Description
It also explains how do banks create new money with help o expample. It explains what is money multiplier and implications of money multiplier.
Money and the Banking System
Savings deposits (Checkable)
Postoffice savings deposits
Shares
Mutual fund investment
Coins & Rupee notes in circulation
Fixed deposits with banks
Bank deposits with the RBI
Deposits with nonbank financial institutions
Savings deposits with banks
Postoffice savings deposits
Shares
Mutual fund investment
Coins & Rupee notes in circulation
Fixed deposits with banks
Cash held in the treasury
Deposits with nonbank financial institutions
Which of the above financial assets can be called `money’?
Functions of Money
Medium of Exchange
Store of value
Measurement of Money in India
The most familiar form of money, narrow money, includes: ? Currency with public (C) ? Demand Deposits (D) ? `Other’ Deposits with the RBI (OD)
M1
Approx. 50% of M1 is held as currency with the public.
Measurement of Money in India
Another important measure of money, broad money, includes: M1 + Time Deposits with banks
M3
?Is
M3 a stock or flow?
Money Stock Measures
as on last reporting Friday of Jan. 2007
Currency Notes in circulation with the Circulation Rupee coins public of Small coins Cash in hand with banks Total Deposit money of the public
2007
(in Rs. Crores)
2 3 4 5 6
1 (6+9)
4,80,197 6,477 1,577 16,406 4,71,845
Post office savings bank depos- its 11 5,041 2 (10+11)
M
(2+3+4-5)
No. 10: Money Stock Measures
March 31/ Reporting Currency with the public Deposit money of the public Fridays of the month/ Notes in Circulation of Cash in Total Demand ‘Other’ Total Last reporting Friday circula- Rupee Small hand with (2+3+4-5) deposits depos- its (7+8) of the month tion(1) coins(2) coins(2) banks with with 1 2 3 4 5 6 7 8 9 January 4,80,197 6,477
Demand deposits with banks ‘Other’ deposits with Reserve Bank Total (7+8)
1,577 16,406 4,71,845 3,97,986 5,709
7
M
4,03,695
8,75,540
8 9
10
12
Time deposits with banks 13
3,97,986
3 (10+13)
M
(Rs. crore)
Total post office depos- its 15 25,969
8,80,581 21,96,166 30,71,706
5,709
14
4,03,695 8,75,540 5,041 8,80,581 21,96,166 30,71,706 25,969 30,97,675
M1
(6+9)
10 11 12 13 14 15 16
Post office savings bank deposits M2 (10+11)
Time deposits with banks M3 (10+13)
Total post office deposits M4 (14+15)
Source: RBI, Bulletin
New Measures of Money
NM3 is the residency-based broad money aggregate. The difference between M3 and NM3, essentially lies in the treatment of non-resident repatriable fixed foreign currency liabilities of the banking system in the money supply compilation. (Reddy Committee Report, 1998). Liquidity aggregates are defined as follows: L1= NM3 + Select deposits with the post office saving banks. L2= L1 +Term deposits with term lending institutions and refinancing institutions (FIs) + Term borrowing by FIs + Certificates of deposits issued by FIs. L3= L2 + Public deposits of non-banking financial companies.
Money Spectrum
The narrow measure of money includes only those forms of money available for immediate exchange, while broader measures include forms held as a store of value as well
Modern forms of Money
Currency issued by the Reserve Bank and guaranteed by the government ? Fiat Money ? Legal tender ? Trust and Confidence ? Unlimited expansion of money possible, in theory.
Modern forms of Money
Demand Deposits with the banks ? Money in the savings account can be withdrawn on demand, at any time ? Facility of writing cheques lends it the characteristic of money as a means of payment
Bank deposits and loans
What do the banks do with the deposits? Banks retain a fraction of the money deposited with them and lend the rest to borrowers – households, corporates, governments.
Bank reserves
The cash retained by the banks (reserves) is to ensure repayment to the depositors who may come for withdrawal on any given day. Banks have to hold the reserves as vault cash or as deposits with the central bank.
Bank’s B/S: An Example
First National Bank
Assets Liabilities
Reserves Deposits Rs10.00 Rs100.00 Loans Rs90.00
Total Assets Total Liabilities Rs100.00 Rs100.00
The deposits are recorded as liabilities for the banks whereas credit (loans) constitute banks’ assets.
Bank’s B/S: An Example
First National Bank
Assets Liabilities
Reserves Deposits Rs10.00 Rs100.00 Loans Rs90.00
Total Assets Total Liabilities Rs100.00 Rs100.00
Fractional reserve banking is the practice of holding a fraction of money deposited as reserves and lending out the rest.
Reserve Requirement
• Banks draw on the reserves to meet
the withdrawal needs of the depositors.
• Central Bank as the monetary
authority sets the reserve requirement.
• Banks don’t earn an interest on the
reserves. Higher the reserves, smaller is the loan portfolio and greater is the income foregone by the banks.
Reserve Ratio
Cash Reserve Ratio (CRR): 6.5 % of additional demand and time liabilities CRR is an instrument of monetary control.
Banks use the depositors money to make loans. What happens if all the depositors come to the bank at the same time to ask for their money?
Crisis of Confidence
A bank will not be able to repay its liabilities if all its depositors want it at one point of time. This could cause the problem of BANK RUN, if the Central Bank doesn’t protect them.
How do banks create new money?
An Example:
First National Bank
Assets Liabilities
Second National Bank
Assets
Reserves Rs9.00
Liabilities
Deposits Rs90.00
Reserves Deposits Rs10.00 Rs100.00 Loans Rs90.00 Total Assets Total Liabilities Rs100.00 Rs100.00
Loans
Rs81.00 Total Assets Rs90.00 Total Liabilities Rs90.00
Creation of Money by Banks
First National Bank
Assets Liabilities
Second National Bank
Assets
Reserves Rs9.00
Liabilities
Deposits Rs90.00
Reserves Deposits Rs10.00 Rs100.00 Loans Rs90.00 Total Assets Total Liabilities Rs100.00 Rs100.00
Loans
Rs81.00 Total Assets Rs90.00 Total Liabilities Rs90.00
Creation of Money by Banks
First National Bank
Assets Liabilities
Second National Bank
Assets
Reserves Rs9.00
Liabilities
Deposits Rs90.00
Reserves Deposits Rs10.00 Rs100.00 Loans Rs90.00 Total Assets Total Liabilities Rs100.00 Rs100.00
Loans
Rs81.00 Total Assets Rs90.00 Total Liabilities Rs90.00
Total Money Supply = Rs190.00!
Creation of Money by Banks
When one bank makes a loan, it is generally deposited into another or the same bank thus creating more deposits and therefore more money.
How much money is eventually created?
Original deposit First National lending Second National lending Third National lending ? ? Total money supply
= Rs 100.00 = Rs 90.00 [=0.9 x Rs 100.00] = Rs 81.00 [=0.9 x Rs 90.00] = Rs 72.90 [=0.9 x Rs 81.00] ? ? = Rs. 1,000
The Multiplier Effect
Each unit of the monetary base allows (1/r) units of money to be created leading to a money supply that is a multiple of the monetary base; all due to multiple expansion of loans and deposits
The Multiplier Effect
?
With a reserve requirement (r) of 10% or 1/10th of deposits, the multiplier will be 10.
?
For an initial deposit of Rs.100 the expansion in money would be Rs. 1000.
What is the impact on money supply if banks hold 100% reserves?
RELATIONSHIP BETWEEN HIGHPOWERED MONEY & MONEY STOCK
The Money Multiplier
M=C+D
H = Reserve (base) Money M = Money Supply H=C+R C = Currency, R = Reserves with banks M C+D D = Demand deposits --- = --------H C+R M C/D + 1 --- = -------------H C/D + R/D
MONEY Multiplier MODEL
M H
c = currency-deposit ratio --- = ------------ r = reserve-deposit ratio
c+1 c+r
c+1 M = --------- H c+r
M=mH c+1 Where m = -------c+r
MONEY Multiplier MODEL
Implications of Money Multiplier
When r increases, banks lend a smaller fraction of each Rupee of deposits; hence less money is created ? m falls. When c increases, public want more currency and put less in banks as deposits; hence banks can make less loans; less money is created ? m falls.
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
1950-51 1954-55 1958-59 1962-63 1966-67 1970-71 1974-75 1978-79 1982-83 1986-87 1990-91 1994-95 1998-99 2002-03
Money Multiplier in India
Problems in Controlling the Money Supply
Two problems that the RBI faces due to fractional-reserve banking: (1) The RBI does not control the amount of money that households choose to hold as deposits in banks.
(2) The RBI does not control the amount of money that bankers choose/ able to lend.
Who affects the Money Supply?
The RBI alone does not. 3 sets of people: • central bank, • commercial banks, • general public The interactions between these 3 groups determine the economy’s money supply.
Monetary authority
Money
Public
Banking system
percentage
10 15 20 25 0 5
1954-55 1957-58 1960-61 1963-64 1966-67 1969-70 1972-73 1975-76 1978-79 1981-82 1984-85 1987-88 1990-91 1993-94 1996-97 1999-00 2002-03 2005-6
Growth of Money (M3)
Overview
Money Demand 1.QTM – Mv = Py = Y 2.Keynesian: M = f(Y, r) 3.Friedman: Modern version
doc_594818395.pptx
It also explains how do banks create new money with help o expample. It explains what is money multiplier and implications of money multiplier.
Money and the Banking System
Savings deposits (Checkable)
Postoffice savings deposits
Shares
Mutual fund investment
Coins & Rupee notes in circulation
Fixed deposits with banks
Bank deposits with the RBI
Deposits with nonbank financial institutions
Savings deposits with banks
Postoffice savings deposits
Shares
Mutual fund investment
Coins & Rupee notes in circulation
Fixed deposits with banks
Cash held in the treasury
Deposits with nonbank financial institutions
Which of the above financial assets can be called `money’?
Functions of Money
Medium of Exchange
Store of value
Measurement of Money in India
The most familiar form of money, narrow money, includes: ? Currency with public (C) ? Demand Deposits (D) ? `Other’ Deposits with the RBI (OD)
M1
Approx. 50% of M1 is held as currency with the public.
Measurement of Money in India
Another important measure of money, broad money, includes: M1 + Time Deposits with banks
M3
?Is
M3 a stock or flow?
Money Stock Measures
as on last reporting Friday of Jan. 2007
Currency Notes in circulation with the Circulation Rupee coins public of Small coins Cash in hand with banks Total Deposit money of the public
2007
(in Rs. Crores)
2 3 4 5 6
1 (6+9)
4,80,197 6,477 1,577 16,406 4,71,845
Post office savings bank depos- its 11 5,041 2 (10+11)
M
(2+3+4-5)
No. 10: Money Stock Measures
March 31/ Reporting Currency with the public Deposit money of the public Fridays of the month/ Notes in Circulation of Cash in Total Demand ‘Other’ Total Last reporting Friday circula- Rupee Small hand with (2+3+4-5) deposits depos- its (7+8) of the month tion(1) coins(2) coins(2) banks with with 1 2 3 4 5 6 7 8 9 January 4,80,197 6,477
Demand deposits with banks ‘Other’ deposits with Reserve Bank Total (7+8)
1,577 16,406 4,71,845 3,97,986 5,709
7
M
4,03,695
8,75,540
8 9
10
12
Time deposits with banks 13
3,97,986
3 (10+13)
M
(Rs. crore)
Total post office depos- its 15 25,969
8,80,581 21,96,166 30,71,706
5,709
14
4,03,695 8,75,540 5,041 8,80,581 21,96,166 30,71,706 25,969 30,97,675
M1
(6+9)
10 11 12 13 14 15 16
Post office savings bank deposits M2 (10+11)
Time deposits with banks M3 (10+13)
Total post office deposits M4 (14+15)
Source: RBI, Bulletin
New Measures of Money
NM3 is the residency-based broad money aggregate. The difference between M3 and NM3, essentially lies in the treatment of non-resident repatriable fixed foreign currency liabilities of the banking system in the money supply compilation. (Reddy Committee Report, 1998). Liquidity aggregates are defined as follows: L1= NM3 + Select deposits with the post office saving banks. L2= L1 +Term deposits with term lending institutions and refinancing institutions (FIs) + Term borrowing by FIs + Certificates of deposits issued by FIs. L3= L2 + Public deposits of non-banking financial companies.
Money Spectrum
The narrow measure of money includes only those forms of money available for immediate exchange, while broader measures include forms held as a store of value as well
Modern forms of Money
Currency issued by the Reserve Bank and guaranteed by the government ? Fiat Money ? Legal tender ? Trust and Confidence ? Unlimited expansion of money possible, in theory.
Modern forms of Money
Demand Deposits with the banks ? Money in the savings account can be withdrawn on demand, at any time ? Facility of writing cheques lends it the characteristic of money as a means of payment
Bank deposits and loans
What do the banks do with the deposits? Banks retain a fraction of the money deposited with them and lend the rest to borrowers – households, corporates, governments.
Bank reserves
The cash retained by the banks (reserves) is to ensure repayment to the depositors who may come for withdrawal on any given day. Banks have to hold the reserves as vault cash or as deposits with the central bank.
Bank’s B/S: An Example
First National Bank
Assets Liabilities
Reserves Deposits Rs10.00 Rs100.00 Loans Rs90.00
Total Assets Total Liabilities Rs100.00 Rs100.00
The deposits are recorded as liabilities for the banks whereas credit (loans) constitute banks’ assets.
Bank’s B/S: An Example
First National Bank
Assets Liabilities
Reserves Deposits Rs10.00 Rs100.00 Loans Rs90.00
Total Assets Total Liabilities Rs100.00 Rs100.00
Fractional reserve banking is the practice of holding a fraction of money deposited as reserves and lending out the rest.
Reserve Requirement
• Banks draw on the reserves to meet
the withdrawal needs of the depositors.
• Central Bank as the monetary
authority sets the reserve requirement.
• Banks don’t earn an interest on the
reserves. Higher the reserves, smaller is the loan portfolio and greater is the income foregone by the banks.
Reserve Ratio
Cash Reserve Ratio (CRR): 6.5 % of additional demand and time liabilities CRR is an instrument of monetary control.
Banks use the depositors money to make loans. What happens if all the depositors come to the bank at the same time to ask for their money?
Crisis of Confidence
A bank will not be able to repay its liabilities if all its depositors want it at one point of time. This could cause the problem of BANK RUN, if the Central Bank doesn’t protect them.
How do banks create new money?
An Example:
First National Bank
Assets Liabilities
Second National Bank
Assets
Reserves Rs9.00
Liabilities
Deposits Rs90.00
Reserves Deposits Rs10.00 Rs100.00 Loans Rs90.00 Total Assets Total Liabilities Rs100.00 Rs100.00
Loans
Rs81.00 Total Assets Rs90.00 Total Liabilities Rs90.00
Creation of Money by Banks
First National Bank
Assets Liabilities
Second National Bank
Assets
Reserves Rs9.00
Liabilities
Deposits Rs90.00
Reserves Deposits Rs10.00 Rs100.00 Loans Rs90.00 Total Assets Total Liabilities Rs100.00 Rs100.00
Loans
Rs81.00 Total Assets Rs90.00 Total Liabilities Rs90.00
Creation of Money by Banks
First National Bank
Assets Liabilities
Second National Bank
Assets
Reserves Rs9.00
Liabilities
Deposits Rs90.00
Reserves Deposits Rs10.00 Rs100.00 Loans Rs90.00 Total Assets Total Liabilities Rs100.00 Rs100.00
Loans
Rs81.00 Total Assets Rs90.00 Total Liabilities Rs90.00
Total Money Supply = Rs190.00!
Creation of Money by Banks
When one bank makes a loan, it is generally deposited into another or the same bank thus creating more deposits and therefore more money.
How much money is eventually created?
Original deposit First National lending Second National lending Third National lending ? ? Total money supply
= Rs 100.00 = Rs 90.00 [=0.9 x Rs 100.00] = Rs 81.00 [=0.9 x Rs 90.00] = Rs 72.90 [=0.9 x Rs 81.00] ? ? = Rs. 1,000
The Multiplier Effect
Each unit of the monetary base allows (1/r) units of money to be created leading to a money supply that is a multiple of the monetary base; all due to multiple expansion of loans and deposits
The Multiplier Effect
?
With a reserve requirement (r) of 10% or 1/10th of deposits, the multiplier will be 10.
?
For an initial deposit of Rs.100 the expansion in money would be Rs. 1000.
What is the impact on money supply if banks hold 100% reserves?
RELATIONSHIP BETWEEN HIGHPOWERED MONEY & MONEY STOCK
The Money Multiplier
M=C+D
H = Reserve (base) Money M = Money Supply H=C+R C = Currency, R = Reserves with banks M C+D D = Demand deposits --- = --------H C+R M C/D + 1 --- = -------------H C/D + R/D
MONEY Multiplier MODEL
M H
c = currency-deposit ratio --- = ------------ r = reserve-deposit ratio
c+1 c+r
c+1 M = --------- H c+r
M=mH c+1 Where m = -------c+r
MONEY Multiplier MODEL
Implications of Money Multiplier
When r increases, banks lend a smaller fraction of each Rupee of deposits; hence less money is created ? m falls. When c increases, public want more currency and put less in banks as deposits; hence banks can make less loans; less money is created ? m falls.
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
1950-51 1954-55 1958-59 1962-63 1966-67 1970-71 1974-75 1978-79 1982-83 1986-87 1990-91 1994-95 1998-99 2002-03
Money Multiplier in India
Problems in Controlling the Money Supply
Two problems that the RBI faces due to fractional-reserve banking: (1) The RBI does not control the amount of money that households choose to hold as deposits in banks.
(2) The RBI does not control the amount of money that bankers choose/ able to lend.
Who affects the Money Supply?
The RBI alone does not. 3 sets of people: • central bank, • commercial banks, • general public The interactions between these 3 groups determine the economy’s money supply.
Monetary authority
Money
Public
Banking system
percentage
10 15 20 25 0 5
1954-55 1957-58 1960-61 1963-64 1966-67 1969-70 1972-73 1975-76 1978-79 1981-82 1984-85 1987-88 1990-91 1993-94 1996-97 1999-00 2002-03 2005-6
Growth of Money (M3)
Overview
Money Demand 1.QTM – Mv = Py = Y 2.Keynesian: M = f(Y, r) 3.Friedman: Modern version
doc_594818395.pptx