Saturday, February 27, 2010

Monetary Base, Excess Reserves, Money Supply - My Analysis

The following chart represents the latest year-over-year change in the adjusted monetary base (AMB) [click here for larger picture]. As you may recall, the AMB is the amount of money printed by the Federal Reserve. After a sustained decline, it has sharply increased. This in part reflects the purchases of U.S. Treasuries and mortgage-backed securities by the Central Bank.

This next graph demonstrates the level of excess reserves in the banking system. It is the amount of money available for bank lending. Through the multiplicative process of fractional reserve banking, whereby only a portion of deposits are kept as a cushion for customer withdrawals, more money is created. For example, assuming a 10% reserve requirement, every $100 will create an additional $900. This extra money will invariably chase a fixed amount of goods, subsequently sparking price inflation.

As we suspect, M1 [see graph below], a measure of the level of money supply in the U.S. is increasing, despite the fact that the money multiplier has declined. This means that the percent change (i.e. decline) in excess reserves has been greater than the decline in the money multiplier ratio.

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