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However, because the depositor can ask for the money back, banks have to maintain minimum reserves to service customer needs. If the reserve requirement is 10% then, in the earlier example, the bank can lend $90 and thus the money supply increases by only $90. The reserve requirement therefore acts as a limit on this multiplier effect.
In some economics textbooks, the supply-demand equilibrium in the markets for money and reserves is represented by a simple so-called money multiplier relationship between the monetary base of the central bank and the resulting money supply including commercial bank deposits. This is a short-hand simplification which disregards several other ...
The Federal Reserve does not actually control the money supply directly and has delegated this authority to banks. If a bank has a reserve requirement of 10% and they have 10 million dollars in bank deposits, they can create 100 million dollars to loan out to borrowers, or make other investments if it is an investment bank.
Consequently, the importance of the money supply as a guide for the conduct of monetary policy has diminished over time, [65] and after the 1980s central banks have shifted away from policies that focus on money supply targeting. Today, it is widely considered a weak policy, because it is not stably related to the growth of real output.
The period when major central banks focused on targeting the growth of money supply, reflecting monetarist theory, lasted only for a few years, in the US from 1979 to 1982. [16] The money supply is useful as a policy target only if the relationship between money and nominal GDP, and therefore inflation, is stable and predictable.
Since the increase in bank reserves may not immediately increase the money supply if held as excess reserves, the increased reserves create the danger that inflation may eventually result when the reserves are loaned out. [110] QE benefits debtors; since the interest rate has fallen, there is less money to be repaid.
An easy money policy is a monetary policy that increases the money supply usually by lowering interest rates. [1] It occurs when a country's central bank decides to allow new cash flows into the banking system. Since interest rates are lower, it is easier for banks and lenders to loan money, thus likely leading to increased economic growth. [2]
Monetary policy is generally presumed to be the policy preserve of reserve banks, who target an interest rate. If control of the amount of base money in the economy is lost due failure by the reserve bank to meet the reserve requirements of the banking system, banks who are short of reserves will bid up the interest rate.