Money creation process, Microeconomics

The Money Creation Process is explained below:

We can now study the money supply or the creation process. Suppose the government wishes to buy pencils worth Rs. 10 for the officials working for it. The supplier firm is called S and has the deposit account with Bank A. In order to buy the pencil, the government asks the central bank to print the 10 rupee note and give it to government.5 this action makes M0 to expand by Rs. 10. Now the government gives this amount to S (in exchange for the pencils) who in turn deposits the sum of money into his account in Bank A. What is the work of A? Assuming it operates the safety cushion or reserve ratio of 10%, A will add Re 1 to its liquidity reserve and then lend Rs 9 to the firm T. Firm T, takes the Rs 9 and deposits it in an another Bank B. B acts in the similar way: it adds 90 paisa (10% of Rs 9) to its existing liquidity reserve and lends the remaining amount which is Rs 8.1 to firm Z. The process goes carries on, the amount lent falling every time by the factor of 10%.

If the money creation process is made as an infinite series (starting from central bank printing   ten   rupee   note),   we   will   get   10   +   10*(90%)   +   10*(90%)*(90%)  + 10*(90%)*(90%)*(90%) + ……. which is an infinite converging series with the first term of 10 and a convergence factor of 0.9 (or 90%). The sum till infinity of this series is 10/(1-0.9) = 100. Therefore, an initial M0 expansion of Rs. 10 has a entire money supply (or M2) impact of Rs 100, thanks to the intermediation of the commercial banks. There is a money multiplier (MM) at action of magnitude 10.

Posted Date: 7/19/2012 4:10:38 AM | Location : United States







Related Discussions:- Money creation process, Assignment Help, Ask Question on Money creation process, Get Answer, Expert's Help, Money creation process Discussions

Write discussion on Money creation process
Your posts are moderated
Related Questions
how can draw the table and diagram of production function function with one veriable


Explain welfare grants and subsidies

any village panchayat in west bengal and get information for doing a project.

During the 1990s, technological advance reduced the cost of computer chips. Explain, with the use supply and demand diagrams, how the following markets are affected in terms of pr

Dumping In the international marketing, when an organization charges less for goods than it real cost or less than the organizations charges in its home market. This procedure

Q. Food purchases are relatively price inelastic since food is a necessity. If food is so required for life, how will we explain the heavy advertising of food items at the

What are the "three basic economic questions" that economists often address when examining how much economic output is formed? The three basic questions are: a) what is prod

what is outputgap?

Examine the factors that influence a country s exchange rate. Suppose and define a floating exchange rate, the major issue here is to outline the factors influencing the supply