Question

The Monetary Base You've seen that the monetary base is the sum of Federal Reserve notes, coins, and banks' deposits at the Fed. The size of the monetary base limits the total quantity of money that the bank- ing system can create. The reason is that banks have a desired level of reserves, households and firms have a desired holding of currency, and both of these desired holdings of the monetary base depend on the quan- tity of deposits.

I drew the link AMONG the three things as below. But, i am not sure correct or not. pls rectify it with explanationS

Answer 1

Total money supply in the economy is equal to liquid cash holds by individual and money in the savings account in the bank.we can also added money in the post office and money in the fixed account.but we also know that bank can lend money to the individuals and firms or producers also.individuals holds money for consumption purpose and cautionary demand for money to meet unexpected expenditure.people also holds money for speculative demand which depends upon rate of interest. the consumption demand for money and cautionary demand for money depends upon the income level of the individual.on the other sides individuals doesn't expend all his income.some of individual's income are save for the future.bank is the link between people who saves and investers.

On the other hand bank can create multiple credit.when any individual deposit a money to any bank then bank can give loan of that amount by taking a cretain amount as reserve and the excess amount lend investors.suppose there is 10% reserve ratio.it means if 100 deposited by individual then after taking 10 as reserve bank can lend the excess 90.now if any investor want a loan to bank then bank creats a account of his name and transfer the money to his account.so it is also a deposit.now after taking 9 as reserve the excess 81 will lend again.in this way the whole banking sector creats 10 times credit if the reserve rate is 10.and if reserve rate decreases to 5 then bank creates 20 times money but if it increases to 20 then banks credit creation will fall to 5times.but the credit creation can fall if investor withdraw the 70 then in the second stage bank will create credit of only 20.and bank holds a reqired reserve rate as if any depositer want bank his money any times then bank can gave it back from the reserve.on the other hand if people holds more money in hands then the money circulation will decrease.