Banking and Money Creation Module 24 & 25 & 26 The Time Value of Money & Banking and Money Creation The Federal Reserve

Module 24 - Time and Value of Money Borrowing, Lending, and Interest If you borrow, you repay with interest Defining present value Amount received one year from now as a result of lending $X today = $X + $X*r = $X*(1+r) R = interest rate Amount received in 1 year if X lent today = $X = $1/(1+r) Ex. $X = 1 dollar, interest rate = 10% = Value of $X when r = .10 = $1/ (1+.10) = $1/1.1= $.91 Lend would be $X = $1*(1+r)

Module 25 - Banking and money Creation Bank reserves Currency in bank vaults and bank deposits held at the Federal Reserve T-Account Took for analyzing banks finances Table shows business assets and liabilities

Module 25 - Banking and money Creation Reserve Ratio = Fraction of bank deposits that a bank holds Required Reserve Ratio Smallest fraction of a bank deposit that a bank must hold Example: $100 dollar deposited. Required Reserve Ratio = 20% Required amount to keep in bank is $20 If bank holds no extra reserves, they will loan out $80

Module 25 - Banking and money Creation The problem of Bank Runs What would happen if a large amount of depositors demanded their money back at the same time? The bank couldn’t raise enough cash to meet demand. Bank would need to sell off assets cheaply to raise the money quickly This can lead to bank failure Self-Fulfilling prophecy People think it will fail so they go on bank run to take out money which makes it fail.

Module 25 - Banking and money Creation Bank Regulation Deposit Insurance Capital Requirements Reserve Requirements Discount Window (Definitions from chapter)

Module 25 - Banking and money Creation Determining the Money Supply How the banks create money *please read page 247-248 for step by step Reserves, Bank Deposits, and the Multiplier

Figure 25.3 When money is deposited into a checkable account, there is not an effect on money supply. Currency in circulation drops Checkable bank deposits increases If money is loaned out, reserves fall and loans increase, and no effect on liabilities When money is loaned out, the currency in circulation increases

Module 25 - Banking and money Creation Excess Reserves Reserves over and above the amount needed for minimum reserve ration *if problem says “no excess reserves” they’re loaning about all available funds* Example: If there is a deposit of $1000 and the reserve ratio is 10% $100 would be saved in bank $900 can be loaned out If calculating the total increase in checkable deposits due to $1000 of excess reserves available, use the multiplier $1000/rr (.10) = $10,000 This is the possible amount of checkable deposits increased

Module 25 - Banking and money Creation Monetary Base Sum of currency in circulation and the reserves held by banks. Depositing money lowers quantity of money in circulation Money Supply $1 in someone’s pocket Checkable deposits Not Money Supply $1 in bank reserves (savings) Monetary base combines savings and money in circulation

Module 25 - Banking and money Creation Money Multiplier Ratio of the money supply to the monetary base. Total dollars created in banking system by each additional $1 added to monetary base. 1/rr = money multiplier If required reserves is 10%, money multiplier = $1/.10 = $10 If money increases by $1000, multiply it by the multiplier ($10) = $10,000 added to money supply

Practice Problem If the reserve requirement is 15%, and $1000 is added to the monetary base, how much does the money supply increase by?

Module 26 Complete guided reading questions on own to work through module.