Money

Money is a good that acts as a medium of exchange in transactions. Classically it is said that money acts as a unit of account, a store of value, and a medium of exchange. Most authors find that the first two are nonessential properties that follow from the third. In fact, other goods are often better than money at being intertemporal stores of value, since most monies degrade in value over time through inflation or the overthrow of governments. Narrow definition: Money means anything that is generally accepted in payment for goods or services or in repayment of debts. Example: Currency that is paper money and Coins (Taka, Dollar etc), Checks (Checking account deposits), savings accounts. Broad definition: Money can defined as currency, demand deposits, and other items that are used to make purchase and wealth, the total collection of pieces of property that serve to store of value. Example: currency and checks plus bond, stock, land, house etc.

Function of Money:
In the past, money was generally considered to have the following four main functions, which are summed up in a rhyme found in older economics textbooks: "Money is a matter of functions four, a medium, a measure, a standard, a store." That is, money functions as a medium of exchange, a unit of account, a standard of deferred payment, and a store of value. However, most modern textbooks now list only three functions, that of medium of exchange, unit of account, and store of value, not considering a standard of deferred payment as a distinguished function, but rather subsuming it in the others. Regardless of what asset is recognized by an economic community as money, in general it serves three functions: Money is a medium of exchange. Money is a measure of value. Money is a store of value. Medium of Exchange

When money is used to intermediate the exchange of goods and services, it is performing a function as a medium of exchange. It thereby avoids the inefficiencies of a barter system, such as the 'double coincidence of wants' problem. -used to pay for goods and services

-minimize transaction cost (less than barter system), which increase economic efficiency. Some criteria a. Easily standardized b. Widely accepted c. Divisible, i.e. easy to make change d. Easy to carry e. Do not deteriorate Unit of account A unit of account is a standard numerical unit of measurement of the market value of goods, services, and other transactions. Also known as a "measure" or "standard" of relative worth and deferred payment, a unit of account is a necessary prerequisite for the formulation of commercial agreements that involve debt. To function as a 'unit of account', whatever is being used as money must be: Divisible into smaller units without loss of value; precious metals can be coined from bars, or melted down into bars again. Fungible: that is, one unit or piece must be perceived as equivalent to any other, which is why diamonds, works of art or real estate are not suitable as money. A specific weight, or measure, or size to be verifiably countable. For instance, coins are often made with ridges around the edges, so that any removal of material from the coin (lowering its commodity value) will be easy to detect. Store of value

To act as a store of value, a commodity, a form of money, or financial capital must be able to be reliably saved, stored, and retrieved and be predictably useful when it is so retrieved. Fiat currency like paper or electronic money no longer backed by gold in most countries is not considered by some economists to be a store of value. Money can also serve as a store of value, since it can quickly be exchanged for desired goods and services. Many assets can be used as a store of value, including stocks, bonds, and real estate. However, there are transaction costs associated with converting these assets into money in order to purchase a desired good or service. These transaction costs could include monetary fees as well as time delays involved in the liquidation process. In contrast, money is a poor store of value during periods of inflation, while the value of real estate tends to appreciate during such periods. Thus, the benefits of holding money must by balanced against the risks of holding money.

Standard of deferred payment:

While standard of deferred payment is distinguished by some texts, particularly older ones, other texts subsume this under other functions. A "standard of deferred payment" is an accepted way to settle a debt a unit in which debts are denominated, and the status of money as legal tender, in those jurisdictions which have this concept, states that it may function for the discharge of debts. When debts are denominated in money, the real value of debts may change due to inflation and deflation, and for sovereign and international debts via debasement and devaluation

Evolution of Money:
Money evolved as a way of avoiding the complexities and difficulties of barter. Money is any asset that is recognized by an economic community as having value. Historically, such assets have included, among other things, shells, stone disks (which can be somewhat difficult to carry around), gold, and bank notes. The modern monetary system has its roots in the gold of medieval Europe. In the Middle Ages, gold and gold coins were the common currency. However, the wealthy found that carrying large quantities of gold around was difficult and made them the target of thieves. To avoid carrying gold coins, people began depositing them for safekeeping with goldsmiths, who often had heavily guarded vaults in which to store their valuable inventories of gold. The goldsmiths charged a fee for their services and issued receipts, or gold notes, in the amount of the deposits. Exchanging these receipts was much simpler and safer than carrying around gold coins. In addition, the depositors could retrieve their gold on demand. Goldsmiths during this time became aware that few people actually wanted their gold coins back when the gold notes were so easy to use for exchange. They therefore began lending some of the gold on deposit to borrowers who paid a fee, called interest. These goldsmiths were the precursors to our modern fractional reserve banking system.

Types of Money:
Currently, most modern monetary systems are based on fiat money. However, for most of history, almost all money was commodity money, such as gold and silver coins. As economies developed, commodity money was eventually replaced by representative money, such as the gold standard, as traders found the physical transportation of gold and silver burdensome. Fiat currencies gradually took over in the last hundred years, especially since the breakup of the Bretton Woods system in the early 1970s. 1. Commodity Money Money made up of precious metal or another valuable commodity is called commodity money. In the modern world we take money for granted. However, pause for a moment and imagine what life would be like without money. Suppose that you want to consume a particular good or service, such as a pair of shoes. If money didn't exist, you would need to barter with the cobbler for the pair of shoes that you want. Barter is the process of

directly exchanging one good or service for another. In order to purchase the pair of shoes, you would need to have something to trade for the shoes. If you specialized in growing peaches, you would need to bring enough bushels of peaches to the cobbler's shop to purchase the pair of shoes. If the cobbler wanted your peaches and you wanted his shoes, then a double coincidence of wants would exist and trade could take place. But what if the cobbler didn't want your peaches? In that case you would have to find out what he did want, for example, beef. Then you would have to trade your peaches for beef and the beef for shoes. But what if the person selling beef had no desire for peaches, but instead wants a computer? Then you would have to trade your peaches for a computer and it would take a lot of peaches to buy a computer. Then you would have to trade your computer for beef and the beef for shoes. But what if? At some point it would become easier to make the shoes yourself or to just do without. Many items have been used as commodity money such as naturally scarce precious metals, conch shells, barley, beads etc., as well as many other things that are thought of as having value. Commodity money value comes from the commodity out of which it is made. The commodity itself constitutes the money, and the money is the commodity. Examples of commodities that have been used as mediums of exchange include gold, silver, copper, rice, salt, peppercorns, large stones, decorated belts, shells, alcohol, cigarettes, cannabis, candy, etc. These items were sometimes used in a metric of perceived value in conjunction to one another, in various commodity valuation or Price System economies. Use of commodity money is similar to barter, but commodity money provides a simple and automatic unit of account for the commodity which is being used as money. Although some gold coins such as the Krugerrand are considered legal tender, there is no record of their face value on either side of the coin. The rationale for this is that emphasis is laid on their direct link to the prevailing value of their fine gold content. [23] American Eagles are imprinted with their gold content and legal tender face value. [6] South Africa ranks among the very few countries where gold coins have been minted as negotiable currency and still remain available for general purchase The ISO currency code of gold bullion is XAU. ISO 4217 includes codes not only for currencies, but also for precious metals (gold, silver, palladium and platinum; by definition expressed per one troy ounce, as compared to "1 USD") and certain other entities used in international finance, e.g. Special Drawing Rights. Barter system Gold standard Silver standard Other metallic

Drawbacks: many exchange rate in barter system, very heavy and hard to transfer, Not portable, Problem of coincidence etc. 2. Fiat Money

Fiat money or fiat currency is money whose value is not derived from any intrinsic value or guarantee that it can be converted into a valuable commodity (such as gold). Instead, it has value only by government order (fiat). Usually, the government declares the fiat currency (typically notes and coins from a central bank, such as the Federal Reserve System in the U.S.) to be legal tender, making it unlawful to not accept the fiat currency as a means of repayment for all debts, public and private. Fiat money, if physically represented in the form of currency (paper or coins) can be accidentally damaged or destroyed. However, fiat money has an advantage over representative or commodity money, in that the same laws that created the money can also define rules for its replacement in case of damage or destruction. For example, the U.S. government will replace mutilated Federal Reserve notes (U.S. fiat money) if at least half of the physical note can be reconstructed, or if it can be otherwise proven to have been destroyed. By contrast, commodity money which has been lost or destroyed cannot be recovered. Decreed by govt. as legal tender (meaning that legally it must be accepted as payment for debts) Lighter than coins Drawbacks; easily stolen, expensive to transport 3. Credit Money Credit money is any claim against a physical or legal person that can be used for the purchase of goods and services. Credit money differs from commodity and fiat money in two ways: It is not payable on demand (although in the case of fiat money, "demand payment" is a purely symbolic act since all that can be demanded is other types of fiat currency) and there is some element of risk that the real value upon fulfillment of the claim will not be equal to real value expected at the time of purchase. This risk comes about in two ways and affects both buyer and seller. First it is a claim and the claimant may default (not pay). High levels of default have destructive supply side effects. If manufacturers and service providers do not receive payment for the goods they produce, they will not have the resources to buy the labor and materials needed to produce new goods and services. This reduces supply, increases prices and raises unemployment, possibly triggering a period of stagflation. In extreme cases, widespread defaults can cause a lack of confidence in lending institutions and lead to economic depression. For example, abuse of credit arrangements is considered one of the significant causes of the Great Depression of the 1930s. The second source of risk is time. Credit money is a promise of future payment. If the interest rate on the claim fails to compensate for the combined impact of the inflation (or deflation) rate and the time value of money, the seller will receive less real value than anticipated. If the interest rate on the claim overcompensates, the buyer will pay more

than expected. The process of fractional-reserve banking has a cumulative effect of money creation by banks. 4. Representative Money In 1875 economist William Stanley Jevons described what he called "representative money," i.e., money that consists of token coins, or other physical tokens such as certificates, that can be reliably exchanged for a fixed quantity of a commodity such as gold or silver. The value of representative money stands in direct and fixed relation to the commodity that backs it, while not itself being composed of that commodity 5. E-Money/Digital Currency Electronic payment systems, already in place for use by credit-card processors, were adapted in the 1990s for use in electronic commerce (e-commerce) on the Internet. Such "digital cash" payments allow customers to pay for on-line orders using secure accounts established with specialized financial institutions; related technology is used for on-line payment of bills. Substitute of cash. E-money means electronic money, money that exists only in electronic form like the binary chain of two variables between zero and one. Debit card, credit card, travelers check Smart card- contain a computer chip that allows it to be loaded with digital cash from the owners bank account whenever needed E-cash- which is used on the internet to purchase goods and services Drawbacks: Technical problem, nonavailability of ATM booths.

MEASURING MONEY:
The money supply is the amount of financial instruments within a specific economy available for purchasing goods or services. The money supply is usually measured as three escalating categories M1, M2 and M3. The categories grow in size with M1 being currency (coins and bills) and checking account deposits. M2 is currency, checking account deposits and savings account deposits, and M3 is M2 plus time deposits. M1 includes only the most liquid financial instruments, and M3 relatively illiquid instruments. Another measure of money, M0, is also used, although unlike the other measures, it does not represent actual purchasing power by firms and households in the economy. M0 is base money, or the amount of money actually issued by the central bank of a country. It

is measured as currency plus deposits of banks and other institutions at the central bank. M0 is also the only money that can satisfy the reserve requirements of commercial banks.

M1= currency + travelers checks + Demand deposit + Other checkable deposits M2 = M1+ short term time deposit + repurchase agreement + savings deposits + money market deposits + money market mutual funds M3 = M2 + Long term time deposits and repurchase agreement + capital markets mutual funds + share + Eurodollars

(N.B. Money earned by illegal way is called Black money. The issue of whitening the black money is controversial from ethical stand point of view. )

Q1. Why does money have value? Money doesn't have any inherent value. It is simply pieces of paper or numbers in a ledger. A car has value because it can help you get where you need to go. Water has a value because it has a use; if you dont drink enough of it you will die. Unless you enjoy looking at pictures of deceased national heroes, money has no more use than any other piece of paper. It didn't always work this way. In the past money was in the form of coins, generally composed of precious metals such as gold and silver. The value of the coins was roughly based on the value of the metals they contained, because you could always melt the coins down and use the metal for other purposes. Until a few decades ago paper money in different countries was based on the gold standard or silver standard or some combination of the two. This meant that you could take some paper money to the government, who would exchange it for some gold or some silver based on an exchange rate set by the government. The gold standard lasted until 1971 when President Nixon announced that the United States would no longer exchange dollars for gold. This ended the Bretton Woods system, which will be the focus of a future article. Now the United States is on a system of fiat money, which is not tied to any other commodity. So these pieces of paper in your pocket are nothing but pieces of paper. Q2: Credit Cards are a form of Money. Is it True or False? Why? An interesting and unusual question about credit cards! Let's take a look at what is considered to be money and where credit cards fit in. In the article How much is the per capita money supply in the U.S.? we saw that there were three basic definitions of money: M1, M2, and M3. We quoted the The Federal Reserve Bank of New York as stating: "[M1] consists of currency in the hands of the public; travelers checks; demand deposits, and other deposits against which checks can be written. M2 includes M1, plus savings accounts, time deposits of under $100,000, and balances in retail money market mutual funds. M3 includes M2 plus large-denomination ($100,000 or more) time deposits, balances in institutional money funds, repurchase liabilities issued by depository institutions, and Eurodollars held by U.S. residents at foreign branches of U.S. banks and at all banks in the United Kingdom and Canada." Since credit cards do not fall under M1, M2 or M3 they are not considered to be part of the money supply. Here's why: Suppose my girlfriend and I go shopping for classic video games, and I find a copy of Music Machine for the Atari 2600 selling for $50. I do not have the $50 so I get my

girlfriend to pay for the game on my behalf with the promise that I'll pay her back at some later date. So we have the following transactions: Q3: Slowly as paper money dissappears, shall we come down to a system of electronic credits across the world? Is that possible? Does that mean we shall have one currency across the world but different prices? Maybe a pot of roast or soup will cost 10 Earth Currency Units in Malawi but 45 ECUs in New Delhi. Can you tell me more about it?

I'm not a futurist, so I'm not the best qualified person to answer this question. However, I'll give it a shot. I'd like to hear what other people think about the matter - you can contact me by using the feedback form. To the question: I don't think paper money will completely disappear, but electronic transactions have become more and more common over the last few decades - I see no reason why this trend will not continue. We may get to the point where paper money transactions become incredibly rare. At that point paper money may act as the backing to our electronic currency, the way the gold standard once backed paper money. That would be kind of unusual, given that gold has an intrinsic value-in-use, whereas money is just pieces of paper. I'm not sure if we'll ever get down to one single currency, though I suspect the number of currencies will fall as time goes on and the world becomes more globalized. We see that happening today - when a Canadian oil firm negotiates a contract with a Saudi Arabian company, typically the deal is negotiated in American dollars or Euros, not Canadian dollars. I could see the world getting to the point where there are only 4 or 5 different currencies in use. At that point we'd likely have a battle over standards, such as we had with VHS vs. Beta VCRs, Apple vs. IBM-compatible computers, and Blu-Ray vs. HDDVD media players. If that happens, then it is likely that soup could be purchased in the same currency in both Malawi and New Delhi. The prices could vary between the two locations as strict purchasing power parity is unlikely to hold for a product like soup, for the reasons given in A Beginner's Guide to Purchasing Power Parity Theory.

ASA University Bangladesh (ASAUB) Program: BBA, Semester: Fall (2009) Fin 221: Money and Banking Class Test Exam #1, Section: 4H Total Marks: 10, Time: 30 Minutes (Answer all the questions having equal values)

1. 2. 3. 4.

How does money avoid the difficulties and complexities of barter system? When a banking system is said to be loaned-up? Give an example. How does credit money differ from commodity and fiat money? Suppose the public wishes to hold Tk 0.55 in pocket money (i.e., currency and coin) and Tk 0.25 in time deposits (especially CDs), while depository institutions plan to keep Tk 0.05 in excess reserves for each new taka of transaction money received. If reserve requirements on demand deposits and time and savings deposit are 10% and 5% respectively, what is the size of the deposit expansion multiplier and the money supply multiplier? 5. Why is the value of Money supply multiplier always greater than that of Deposit expansion multiplier? Defend your opinion.

ASA University Bangladesh (ASAUB) Program: BBA, Semester: Fall (2009) Fin 221: Money and Banking Class Test Exam #1, Section: 4H Total Marks: 10, Time: 30 Minutes (Answer all the questions having equal values) 1. 2. 3. 4. How does money avoid the difficulties and complexities of barter system? When a banking system is said to be loaned-up? Give an example. How does credit money differ from commodity and fiat money? Suppose the public wishes to hold Tk 0.55 in pocket money (i.e., currency and coin) and Tk 0.25 in time deposits (especially CDs), while depository institutions plan to keep Tk 0.05 in excess reserves for each new taka of transaction money received. If reserve requirements on demand deposits and time and savings deposit are 10% and 5% respectively, what is the size of the deposit expansion multiplier and the money supply multiplier?

5. Why is the value of Money supply multiplier always greater than that of Deposit expansion multiplier? Defend your opinion.

ASA University Bangladesh (ASAUB) Program: BBA, Semester: Fall (2009) Fin 221: Money and Banking Class Test Exam # 1, Section: 4A Total Marks: 10, Time: 30 Minutes (Answer all the questions having equal values) 1. Explain the problem of double coincidence of wants under a barter system. 2. Describe the basic functions of money in a modern economy. 3. What is meant by the supply of money? 4. Illustrate the following equation of money supply:

M = (1+c/rd+c+art+e) R
5. What constitutes reserves? Why should bank hold excess reserves at all knowing the fact that it is a nonearning assets for the bank?

ASA University Bangladesh (ASAUB) Program: BBA, Semester: Fall (2009) Fin 221: Money and Banking Class Test Exam#1, Section: 4B Total Marks: 10, Time: 30 Minutes (Answer all the questions having equal values) 1. Explain the problem of double coincidence of wants under the barter system. 2. Describe the basic functions of money in a modern economy. 3. What is meant by the supply of money? 4. Illustrate the following equation of money supply:

M = (1+c/rd+c+art+e) R
5. What constitutes reserves? Why should bank hold excess reserves at all knowing the fact that it is a nonearning assets for the bank?

Measurement of Money Supply

The money supply is the amount of financial instruments within a specific economy available for purchasing goods or services. The money supply is usually measured as three escalating categories M1, M2 and M3. The categories grow in size with M1 being currency (coins and bills) and checking account deposits. M2 is currency, checking account deposits and savings account deposits, and M3 is M2 plus time deposits. M1 includes only the most liquid financial instruments, and M3 relatively illiquid instruments. Another measure of money, M0, is also used, although unlike the other measures, it does not represent actual purchasing power by firms and households in the economy. M0 is base money, or the amount of money actually issued by the central bank of a country. It is measured as currency plus deposits of banks and other institutions at the central bank. M0 is also the only money that can satisfy the reserve requirements of commercial banks.

M1= currency + travelers checks + Demand deposit + Other checkable deposits M2 = M1+ short term time deposit + repurchase agreement + savings deposits + money market deposits + money market mutual funds M3 = M2 + Long term time deposits and repurchase agreement + capital markets mutual funds + share + Eurodollars With the narrowly defined money supply (M) equal to the sum of currency (C), and demand deposit (DD), held by the public. The amount of C on any date is the amount the public chooses to hold: the public can, without restriction and without delay, switch out of DD into C or out of C into DD. However, the public doesnt control what the total of C plus DD-that is, M-will be, and therefore it doesnt have control over what DD will be. Therefore, the first step in explaining what determines M is to explain what determines DD. We begin by assuming that the public is holding the amount of currency it wishes to hold and that this amount temporarily remains fixed. For simplicity, we also assume that the only deposits that the public hold is DD. Given these assumptions, what then determines the amount of DD? That amount depends on two things-the dollar amount of reserves held by the banks and the size of the percentage reserve requirement imposed on the banks DD by the central bank. Only two assets held by commercial banks qualify as reserves-the currency in their vaults and their deposits with the central bank. The central bank can control the total dollar amount of these two assets held by the commercial banks. With this power over the

amount of these assets plus the power to set the minimum percentage of the DD liabilities that the banks must hold in the form of two assets, the central bank determines the maximum amount of DD that can be outstanding for any time period. If the outstanding amount of DD is at its maximum, then

R = rd.DD or R = rd. DD
Here R is the amount of reserves and rd is the percentage reserve requirement against DD. We may rewrite this equation as under

DD = R/rd or DD = (1/rd) R or DD = (1/rd) R

Here (1/rd) is the called the deposit expansion multiplier. In the simplest case it is assumed that the commercial banks expand DD to the maximum amount consistent with any increase in reserves. A third complication arises because some banks do not do this: some banks choose not to be fully loaned up, but to hold some excess reserves This means that the actual expansion of DD will be less than the maximum possible with any given increase in reserves. Now we will modify the three complications and determine the change in money supply generated by a change in reserves.

1. The public varies its currency holdings. 2. Commercial banks have Time Deposit as well as Demand Deposit. 3. The banks choose to hold excess reserve i.e. the banking systems are no
longer loaned up. 1) The public varies its currency holdings As the publics holdings of demand deposits increase year by year, its holdings of currency also increase. If people and firms now want more currency, they draw checks against their DD and currency is drained from the banks. We now consider the fact that the banks will not be able to retain all of the increase in reserves as they as they expand DD; some of the reserves will be lost through withdrawals of currency. Because the increase in reserves will either be absorbed as an increase in required reserve or as an increase in currency in hands of the public, we have

R = rd. DD +C C = cDD
Where c = C/DD

R = rd. DD + cDD R = (rd+c) DD DD = (1/rd+c) R

The deposit expansion multiplier is (1/rd+c) in contrast to (1/rd) before allowance for this fact. We have

M = DD+C
To find M that result from any R, we must add C to both sides of equation for DD. For DD we have

DD = (1/rd) R
For M, we have

M = DD+C = (1/rd+c) R + C = (1+c/rd+c). R, because C = cDD

Here (1+c/rd+c) is the money supply multiplier 2. Commercial banks have Time Deposit as well as Demand Deposit. With two complications now being considered, an increase in reserves will be absorbed in meeting the reserve requirement against an increase in DD, in meeting a cash drain, and in meeting the required reserve against an increase in TD. That is

R = rd. DD +C + rt TD
Here TD is time deposit and rt is the percentage reserve requirement against TD.

Where TD = a DD a = TD/DD R = rd. DD + cDD +art DD = (rd+c+art) DD DD = (1/rd+c+art) R M = (1+c/rd+c+art) R 3) The banks choose to hold excess reserves
Someone once said that banks abhor nonearning assets as much as nature abhors a vacuum. If that is correct, we might expect that banks would hold only the minimum amount of reserves (nonearning assets) needed to meet the percentage reserve requirements against their deposits-in other words, that banks would ordinarily be in a fully loaned-up position. However, in practice, the banks do hold excess reserves, although the amount is relatively small. The reason for holding excess reserve is protection in the event of unusually large withdrawals of currency or unusually large losses of reserves to other banks through adverse clearing balances.

ER = eDD
Here ER is the desired amount of excess reserves and e is the desired ratio of ER to DD i.e. e = ER/DD

ER = e DD R = rd. DD +C + rt TD + e DD = (rd+c+art+e) DD DD = (1/rd+c+art+e) R M = (1+c/rd+c+art+e) R

In the absence of these complications, the central bank control over the money supply could be, at least potentially, as precise as its control over total reserves. However, once these three complications are taken into account, the central bank power to effect any desired change in the money supply from one month to the next is significantly diminished. The following equation provides a helpful framework through which to show how these complications restrict the central bank ability to control the money supply:

M = (1+c/rd+c+art+e) R
From a purely mechanical point of view, M is rigidly linked to R as long as the value of multiplier remains fixed. If such were actually the case, the central bank control over M would as precise as its control over R, and its control over R is in fact fairly precise. Of these terms, the central bank has complete control over rd and rt . Neither the public nor the commercial banks have any power to change them. But the public and the commercial banks still have the power to maintain larger or smaller values for c, a and e from one time period to the next quite independently.

An Illustration:
Suppose percentage reserve requirement (rd) is 20% and actual reserves (R) are 25 billion, what would be the maximum amount of DD that can be outstanding for any time period? We have

R = rd.DD DD = 1/.20*25 = 125 billion

Suppose now that the central bank takes action to increase R by 100 million, but leaves the percentage reserve requirement unchanged. The new DD would be

DD = (1/rd) R DD = 1/.20*100

= 500 million 1. Assuming that rd is 20% and c is 40% and the central bank increases R by 100 million through open market operation, then DD = (1/rd+c) R = (1/.2+.4)*100 = 166.67 million M = (1+c/rd+c). R = (1.4/.60)*100 = 233.33 million
A lower or higher value for c will mean a larger or smaller money supply multiplier respectively. For example, for c=.30 and c=.50, the money supply multiplier will be 2.6 and 2.1 respectively.

2. Assuming that rd is 20%, c is 40%, rt is 5%, a is 2 and the central bank increases R by
100 million through open market operation, then

DD = (1/rd+c+art) R
= (1/.2+.4+2*.05)*100 = 143 million

M = (1+c/rd+c+art) R
= (1.4/.2+.4+2*.05)*100 = 200 million A change in reserves of 100 million will lead to a change in money supply of 200 million. 3. Assuming that rd is 20% , c is 40%, rt is 5%, a is 2 , e is 1% and the central bank increases R by 100 million through open market operation, then

DD = (1/rd+c+art+e) R = (1/.2+.4+2*.05+.01)*100 = 141million M = (1+c/rd+c+art+e) R = (1.4/.2+.4+2*.05+.01)*100 = 197million

A change in reserves of 100 million will lead to a change in money supply of 197 million. Exercise#1: If M = C+DD, derive the deposit expansion and money supply multiplier under the following cases: Case 1: The banking system is loaned up and C and TD are fixed. Case 2 : The public varies its currency holdings Case3: The commercial banks have TD as well as DD

Case4 : The banks choose to hold excess reserve Exercise#2 Suppose the public wishes to hold Tk 0.55 in pocket money (i.e., currency and coin) and Tk 0.45 in time deposits (especially CDs), while depository institutions plan to keep Tk 0.10 in excess reserves for each new taka of transaction money received. If reserve requirements on transaction deposits and time and savings deposit are 5 percent i) ii) iii) iv) v) Exercise#3 Suppose the public wishes to hold Tk 0.45 in pocket money (i.e., currency and coin) and Tk 0.35 in time deposits (especially CDs), while depository institutions plan to keep Tk 0.10 in excess reserves for each new taka of transaction money received. If reserve requirements on transaction deposits and time and savings deposit are 3 percent, what is the size of the transactions deposit multiplier? The money multiplier? Suppose Tk 5,000 in new excess reserves appear in the banking system. How much will be created in the form of new deposits and loans? What is the size of the transactions deposit multiplier? What is the size of the transactions money multiplier? Suppose Tk 5,000 in new excess reserves appear in the banking system. How much will be created in the form of new deposits and loans? How much will be created in the form of money supply? Why money multiplier and money supply is greater than that of deposit