Banking 13: Open market operations발음듣기
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Banking 13: Open market operations
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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.발음듣기
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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.발음듣기
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So there were two definitions. When we had originally talked about kind of an M0, I talked about just the gold reserves, but now we're going to expand that definition a little bit and I think you can tell--발음듣기
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I've got a lot of questions about this - eventually getting off the gold reserve system and we will get there and we're kind of already there, but now I'll consider the base money supply as Federal Reserve deposits and notes.발음듣기
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So in this reality that I just created, all of the Federal Reserve deposits have essentially been turned into notes, but if this bank didn't want all cash, it could have had some of this as just a checking account with the Federal Reserve bank.발음듣기
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So a Federal Reserve note and a Federal Reserve deposit account is essentially the same thing.발음듣기
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You can hand it to someone and then they can hand it to someone else, while a checking account or demand account with the Federal Reserve bank, you have to kind of do a wire transfer or write a check, et cetera, but that is the base money supply.발음듣기
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And that's essentially the size of the liabilities of the Federal Reserve, in very broad terms. We'll go into detail on the actual Federal Reserve's balance sheet in the near future.발음듣기
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And that's the cash out there, which are the Federal Reserve notes plus the Federal Reserve demand deposits.발음듣기
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So for example, this could have been just 100, like a checking account at the reserve bank and then this over here would have been a checking account instead.발음듣기
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But it would still be considered part of the base money supply because if this bank, who had a checking account, says, I just want that in terms of notes, then the Federal Reserve bank will just issue notes and cancel out this checking account and it would turn back into notes.발음듣기
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It's sometimes referred to as that and the formal definition is M1 - and that's essentially that notion that I went over I think almost 10 videos ago - how much money do people think they have?발음듣기
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This bank had $100 in gold and it could lend out up to $200 in - or it could put out up to $200 in checking deposit accounts.발음듣기
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So it has $200. Right, that's what I was - because we talked about earlier in the last video that we have a 50% reserve ratio, which tells us that if this bank has $100 in reserves, that it can essentially manage - or it can issue $200 in demand deposit accounts.발음듣기
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And so the total amount of money that people think they have, either in demand deposit accounts - in this situation, I'm assuming that all of the cash is sitting in the reserve bank, although we do know that some of this is going to be sitting around circulating.발음듣기
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But let's just say we live in a world where everyone uses debit cards all the time and no-one uses cash.발음듣기
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So we can kind of assume that banks tend to get as close to their reserve requirement as they can because they don't get interest on reserves.발음듣기
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So if the reserve requirement were 10% and our base money was $200, we would probably see $2,000 in the M1 supply.발음듣기
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So my question to you is - and maybe you want to pause and think about this is - how can the government or the central bank or, how can the economy, increase or decrease the money supply?발음듣기
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And I guess the first question is, why would you want to increase or decrease the money supply?발음듣기
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Or maybe it's just seasonal. Maybe it's the crop planting season so a lot of farmers need their cash in order to hire people to plant the crops.발음듣기
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If you don't increase the money supply at those times when you have economic expansion or there's just more demand because of some type of seasonal fluctuation--발음듣기
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if you don't increase the money, then what you're going to do is money's going to become more expensive.발음듣기
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And I'll do a whole video on that so don't get too confused, but money getting more expensive means that interest rates will go up.발음듣기
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And if money becomes too expensive, then some good projects, maybe some farmers who might have planted seeds, wouldn't be able to - and so you would kind of restrict economic expansion.발음듣기
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But we'll have a whole other discussion on when does it make sense to expand or contract money.발음듣기
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So there's two ways. I just said if this reserve requirement were 10%, then these banks could create more checking accounts, right?발음듣기
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They could lend out more money and create more checking accounts if the reserve requirement were 10%.발음듣기
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Because we've said in the past that the Federal Reserve bank actually sets these reserve requirements.발음듣기
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But the problem with that tool, if you think about it, is, if we made a reserve requirement 10%, right?발음듣기
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And all of a sudden all of these banks started lending a lot more money and they only had 10%.발음듣기
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If you were to lower the reserve requirement and then wanted to actually increase it again, you would actually make a lot of banks become undercapitalized, because most banks just operate right at where they need to.발음듣기
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So the question is, if you're not going to change the reserve requirement, which is the ratio of the reserves to checking accounts,발음듣기
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if you're not going to mess with that, the only other way that you can actually increase the number of checking accounts is if somehow you can increase the reserves.발음듣기
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Well, let's just say that - we're hopefully already reasonably familiar with fractional reserve banking.발음듣기
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And that's because to some degree, it can always provide the liquidity because its notes are obligations of the government.발음듣기
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So what essentially the Federal Reserve can do is - and this is the printing press of the base money supply that people talk about.발음듣기
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But there's two printing presses. There's the base money printing press and then there's the leverage printing press.발음듣기
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So if this increases - well, I'll do a whole video on that another - I don't want to get too technical because I realize I'm running out of time.발음듣기
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So let's say it prints 100 of the notes, right, and those are just - it literally just prints those dollars.발음듣기
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It pays the treasury to print it for them, but it creates these notes and then of course, offsetting that is a liability, right?발음듣기
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Notes outstanding, 100 liability. And then what it does is, it takes these $100 - I mean, these are literally dollar bills although it could be some type of demand account or whatever, but take these $100 bills that it printed and then it can buy treasury securities.발음듣기
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Because whenever the government does issue treasuries, it's bought by just a bunch of people in the world.발음듣기
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There's always a bunch of treasuries sitting out there as long as the treasury has some debt.발음듣기
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Maybe I don't want to sell it at the current price so they have to pay me a little bit more than the current price in order for me to part with it--발음듣기
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and I'll do a whole other video on what that means and how that changes the yield curve and all of that, but I just want to get you to that base notion that the treasury essentially creates a notes outstanding liability and has an offsetting $100 of dollar bills that it just created or prints--발음듣기
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and then it can use those $100 bills to buy treasuries, or government IOUs, in the open market.발음듣기
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Maybe I deposited it up here, but - and my checking account grows a little bit, but what's the net effect?발음듣기
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Now all of a sudden the banking system, the national banking system, has more currency, more dollar reserves, that apply to its reserve ratio.발음듣기
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So I would have essentially increased the base - so now the M0 goes from $200 to $300 right, because I have $300 in notes outstanding.발음듣기
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And now my M1 - I took that $100 bill that the treasury gave me, deposited it in a bank account.발음듣기
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Now I have a bank account that says $100 and then because of a 50% reserve requirement, the bank can issue another loan.발음듣기
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So just like that, just by printing money and issuing treasuries, the central bank was able to increase the M1 by $200.발음듣기
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