Explain the Mechanism Behind the Money Multiplier. How Can the Monetary Authorities Influence Its Size and the Supply of Money?
Title: Explain the mechanism behind the money multiplier. How can the monetary authorities influence its size and the supply of money?
Thursday 16th December 2010
Word count: 1599
Money is a general accepted means of payment for the purchase and selling of goods and services (Pilbeam 2010). These could include purchasing loans, settling debts. Money is also used to as a common unit of account, where prices for products and services can be easily compared. Money can also act as a store of value, where individuals or institutions can deposit them in commercial banks to earn interest over time.
The money multiplier defines the relationship between the money supply and the monetary base. The money multiplier was originally developed by Brunner and Meltzer and it has become the standard concept to explain how the policy actions of central banks influence the money stock. It also has been used in empirical analyses of money stock control and the impact of monetary policy actions on other economic variables.
The behaviour of the money multiplier has changed considerably over time. From 1870 to 1970, it was relatively stable, fluctuating within narrow limits. Since the 70s it has more than doubled in magnitude. During the last ten years the demand for cash by the public has fallen and the demand for bank deposits has increased considerably. The private sector has made greater use of the banks because they have offered interest rates on deposits in order to attract business. As intermediaries, banks have expanded their assets, and bank lending has increased because of shifts in supply rather than in demand. At the same time, banks have been able to lower their cash reserves and expand their lending.
This essay will carefully derive the money multiplier mechanism and it will also explain how monetary authorises can influence its size and the money supply in the economy.
Mishkin (2010) stated that high-powered money or the monetary base is the sum of the
Thursday 16th December 2010
Word count: 1599
Money is a general accepted means of payment for the purchase and selling of goods and services (Pilbeam 2010). These could include purchasing loans, settling debts. Money is also used to as a common unit of account, where prices for products and services can be easily compared. Money can also act as a store of value, where individuals or institutions can deposit them in commercial banks to earn interest over time.
The money multiplier defines the relationship between the money supply and the monetary base. The money multiplier was originally developed by Brunner and Meltzer and it has become the standard concept to explain how the policy actions of central banks influence the money stock. It also has been used in empirical analyses of money stock control and the impact of monetary policy actions on other economic variables.
The behaviour of the money multiplier has changed considerably over time. From 1870 to 1970, it was relatively stable, fluctuating within narrow limits. Since the 70s it has more than doubled in magnitude. During the last ten years the demand for cash by the public has fallen and the demand for bank deposits has increased considerably. The private sector has made greater use of the banks because they have offered interest rates on deposits in order to attract business. As intermediaries, banks have expanded their assets, and bank lending has increased because of shifts in supply rather than in demand. At the same time, banks have been able to lower their cash reserves and expand their lending.
This essay will carefully derive the money multiplier mechanism and it will also explain how monetary authorises can influence its size and the money supply in the economy.
Mishkin (2010) stated that high-powered money or the monetary base is the sum of the
References: Bank of England (2010) Available at: http://www.bankofengland.co.uk/ [Accessed 14th December 2010] BBC (2007) Available at: http://news.bbc.co.uk/1/hi/business/6997765.stm [Accessed: 12th December 2010] Mishkin, F.S (2010) The Economics of Money, Banking and Financial Markets 9th edn Pearson Boston Pilbeam, K. (2010) Finance and Financial Markets 3rd edn Palgrave Macmillan Hampshire Randall, J (2010) Interviews with leaders in business and finance. Sky News. 14th December 2010 Thomas, G. (2010) Money Supply & The Money Multiplier, the Adjustment Process and the Money Supply in an Open Economy Lecture Notes 2 & 3 [6BUS0341]. University of Hertfordshire 15th December, 2010.