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Money Creation Chapter 15 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
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Money Creation
Chapter 15
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
15-2
Fractional Reserve System
• The Goldsmiths• Stored gold and gave a receipt• Receipts used as money by public• Made loans by issuing receipts
• Characteristics:• Banks create money through lending• Banks are subject to “panics”
LO1LO1
15-3
Fractional Reserve System
• Balance sheet• Assets = Liabilities + Net Worth• Both sides balance
• Necessary transactions• Create a bank• Accept deposits • Lend excess reserves
LO1LO1
15-4
A Single Commercial Bank
Transaction #1Vault cash: cash held by the bank
Assets Liabilities and Net Worth
Creating a BankBalance Sheet 1: Wahoo Bank
Cash $250,000 Stock Shares $250,000
LO1LO2
A Single Commercial Bank
Transaction #2Acquiring property and equipment
Assets Liabilities and Net Worth
Acquiring Property and EquipmentBalance Sheet 2: Wahoo Bank
Cash $10,000 Stock Shares $250,000Property 240,000
LO1LO2
A Single Commercial Bank
Transaction #3Commercial bank functions
• Accepting deposits• Making loans
Assets Liabilities and Net Worth
Accepting DepositsBalance Sheet 3: Wahoo Bank
Cash $110,000 Checkable Deposits $100,000Property 240,000Stock Shares 250,000
LO1LO2
15-7
A Single Commercial Bank
Transaction #4Depositing reserves in a Federal Reserve bank
• Required reserves• Reserve ratio
Reserveratio =
Commercial bank’sRequired reserves
Commercial bank’sCheckable-deposit liabilities
LO2LO2
15-8
A Single Commercial Bank
• The Fed can establish and vary the reserve ratio within limits set by Congress
• Required reserves help the Fed control lending abilities of commercial banks
LO2
Type of DepositCurrent
RequirementStatutory
Limits
Checkable deposits:
$0-$12.4 Million$12.4 - $79.5 MillionOver $79.5 Million
Noncheckable nonpersonalsavings and time deposits
0% 310
3% 38-14
0 0-9
LO2
15-9
A Single Commercial Bank
Assets Liabilities and Net Worth
Depositing Reserves at the FedBalance Sheet 4: Wahoo Bank
Cash $0 Checkable Deposits $100,000
Property 240,000 Stock Shares 250,000
Reserves 110,000
Transaction #4Assume the bank deposits all cash on
reserve at the Fed
LO2
15-10
A Single Commercial Bank
• Excess reserves• Actual reserves - required reserves
• Required reserves• Checkable deposits x reserve ratio
• Example:• Checkable deposits $100,000• Reserve ratio 20%
LO2LO2
15-11
A Single Commercial Bank
Transaction #5Clearing a check
• $50,000 check reduces reserves and checkable deposits
Assets Liabilities and Net Worth
Clearing a CheckBalance Sheet 5: Wahoo Bank
Checkable Deposits $50,000
Property 240,000 Stock Shares 250,000
Reserves $60,000
LO2LO2
15-12
Money Creating Transactions
Transaction #6aGranting a loan
• $50,000 loan deposited to checking
Assets Liabilities and Net Worth
When a Loan is NegotiatedBalance Sheet 6a: Wahoo Bank
Checkable Deposits $100,000
Property 240,000 Stock Shares 250,000
Reserves $60,000
Loans 50,000
LO3LO3
15-13
Money Creating Transactions
Transaction #6bUsing the loan
• $50,000 loan cashed
Assets Liabilities and Net Worth
After a Check is Drawn on the Loan Balance Sheet 6b: Wahoo Bank
Checkable Deposits $50,000
Property 240,000 Stock Shares 250,000
Reserves $10,000
Loans 50,000
A single bank can only lend an amountequal to its preloan excess reserves
LO3LO3
15-14
Money Creating Transactions
Transaction #7Bank buys government securities
from a dealer• Deposits payment into checking
Assets Liabilities and Net Worth
Buying Government SecuritiesBalance Sheet 7: Wahoo Bank
Checkable Deposits $100,000
Property 240,000 Stock Shares 250,000
Reserves $60,000
Securities 50,000
• New money is createdLO3LO3
15-15
Profits, Liquidity, and the Fed Funds Market
• Conflicting goals• Earn profit
• Make loans to earn interest• Buy securities to earn interest
• Maintain liquidity• Alternative?
• Overnight bank loans• Federal funds rate
LO3LO3
15-16
The Banking System
• Multiple-deposit expansion• Assumptions:
• 20% required reserves• All banks “loaned up”• Banks lend all of their excess reserves
• A $100 bill is found and deposited• Multiple deposits can be created
LO4LO4
15-17
The Monetary Multiplier
Monetarymultiplier =
1
required reserve ratio=
1
R
LO5LO5
15-18
The Monetary Multiplier
• Maximum amount of new money created by a single dollar of excess reserves
• Higher R, lower m• Reversibility
• Making loans creates money• Loan repayment destroys money
LO5
15-19
Banking, Leverage, and Financial Instability
• Leverage is the use of borrowed money to magnify profits and losses
• Modern banks use lots of leverage• Thus small losses can drive banks into
insolvency
