Suppose that the Fed buys 1 million of bonds from the First...

Suppose that the Fed buys $\$ 1$ million of bonds from the First National Bank. If the First National Bank and all other banks use the resulting increase in reserves to purchase securities only and not to make loans, what will happen to checkable deposits?

Key Concepts

Open Market Operations

This is the process by which the central bank buys or sells government securities to regulate the money supply. When the Fed purchases securities, it injects reserves into the banking system, potentially affecting lending and liquidity conditions.

Bank Reserves

Bank reserves are the funds that banks hold either in their vaults or at the central bank. An increase in reserves typically enables banks to create more loans through the money multiplier effect, thereby expanding the deposit base.

Checkable Deposits

These are the funds in bank accounts that can be readily used to make payments, such as those accessible by check. Checkable deposits largely increase when banks extend more loans; if banks do not make additional loans with increased reserves, the level of checkable deposits remains unchanged.

Monetary Policy Transmission

This concept involves the mechanisms through which central bank actions, like adjusting reserves via open market operations, affect broader economic variables such as lending, deposits, and overall economic activity. The decision to use extra reserves for purchasing securities rather than for making loans demonstrates an instance where the typical expansion of deposits does not occur.

Transcript

00:01 Here we're taking a look at the money supply process, and we're going to end up using the process of multiple deposit creation to solve this.

00:08 But let's start by explaining what we're working with.

00:10 We're giving an example where the fed buys $1 million in bonds from a bank.

00:15 That bank and all others that will be involved use this increase in their reserves to buy securities rather than lending that money out.

00:23 So we'd like to know what the effect on checkable deposits is as a result of this.

00:27 Well, for the purpose of best understanding this, let's suppose that there's a 10 % reserve ratio, right? so that means that for all the checkable deposits that a bank gets, they have to hold 10 % of that in reserves, right? so we're just going to use that as a means of best understanding the process of multiple deposit creation.

00:48 So let's start with our first bank, this bank that the fed buys the $1 million in bonds from.

00:53 Well, they buy those bonds.

00:55 The bank then has to take that $1 million, keep that 10 % of it in its reserves, so that they now have $900 ,000 that they're left to work with because they took that $100 ,000 and put it in their reserves.

01:10 With this $900 ,000, they buy securities, and suppose these securities are being bought from just some individual.

01:18 Okay, so that individual then has $900 ,000 that they thus depose.

01:27 Into a bank.

01:29 Okay? so let's say they deposit this into bank two, supposing that this was bank one...

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