to prevent them from failing. Fed increases the monetary base by increasing the amount of reserves and payment to securities, increasing bank deposit reserves. The role of banks : The Fed can increase or decrease the monetary base as much as it desires. Changes in the monetary base work their way through the banking system, leading banks to create additional money or destroy existing money. Recall that the money supply is not just the amount of currency outstanding but also includes various deposit accounts at banks. Thus, banks may influence the money supply through their impact on those accounts. The basic idea is that a bank makes a loan that is deposited in other banks, causing increases in the funds on deposit at those banks.

The sum of currency held by the non-bank public and banks reserves is called the monetary base. In banks' reserves some currency held in banks' vaults and some held on deposit in banks' accounts at the Fed. The term bank means all depositary institutions, including commercial banks, savings banks, savings and loan associations, and credit unions. The Federal Reserve determines it. The Fed controls the money supply mainly by changing the monetary base. Another name for the monetary base is high-powered money. To know how a change in monetary base affects the money supply, the following formula is used: Change in money supply = multiplier img Change in monetary base img img The symbol img means the change in the variable that follows.

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