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  • What I want to explore in this video is

  • the different ways of measuring the amount of money

  • we have in circulation.

  • So we're going to start things with our Central

  • Bank in the US.

  • This would be the US Federal Reserve.

  • And let's say that they print $4.

  • And we're going to focus, just for visualization purposes,

  • on that they're doing it physically.

  • They could also do it electronically.

  • But we're just going to focus on the physical.

  • And the way that they get this into circulation

  • is it they'll take these $4 and they'll

  • go buy securities in the open market, normally

  • very safe and very liquid securities.

  • Liquid means it's very easy to buy and sell

  • those securities in large quantities.

  • For example, government treasuries

  • is a liquid security, or liquid asset.

  • PEZ dispensers would not be a liquid asset.

  • If I bought a billion dollars worth of PEZ

  • dispensers it would be very hard for me to sell-- one

  • it would be very hard for me to buy a billion dollars worth.

  • And it would be even probably even harder

  • for me to sell a billion dollars worth in any short or medium

  • timeframe.

  • So the Central Bank goes out, and let's say they go and buy

  • one liquid security for $4.

  • So this is a security right over here.

  • And the person that they bought the security from

  • decides to deposit it in a bank.

  • They could either directly deposit it in a bank

  • or they could use that money that they

  • got from selling their security to buy things,

  • and the person they bought things from

  • could deposit it in a bank.

  • But one way or another we can imagine it all gets

  • deposited in a bank.

  • So this is our private bank.

  • I'll call this private bank number one.

  • So now all of these dollars are transferred

  • to private bank number one.

  • And they are no longer-- the Federal Reserve,

  • or the Central Bank, in the general case,

  • is no longer in possession of them.

  • They've been transferred right over here.

  • And I want to cross these out just

  • so we can keep track of things.

  • Now when they deposit it in private bank number one,

  • they said, well, I need three of these dollars on demand.

  • And I want to write checks against them.

  • So they put three of these dollars in a checking account.

  • There are at three of these dollars a checking account.

  • So checks up too-- so write checks up to $3.

  • And so they can get a little bit more interest,

  • and the bank's willing to give a little bit more interest

  • on a savings account because they don't have

  • to keep the reserves, they put $1 into a savings account.

  • And they cannot write checks against that savings account.

  • Now there are special circumstances now,

  • but for simplicity, let's just say that they cannot write

  • checks.

  • There are some that have restricted check writing

  • and things like that now.

  • So this bank says, OK, well, this dollar, I

  • don't have to even have any reserves against it.

  • I could loan out this dollar.

  • And the person they lend it to, let's

  • say that they immediately go and deposit it into another bank.

  • So they immediately go and deposit this in private bank,

  • I'll call this private bank two.

  • So it's no longer in private bank one.

  • Let me draw a private bank two.

  • Private bank two is a right over here.

  • Private bank number two.

  • And they deposit it into a savings account

  • in private bank number two.

  • And let's say all of this, out of all of this,

  • the bank says, well, this is a demand deposit,

  • I have to keep some reserves.

  • This is a fractional reserve system.

  • But I can lend out, in the US, I could lend out up to 90%

  • of this.

  • And maybe this bank is a little bit more conservative,

  • They only lend out 2/3 of this.

  • So they lend out $2 out of these $3

  • And let's say the person they let it do also

  • happens to deposit it in private bank number

  • two, just coincidentally.

  • So these two also end up in private bank number two.

  • And so they're no longer in private bank number

  • one, although this person could still write checks up to $3.

  • And now here in private bank number

  • two-- and let's say these are deposited

  • in a checking account.

  • These are deposited right over here in a checking account.

  • Now private bank number two, it can do a couple of things.

  • In this checking account it has to keep some reserves.

  • Let's say it's even more conservative.

  • It only decides to lend out half of this,

  • even though it could lend out 90%.

  • And so it lends out one of these dollars.

  • And the person that they lend it to just takes that dollar

  • and they put it in their wallet.

  • So they just put it in their wallet.

  • And they could also lend out this entire savings.

  • And let's just say that the person

  • that they lend that $1 in savings to also

  • puts it in their wallet.

  • And notice, the original $4 are still there.

  • One, two, three, four.

  • Now, and just to be clear, this person right over here can

  • write checks up to $3 .

  • And this person right over here can

  • write checks-- let me do that same checking account

  • color-- they can write checks up to $2.

  • Now let's think about the different forms of money

  • there are here.

  • Well, we could think of money in a very, very narrow way, which

  • is just what did the Central Bank print, or create

  • electronically as electronic reserves of its member banks?

  • But for simplicity here you can just

  • think about the physical currency that it printed,

  • its base money.

  • And so that, often, is just referred to as base money.

  • And in the US and other countries

  • it's often the same thing as M0.

  • There's slight differences from country to country.

  • And in this example, as soon as they printed it and put it

  • into circulation, that was $4.

  • We had $4 of base money.

  • And that's obvious because as soon as they printed this

  • and they bought the security with it,

  • and it was in circulation, that $4 could be used to buy things.

  • It could be used to facilitate transactions.

  • Now that clearly isn't all of the stuff that

  • can be used as money in this little universe we created.

  • This guy, you have the $4 but these people

  • can also write checks right over here.

  • And so we can have a slightly broader definition of money.

  • And over here, we will call it M1.

  • And here, there's a couple of ways you could think about it.

  • You could think about it as all of the currency that's

  • in people's pockets plus all of the check writing capabilities.

  • So if you view it that way it, would

  • be this $2 plus $5 of check writing capabilities

  • right over here.

  • So you could have $2 of physical currency

  • that's in people's wallets, not in bank reserves,

  • plus the $5 of check writing capability,

  • which would give you $7.

  • Another way you could view it, you

  • could view it as M0 plus checkable deposits.

  • I'll just write checks here, plus-- well

  • I'll write-- checkable deposits.

  • But if you do that, you are now double

  • counting because some of the M0 is

  • reserves in the checkable deposits.

  • Or you could say some of the checkable deposits

  • is held as reserves for M0.

  • So then you would have to subtract out the bank reserves.

  • And so then you would get $4 because we

  • don't want to double count these right over here.

  • You would get M0 is $4.

  • And I want to do that in white.

  • M0 is $4.

  • The checkable deposits is $5.

  • Let me do that in the pink.

  • Plus the $5.

  • And then you would want to subtract out the reserves.

  • And the reserves here, there are $2 of the reserves.

  • So minus $2.

  • And you would get yourself back to the $7.