The UK banking sector plays a crucial role in determining not only the amount of money in circulation in the economy but also the form that it takes (e.g. fiat money or current/deposit account holdings available to be given by the banks as loans). These aspects of the monetary policy can, in turn, have key implications in achieving specific macro policy goals such as price stability, full employment and economic growth. This paper will first discuss the money multiplier approach and how the non-bank public's demand for currency affects the money supply. It will then conclude by looking at the policy implications and the limitations of this approach.
Bank deposits make up for over 80% of the M31. M3 money equals notes & coins in circulation, plus private sector total sterling current and deposit accounts. Thus bank behavior is very important to money supply.
[...] Thus the reserve ratio r = r = rr + er R becomes: D RR D where required reserve ratio = Therefore we can re-write the money multiplier in full as: c (rr + er ) + c If required reserves 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'. [...]
[...] Conclusion The banking sector can exert influence on Money Supply by variations in the ratio of currency to deposits and the Bank of England by influencing the base rate & www.en.oboulo.com reserve ratio. The less that c and r the vary, the greater the degree of exogenity of MS. The Monetarist view here is that MS can thus be changed independently of MD (in other words velocity is stable and predictable). In the opposing Keynesian theory, MS is determined by MD and so cannot be changed independently of the demand for money (velocity is unstable and unpredictable). [...]
[...] When a central bank is said to be "easing", it triggers an increase in money supply by purchasing government securities on the open market thus increasing available funds for private banks to loan through fractional reserve banking (the issue of new money through loans) and thus grows the money supply. When the central bank is "tightening", it slows the process of private bank issue by selling securities on the open market to banks and pulling money (that could be loaned) out of the private banking sector. [...]
[...] the monetary authorities provider a particular fixed quantity of base money from which the banks must meet reserve requirements and obtain their desired holdings of excess reserves and from which the public acquires its currency holdings) then the banking system as a whole can only increase its volume of deposits by increasing the interest rate on time deposits and so attract more cash reserves by persuading the public to hold less currency. One critique of the multiplier model is that the money supply 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 to deposit ratio so that a higher proportion of high-powered money is held by banks. Banks move up the MC curve by increasing the interest rate, and thereby increasing deposits, and also increasing loans at same time. From the basic bank multiplier approach, the currency to www.en.oboulo.com deposit ratio has decreased , because iD and iL have risen, thus causing the bank multiplier to become larger. NB: m = c r+c and C D Before c and r were assumed constant, but c changes. [...]
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