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
what is the energy of violet light with a frequency =7.50 x 10 to the 14 s-1

Price elasticity of supply: It is the responsiveness of quantity supplied of a commodity to a change in the price of the commodity and measured as percentage change in quantit


use the concept of the income elasticity of demand to explain the difference necessities, luxuries and inferior goods

Why narrowness of definition of a commodity may influence price elasticity of demand

Suppose D1 represents the demand curve for paperback novels, D2 represents the demand curve for gasoline,S1 represents the supply curve for paperback novels and S2 represents the s

What are the three approaches to measuring GDP? The three approaches are: a)  The production approach, b)  The spending approach and c)  The income approach.

Maurice has the following utility function: U (X; Y ) = 20X + 80Y ?? X2 ?? 2Y 2 where X is his consumption of CDs, with a price of $1, and Y is his consumption of movie videos, wit

What is the mathematical definition of price elasticity of demand The price elasticity of demand is the percentage alters in quantity demanded divided by the percentage change