Introduction to Finance

2.
Bank A’s reserves at the Reserve Bank are increased by $1,000.
3.
The deposit account of the Treasury at the Reserve Bank is reduced by $1,000.
Treasury funds from tax collections or the sale of bonds are generally deposited in its 
accounts in banks. When the Treasury needs payment funds from its accounts at the Reserve 
Banks, it transfers funds from commercial banks to its accounts at the Reserve Banks. This 
process reduces bank reserves. When $1,000 is transferred from the account in Bank A and 
required reserves are 20 percent, transactions may be summarized as follows:
1.
The Treasury deposit in Bank A is reduced by $1,000, required reserves by $200, and excess 
reserves by $800.
2.
The Treasury account at the Reserve Bank is increased by $1,000, and the account of Bank 
A is reduced by $1,000.
The Treasury is the largest depositor at the Fed. The volume of transfers between the account 
of the Treasury and the reserve accounts of banks is large enough to cause signifi cant changes in 
reserves in the banking system. For this reason, the Fed closely monitors the Treasury’s account 
and often uses open-market operations to minimize its eff ect on bank reserves. This is accom-
plished by purchasing securities to provide reserves to the banking system when the Treasury’s 
account increases and by selling securities when the account of the Treasury falls to a low level.
The eff ect on bank reserves is the same for changes in Treasury cash holdings as it is for 
changes in Treasury accounts at the Reserve Banks. Reserves are increased when the Treasury 
decreases its cash holdings, and reserves are decreased when it increases such holdings.
DISCUSSION QUESTION 3
Is monetary policy or fi scal policy more important in achieving the U.S. national policy 
objectives?
5.8
The Monetary Base and 
the Money Multiplier
Earlier in this chapter we examined the deposit multiplying capacity of the banking system. 
Recall that, in the example shown in Table 5.1, excess reserves of $1,000 were introduced into 
a banking system having a 20 percent required reserves ratio, resulting in a deposit expansion 
of $5,000. This can also be viewed as a money multiplier of 5.

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5.8 The Monetary Base and the Money Multiplier
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In our complex fi nancial system, the money multiplier is not quite so straightforward. 
It will be useful to focus on the relationship between the monetary base and the money 
supply to better understand the complexity of the money multiplier. The 
monetary base
is defi ned as banking system reserves plus currency held by the public. More specifi c-
ally, the monetary base consists of reserve deposits held in Reserve Banks, vault cash or 
currency held by depository institutions, and currency held by the nonbank public. The