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
Strengthening the Financial Instruments - rationale in era of globalisation: With this in view, following suggestions can be made: i) Finance must be conditioned on a poli


Which of these will be included in US GDP for 2005? a) A car produced in Japan in 2005 and sold in the US in 2005 b) A car produced in the US in 2004 and sold in Japan in 2005 c) A

Devil's Advocate Explicit role undertaken by a group member who actively questions and challenges the group's ideas, procedure, and decisions. Such active questioning helps de

In an updated GDP that contains household production, how would the purchase of a car or appliance for household use be treated? A car or appliance would be treated as a househ

what is the mass of a body when it is taken to the moon

Point Elasticity: Point elasticity is brought in use when the change in price is quite small, which means. The two points between which elasticity is being measured or calculat

Summary of Demand and Supply Considerations of Education A study of supply and demand considerations in education helps in understanding four major issues and concerns of an e

Private benefit and social benefit: Bridge the gab between private cost and social cost, and private benefit and social benefit.Under perfect market, there may be a divergence

suppose ismail were to eat five pizzas per week.what is the total value ismail would place on his five weekly pizzas?