Key principles

A single bank can create money through loans by the amount of excess reserves

The banking system as a whole can create money by a multiple (deposit on money multiplier) of the initial excess reserves.

Initial deposit	New or existing  $	Bank reserves	Immediate change in MS (money supply)
Cash (money created in the banking system only)	Existing	Increase	No:  composition of money changes( cash to currency)
FED purchase of a bond from public	New	increase	Yes: money coming from the fed puts new $ in circulation
Bank purchase of bond from the public	New	increase	Yes: money is coming from actual reserve which puts new money in circulation

Initial deposit + money created in the banking system = total or change in money supply

Factors that weaken the effectiveness of the deposit multiplier:

1.       If banks fail to loan out all of their excess reserves

2.       If bank customers take their loans in cash rather than in new checking account deposits it creates a cash or currency drain.

The money market

The demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded

1.       What happens to the quanitity demanded of money when interest rates increase?

MD DM  increase à IR decreases

MD DM decreases à IR increases