This appendix deals with money creation and monetary policy. It is intended to supplement the rather brief discussion of the money supply in Chapter 13.
The various depository institutions--commercial banks, savings and loan associations, mutual savings banks, and credit unions--are discussed because of their role in the money creation process.
The Federal Reserve is also discussed both because of its role in the money creation process and its role as the nation's central bank.
The money creation process is discussed at some length and a formula is developed that permits the determination of the maximum increase in the money supply due to an increase in reserves. It is then explained that the actual increase in the money supply will fall short of the maximum increase if (1) depository institutions add to their holdings of excess reserves and (2) the public adds to its holdings of cash.
| The appendix also considers the means by which the Federal Reserve can alter the money supply: (1) open market operations, (2) changing reserve requirements, and (3) altering the discount rate. After considering the advantages and disadvantages of each approach, it is noted that the Federal Reserve almost always uses open market operations to alter the money supply.
| Instructional Objectives |
| After completing this appendix, your students should know:
1. The roles that depository institutions and the Federal Reserve play in the money creation process.
2. Why a change in reserves generates a change in the money supply several times greater than the initial change in reserves.
3. How to determine the maximum possible change in the money supply corresponding to a change in reserves and why the maximum change is unlikely to occur.
4. The means by which the Federal Reserve can alter the money supply and the
advantages and disadvantages of each approach.
| Terms from Previous Chapters |
| You should review the terms in this section at the beginning of your discussion of the appendix.
monetary policy (Chapter 11)
central bank(Chapter 13)
money supply (Chapter 13)
demand deposits (Chapter 13)
| Key Terms |
| These terms are introduced in this appendix:
depository institutions
national banks
state banks
member banks
vault cash
required reserves
excess reserves
reserve requirement
open market operations
discount rate
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