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14 creating money new

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14 creating money new

  1. 1. MoneyCreationChapter 32McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
  2. 2. Chapter Objectives• “Fractional Reserve” system• Actual reserves vs. requiredreserves• How banks create money throughgranting loans• Multiple expansion of loans andmoney by the banking system• The monetary multiplier32-2
  3. 3. Fractional Reserve Banking• The Goldsmiths–Stored gold and gave a receipt–Receipts used as money by public–Made loans by issuing receipts• Characteristics–Banks create money throughlending–Banks are subject to “panics”32-3
  4. 4. Fractional Reserve System• Balance sheet–Assets = Liabilities + Net Worth–Both sides balance• Necessary transactions–Create a bank–Accept deposits–Lend excess reserves32-4
  5. 5. Assets Liabilities and Net WorthCreating a Bank• Transaction #1• Vault cash: cash held by thebankCreating a BankBalance Sheet 1: Wahoo BankCash $250,000 Stock Shares $250,00032-5
  6. 6. Assets Liabilities and Net WorthCreating a Bank• Transaction #2• Acquiring property and equipmentAcquiring Property and EquipmentBalance Sheet 2: Wahoo BankCash $10,000 Stock Shares $250,000Property 240,00032-6
  7. 7. Assets Liabilities and Net WorthCreating a Bank• Transaction #3• Commercial bank functions–Accepting deposits–Making loansAccepting DepositsBalance Sheet 3: Wahoo BankCash $110,000 CheckableDeposits $100,000Property 240,000Stock Shares 250,00032-7
  8. 8. Creating a Bank• Transaction #4• Depositing reserves in a FederalReserve bank–Required reserves–Reserve ratioReserveratio =Commercial bank’sRequired reservesCommercial bank’sCheckable-deposit liabilities32-8
  9. 9. Reserve RequirementsType of DepositCurrentRequirementStatutoryLimitsCheckable deposits:$0-$9.8 Million$9.3-$43.9 MillionOver $43.9 MillionNoncheckable nonpersonalsavings and time deposits0%3103%38-140 0-9• Fed can establish and vary reserveratio within limits set by Congress• Required reserves help Fed controllending abilities of commercial banks32-9
  10. 10. Assets Liabilities and Net WorthCreating a BankDepositing Reserves at the FedBalance Sheet 4: Wahoo BankCash $0 CheckableDeposits $100,000Property 240,000 Stock Shares 250,000Reserves 110,000• Transaction #4• Assume the bank deposits allcash on reserve at the Fed32-10
  11. 11. Reserve Requirements• Excess reserves–Actual reserves - required reserves• Required reserves–Checkable deposits x reserve ratio• Example:–Checkable deposits $100,000–Reserve ratio 20%32-11
  12. 12. Assets Liabilities and Net WorthCreating a Bank• Transaction #5• Clearing a check–$50,000 check reduces reservesand checkable depositsClearing a CheckBalance Sheet 5: Wahoo BankCheckableDeposits $50,000Property 240,000 Stock Shares 250,000Reserves $60,00032-12
  13. 13. Assets Liabilities and Net WorthMoney Creating Transactions• Transaction #6a• Granting a loan–$50,000 loan deposited to checkingWhen a Loan is NegotiatedBalance Sheet 6a: Wahoo BankCheckableDeposits $100,000Property 240,000 Stock Shares 250,000Reserves $60,000Loans 50,00032-13
  14. 14. Assets Liabilities and Net WorthMoney Creating Transactions• Transaction #6b• Using the loan–$50,000 loan cashedAfter a Check is Drawn on the LoanBalance Sheet 6b: Wahoo BankCheckableDeposits $50,000Property 240,000 Stock Shares 250,000Reserves $10,000Loans 50,000A single bank can only lend an amountequal to their preloan excess reserves 32-14
  15. 15. Assets Liabilities and Net WorthMoney Creating Transactions• Transaction #7• Bank buys government securitiesfrom dealer–Deposits payment into checkingBuying Government SecuritiesBalance Sheet 7: Wahoo BankCheckableDeposits $100,000Property 240,000 Stock Shares 250,000Reserves $60,000Securities 50,000New money is created 32-15
  16. 16. Commercial Banks• Conflicting goals• Earn profit–Make loans to earn interest–Buy securities to earn interest• Maintain liquidity• Alternative?–Overnight bank loans–Federal funds rate32-16
  17. 17. The Banking System• Multiple-deposit expansion• Assumptions:–20% required reserves–All banks “loaned up”–Banks lend all of excess reserves• A $100 bill is found and deposited• Multiple deposits can be created32-17
  18. 18. Bank(1)AcquiredReservesand Deposits(2)RequiredReserves(3)ExcessReserves(1)-(2)(4)Amount Bank CanLend; New MoneyCreated = (3)Bank A $100 $20 $80 $80Bank B $80 $16 $64 $64Bank C $64 $12.80 $51.20 $51.20Bank D $51.20 $10.24 $40.96 $40.96The process will continue…The Banking System32-18
  19. 19. Bank ABank BBank CBank DBank EBank FBank GBank HBank IBank JBank KBank LBank MBank NOther BanksBank(1)AcquiredReservesand Deposits(2)RequiredReserves(ReserveRatio = .2)(3)ExcessReserves(1)-(2)(4)Amount Bank CanLend; New MoneyCreated = (3)$100.0080.0064.0051.2040.9632.7726.2120.9716.7813.4210.748.596.875.5021.99$20.0016.0012.8010.248.196.555.244.203.362.682.151.721.371.104.40$80.0064.0051.2040.9632.7726.2120.9716.7813.4210.748.596.875.504.4017.59$80.0064.0051.2040.9632.7726.2120.9716.7813.4210.748.596.875.504.4017.59$400.00The Banking System32-19
  20. 20. The Monetary MultiplierMonetarymultiplier =1required reserve ratioNew Reserves$100$20RequiredReserves$80ExcessReserves$100InitialDeposit$400Bank System LendingMoney CreatedGraphicExample=1R32-20
  21. 21. The Monetary Multiplier• Maximum amount of new moneycreated by single dollar of excessreserves• Higher R, lower m• Reversibility–Making loans creates money–Loan repayment destroys money32-21
  22. 22. Bank Panics of 1930-1933• Before deposit insurance• Bank failure led to mass withdrawals• Forced loan reduction• 25-33% decline in money supply• 1933 national bank holiday toevaluate all banks• Contributed to the Great Depression• Regulation protects the system today32-22
  23. 23. Key Terms• fractional reserve banking system• balance sheet• vault cash• required reserves• reserve ratio• excess reserves• actual reserves• Federal funds rate• monetary multiplier32-23
  24. 24. Next Chapter Preview…Interest Ratesand MonetaryPolicy32-24

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