Home Random Page


CATEGORIES:

BiologyChemistryConstructionCultureEcologyEconomyElectronicsFinanceGeographyHistoryInformaticsLawMathematicsMechanicsMedicineOtherPedagogyPhilosophyPhysicsPolicyPsychologySociologySportTourism






The Determination of the Interest Rate II

Now introduce banks into the model. Banks receive funds from depositors (individuals and firms) and allow their depositors to write checks against (or withdraw) their account balances. These checkable deposits are liabilities of banks. On the asset side, banks hold bonds, loans (which are claims against borrowers), and reserves of some of their deposits. Some bank reserves are held in cash and the rest in accounts at the central bank. Banks hold reserves in part to protect against daily excesses of withdrawals (in currency or check form) over deposits and in part because they are required to do so by the central bank. In the United States, the Federal Reserve may set the required reserve ratio between 7% and 22% of checkable deposits. The actual reserve ratio in the United States is about 10%.

 

Reconsidering the central bank balance sheet in an economy with banks, the only difference is that central bank liabilities now consist of currency held by the public plus reserves held by banks. Central bank liabilities—the money the central bank has created—are called central bank money.

 

Now reconsider money market equilibrium in terms of central bank money (H). The demand for money arises from two sources: currency held by the public and reserves held by banks. The supply of money is under the control of the central bank. Thus, equilibrium is given by

 

H=CUd+Rd, (4.4)

 

where CUd refers to the demand for currency and Rd to the demand for reserves.

On the demand side, assume that overall money demand is determined as before, i.e., Md=$YL(i), and that the demand for currency (as opposed to checkable deposits) is a fraction c (where 0<c<1) of overall money demand. In addition, assume that banks keep a fixed fraction q of checkable deposits as reserves. Putting these assumptions together with equation (4.4) gives

 

H= CUd+Rd=cMd+ q(1-c)Md=[c+ q (1-c)]$YL(i). (4.5)

 

Equilibrium can be depicted just as in Figure 4.1, with H substituting for M on the horizontal axis. An increase in H (through open market operations) leads to a decrease in the nominal interest rate.

 


Date: 2015-02-16; view: 892


<== previous page | next page ==>
The Determination of the Interest Rate I | Two Alternative Ways to Think about the Equilibrium
doclecture.net - lectures - 2014-2024 year. Copyright infringement or personal data (0.005 sec.)