Banking 13: Open Market Operations

TL;DR

This video explains the concepts of the money supply, base money, bank money, and how the government can increase or decrease the money supply.

Transcript

In the last video, I hinted that this was leading to a discussion of an elastic money supply-- or a supply of money that can change depending on the needs for the money. So before we go there-- and I took a little hiatus and told you a little bit about treasuries because that's a critical component-- let's review what the money supply even is. So t... Read More

Key Insights

• 💵 The money supply consists of base money and bank money, with the former containing Federal Reserve notes and demand deposits.
• 💵 Increasing or decreasing the money supply has implications on interest rates, economic growth, and the liquidity of banks.
• 💵 The central bank can expand the money supply by creating new money, buying treasuries, and injecting currency into the banking system.

Questions & Answers

Q: What is the difference between Federal Reserve notes and Federal Reserve deposit accounts?

Both are part of the base money supply, but notes are more fungible as they can be directly exchanged, while deposit accounts require a more complex transfer process.

Q: How is the money supply expanded or decreased?

The government or central bank can increase the money supply by lowering the reserve requirement or by creating more reserves through lending and issuing treasuries. Decreasing the money supply could involve raising the reserve requirement or reducing reserves.

Q: Why would the government or central bank want to increase or decrease the money supply?

Increasing the money supply is necessary during economic expansion or when there is increased demand for money. Not increasing the money supply during such times could make money more expensive, leading to higher interest rates that may restrict economic growth.

Q: How does fractional reserve banking work for the central bank?

The central bank can also engage in fractional reserve lending, as it has no reserve requirement. It can increase reserves by creating new money, buying treasuries, and injecting the currency into the banking system.

Summary & Key Takeaways

• The money supply consists of two definitions: M0, which includes gold reserves, and a broader definition that includes Federal Reserve deposits and notes.

• Base money supply, or M0, refers to the total cash in circulation, including Federal Reserve notes and demand deposits.

• Bank money, or M1, refers to the total amount of money people think they have, including demand deposit accounts.