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Principles of Macroeconomics Supplement to Chapter 9 How Banks Create Money
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Principles of Macroeconomics Supplement to Chapter 9
How Banks Create Money
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 1
Creating a bank$250,000 Cash
forCapital Stock
Cash $250,000 Capital Stock $250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Deposit Added to Vault Cash
Cash $250,000 Capital Stock $250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 2
Acquiring Property and
Equipment$240,000 Cash
Cash $ 10,000Property 240,000
Capital Stock $250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Cash $ 10,000Property 240,000
Capital Stock $250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 3
AcceptingDeposits
$100,000 Cash
Cash $110,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Cash $110,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
NOTES:Bank deposits aresubject to a reserverequirement.
Reserveratio
Commercial bank’srequired reserves
Commercial bank’scheckable-depositliabilities
=
Cash $110,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Three Important Issues...
1 - Excess Reserves = Actual Reserves - Required Reserves
(assume 20% reserve requirement) $110,000 - 20,000 = $90,0002 – Control of Lending Ability3 - Asset or Liability to Which Bank?
Cash $110,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 4
Depositsat the FED
$110,000 Cash
Cash $ 0Reserves 110,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Cash $ 0Reserves 110,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 5
A check is drawn against the bank
$50,000
Cash $ 0Reserves 60,000Property 240,000
Checkable Deposits $ 50,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Cash $ 0Reserves 60,000Property 240,000
Checkable Deposits $ 50,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
NOTES:Banks create moneyby lending excessreserves and destroyit by loan repayment.Purchasing bondsfrom the public alsocreates money.
Reserves $ 60,000Property 240,000
Checkable Deposits $ 50,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 6
Make a loan from excess reserves
$50,000
Reserves $ 60,000Loans 50,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Making the loancreated money!
Reserves $ 10,000Loans 50,000Property 240,000
Checkable Deposits $ 50,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
After a check for the $50,000is drawn against the bank
Reserves $ 10,000Loans 50,000Property 240,000
Checkable Deposits $ 50,000Capital Stock 250,000
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 7
Repaying a loan with cash$50,000
FORMATION OF ACOMMERCIAL BANK
Reserves $ 10,000Loans 0Property 240,000
Checkable Deposits $ 0Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
$50,000 in money supplyis destroyed!
Reserves $ 60,000Securities 50,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 8
(Assume previous balance sheet)
Buy GovernmentSecurities$50,000
Reserves $ 60,000Securities 50,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Bankers pursue two conflicting goals:Profits and Liquidity
Use of Federal Funds MarketFederal Funds Rate
MULTIPLE DEPOSIT EXPANSION PROCESS
BankAcquired reserves
and depositsRequiredreserves
Excessreserves
Amount bankcan lend - Newmoney created
ABCDEFGHIJKLMNOther banks
$100.00 80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 21.99
$20.00 16.00 12.80 10.24 8.19 6.55 5.24 4.20 3.36 2.68 2.15 1.72 1.37 1.10 4.40
$80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.59
$80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.59
$400.00Total amount of money created by the banking system
MULTIPLE DEPOSIT EXPANSION PROCESS
BankAcquired reserves
and depositsRequiredreserves
Excessreserves
Amount bankcan lend - Newmoney created
ABCDEFGHIJKLMNOther banks
$100.00 80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 21.99
$20.00 16.00 12.80 10.24 8.19 6.55 5.24 4.20 3.36 2.68 2.15 1.72 1.37 1.10 4.40
$80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.59
$80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.59
$400.00Total amount of money created by the banking system
Moneydestruction worksin exactly the same
multiple way!
Maximumcheckable-
depositcreation
= Excessreserves x Deposit
Multiplier
DepositMultiplier Required reserve ratio
1=
THE DEPOSIT MULTIPLIER
$20Requiredreserves
$100New reserves
$100Initial
Deposit
$400Bank system lending
Money Created
$80Excess
reserves
OUTCOME OF MONEY EXPANSION
$20Requiredreserves
$100New reserves
$100Initial
Deposit
$400Bank system lending
Money Created
$80Excess
reserves
OUTCOME OF MONEY EXPANSION
Leakages exist...
Currency Drains Excess Reserves
