Bank deposits make up over 80% of the M3. Thus bank behavior is important to money supply.
Cash is an asset to the bank. Deposits are a liability since the bank must repay them on demand or at short notice.
The banks know that at any point in time only a % of investors will remove deposits. They calculate how much will be withdrawn and invest the rest for profit.
In the balance account, the total of assets equals the total of liabilities.
[...] the monetary authorities provider a particular quantity of base money) The banking system as a whole can only its volume of deposits by the interest rate on time deposits and so attract more cash reserves by persuading the public to hold currency. One critique of the multiplier model is that c and r are in fact highly variable and so make the multiplier unstable. A second critique is that the Ms process presented by the money multiplier approach is that it is inapplicable to the credit economy (Radcliffe Report, Kaldor Evidence to the Select Committee on Monetary Policy). [...]
[...] The non-bank sector is thereby induced to hold a small currency: deposit ratio so that a higher proportion of high-powered money is held by banks. Banks move up the MC curve by rate, and loans, and deposits at same time. In the basic bank multiplier approach, as the currency: deposit ratio has , because iD and iL have risen, causing the bank multiplier to become larger. NB: m = and Before c and r were assume constant, but c changes. [...]
[...] Thus the reserve ratio becomes: r = rr + er where required reserve ratio = Therefore we can Re-write the money multiplier as: m = If rr is a policy determined variable, control of the money supply might be achievable by H if the ratios of c and e are stable. However, the question of stability of the money supply processes arises because c and e are what Friedman and Schwartz call ‘proximate determinants'. These ratios are the outcome of portfolio decisions of both the non- bank public and bank sectors. [...]
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