M1 can be a slippery commodity. The central bank admits to having significantly underestimated the transactions money flying around the system. One reason is that banks' bigger corporate customers cottoned onto the advantage of so managing their moneys as to achieve, al a consolidated, central checking account, practically zero balances. For the banks promoting this switch of idle money to easily accessible interest-bearing deposits, there were similar economies: reserve requirements on such deposits are much lower.
What is meant by "transactions" money, as opposed to what other kind of money?
Transactions money is money used to pay for purchases (monetary transactions) as opposed to money used purely as a store of value.
What is the significance of underestimating transactions money?
Transactions money is thought to be connected to spending, so if it is underestimated, monetary policy will promote more spending than suitable, creating inflation.
Why would corporations want to achieve zero balances?
Checking accounts pay little or no interest. By keeping most of their transactions money in savings, or interest-bearing, accounts, which are easily switched into checking accounts, they can earn interest on most of their transactions moneys.
Explain how the banks gain from this corporate behavior.
Because the legal reserve requirement on interest-bearing accounts is lower (now it is zero, but when this clipping was written it may not have been zero) the banks are able to make more loans and thus more profits.
Example 2
In the process, the money multiplies, since the banks are allowed to lend more money than they actually have, within limits set by the Federal Reserve Board. The board tries to anticipate how much the money will multiply as this process unfolds. If its calculations are right, just enough money will be created to accommodate the growth it desires for the economy. If the calculations are wrong, it would make them right by pumping some money into the economy or pumping some out.
What money is being multiplied here?
The Fed has increased the money base, which is being multiplied.
What are the limits set by the board?
The board has a legal reserve requirement that must be met by the banks. This limits the amount of extra loans that banks can make.
What name do economists use to refer to "how much the money will multiply as this process unfolds"?
