How Banks Create Money[MS] MS = Currency + DD of Public Give me a loan so there will be more DD in the system. How Banks Create Money[MS] MS = Currency + DD of Public Banks [thru loans] Create More DD

How Banks and Thrifts Create Money

Dennis Rodman deposits $1 with A 10% RR Total(Actual) Reserves .10 90 cents RR Excess Reserves Total(Actual) Reserves One Dollar PMC = M x ER, so 10 x .90 = $9 TMS = PMC[$9] + DD[$1] = $10 [MS = currency + DD of public]

Rodman’s Bank Borrows $1 From The Fed [10% RR] Total(Actual) Reserves One Dollar RR Excess Reserves Total(Actual) Reserves One Dollar PMC = M x ER, so 10 x $1 = $10 TMS [$10] = PMC[$10] [MS = currency + DD of public]

BALANCE SHEET OF A COMMERCIAL BANK ASSETS [cash] = LIABILITIES[DD] [The cash is property of the bank] [“liable”, DDs are owed to depositors] Cash $100,000 DD $100,000 The Goldsmiths Fractional Reserve Banking System Money Creation & Reserves Bank Panics and Regulation

$1,000 DD by Brian [MS=Currency+DD of Public] Katy $1,000.00 800.00 Dell 800.00 640.00 640.00 512.00 Sam’s 512.00 409.60 Canon 409.60 327.70 Target 5,000.00 4,000.00 MS grows by a multiple of 5 Katy

$1,000 DD by Tammy [MS=Currency + DD of Public] $1,000.00 900.00 810.00 900.00 729.00 729.00 810.00 729.00 656.10 656.10 590.49 656.10 $9,000 $10,000 MS grows by a factor of “10” Tammy

MS is MS MS RR=20% $10,000 RR = 20% $10,000 $8,000 $6,400 $24,400 MS = DD + Currency of the Public [A DD of $10,000 will incr MS by another $40,000($50,000 MS] RR=20% MS $10,000 $8,000 $6,400 $24,400 MS is $10,000 4. 2nd Bank lends Sports Shop $6,400. 1. Joe Biker deposits $10,000 in his bank. RR = 20% MS $10,000 $8,000 $18,000 2. Suzie Rah Rah borrows $8,000 5. Eventually the MS will be $50,000 Joe 3. Suzie pays $8,000 for a new car. GoNow Auto deposits the $ in 2nd Bank. $10,000+$40,000=$50,000

How Banks Create Money [Vocabulary] 1. Fractional Reserve Banking System – a fraction of DD are kept in reserve(say, 10%) at either the banks vault or at the Fed. 2. Vault cash cash held by a bank (banks rarely keep more than 2% of their in cash) 3. Required Reserve(RR) specified percentage of DD that banks must keep as RR. 4. Excess reserves total reserves(TR) RR. ER is what can be loaned out. Also some ER is used to meet sudden withdrawal demands. 5. Actual(Total) reserves RR + ER. 6. Deposit Multiplier one/RR or 1/.10 or $1/10 cents or 10 Multipliers 1/RR[$1/5 cents = 20] 1/5% = 20 1/25% = 4 1/10% = 10 1/33.3%= 3 1/12.5% = 8 1/40 = 2.5 1/20% = 5 1/50% = 2 7. Balance Sheet statement of assets & liabilities[assets=liabilities]. 8. Discount Rate when banks borrow from the Fed. [symbolic - emergencies] “wholesale price of money” 9. Federal Funds Rate banks borrow from other banks for overnight loans. 10. Prime Rate when a bank’s prime customers [good credit] get loans. “retail price of money” 11. Buying Bonds “buying” bonds means “bigger ” supply of money and “lower interest rates”. [So, more “C”, “Ig”, and “Xn” ] 12. Selling Bonds “selling” bonds mea ns “smaller” supply of money and “higher interest rates”. less “C”, “Ig”, and “Xn”]

Most Famous “Panic Run” in Movie History

History of Deposit Insurance In 1934, federal deposit insurance made its debut at $2,500 to protect the average family’s savings and end the bank runs that had shut down businesses and contributed to the Great Depression. Through the years the coverage rose in $5,000 increments until the 70s when it jumped to $40,000. In 1980, it was raised to $100,000.

The Very Early Days Of Banking “Wow, you mean we can create money out of thin air.?” There were more claims to gold than there were ounces of gold. The fractional banking system began when someone issued claims for gold that already belonged to someone else. Once upon a time there was a gold-smithy who offered to store people’s gold in his vault. He issued paper receipts for the gold, and it was not long before the townsfolk used the paper to purchase eggs and beer. The smithy’s paper receipts became as “good as gold.” Our Smithy was not stupid. He said to himself. “I have 2000 ounces of gold stored in my vault, but in the last year I was never called upon to pay out more than 100 ounces in a single day. What harm could it do if I lent out say, half the gold I now have? I’ll still have more than enough to pay off any depositors that come in for a withdrawal. No one will know the difference. I could earn 30 additional ounces of gold each week. I think I’ll do it.” “The smithy has invented the Fractional Reserve Banking System.” Advantages of Lending [One disadvantage was the possibility of “bank runs”] 1. Depositors haven’t lost money [Goldsmiths paid them instead of other way] 2. With the interest you earned you could give some to depositors. 3. The loans benefited the community thru loans

Birth of a COMMERCIAL BANK In Lovelady, Texas LIABILITIES AND NET WORTH ASSETS TRANSACTION 1 Creating a bank $250,000 Cash for Capital Stock

FORMATION OF A COMMERCIAL BANK In Lovelady, Texas LIABILITIES AND NET WORTH ASSETS Cash $250,000 Capital Stock $250,000 Deposit Added to Vault Cash

Birth OF A COMMERCIAL BANK In Lovelady, Texas LIABILITIES ANDNET WORTH ASSETS Cash $250,000 Capital Stock $250,000 TRANSACTION 2 Acquiring Property and Equipment $240,000 Cash

Birth OF A COMMERCIAL BANK In Lovelady, Texas LIABILITIES AND NET WORTH ASSETS Cash $ 10,000 Property 240,000 Capital Stock $250,000 Lovelady Bank

Birth OF A COMMERCIAL BANK In Lovelady, Texas LIABILITIES AND NET WORTH ASSETS Cash $ 10,000 Property 240,000 Capital Stock $250,000 $250,000 $250,000 TRANSACTION 3 Accepting Deposits $100,000 Cash

Birth OF A COMMERCIAL BANK In Lovelady, Texas LIABILITIES AND NET WORTH ASSETS Was $10,000 Cash $110,000 Property 240,000 DD $100,000 Capital Stock 250,000

Birth OF A COMMERCIAL BANK In Lovelady, Texas ASSETS LIABILITIES AND NET WORTH Was $10,000 Cash $110,000 Property 240,000 DD $100,000 Capital Stock 250,000 $350,000 $350,000

FORMATION OF A COMMERCIAL BANK In Lovelady, Texas LIABILITIES AND NET WORTH ASSETS Cash $110,000 Property 240,000 DD $100,000 Capital Stock 250,000 $350,000 $350,000 TRANSACTION 4 A $50,000 check is written against the bank

Birth OF A COMMERCIAL BANK In Lovelady, Texas LIABILITIES AND NET WORTH ASSETS Was $110,000 Cash $ 60,000 Property 240,000 DD $ 50,000 Capital Stock 250,000 $300,000 $300,000

Birth OF A COMMERCIAL BANK In Lovelady, Texas NOTES: Banks create money by lending ER and destroy money by loan repayment. Purchasing bonds from the public also creates money.

Birth OF A COMMERCIAL BANK In Lovelady, Texas LIABILITIES AND NET WORTH ASSETS Cash $ 60,000 Property 240,000 DD $ 50,000 Capital Stock 250,000 TRANSACTION 5 Make a loan from excess reserves of $50,000

FORMATION OF A COMMERCIAL BANK In Lovelady, Texas ASSETS LIABILITIES AND NET WORTH Cash $ 60,000 Loans 50,000 Property 240,000 DD $100,000 Capital Stock 250,000 Making the loan created money!

Birth OF A COMMERCIAL BANK In Lovelady, Texas LIABILITIES AND NET WORTH ASSETS Cash $ 60,000 Loans 0 Property 240,000 DD $ 50,000 Capital Stock 250,000 After a check for the $50,000 is written against the bank

(a) Joe Bozo pays Best Buy a $50,000 check Dallas Big “D” Lovelady Bank Hateman Bank (a) Joe Bozo pays Best Buy a $50,000 check

Birth OF A COMMERCIAL BANK In Lovelady, Texas LIABILITIES AND NET WORTH ASSETS Reserves $ 10,000 Loans 50,000 Property 240,000 DD $ 50,000 Capital Stock 250,000 TRANSACTION 6 Repaying a loan with cash $50,000

Birth OF A COMMERCIAL BANK In Lovelady, Texas LIABILITIES AND NET WORTH ASSETS Reserves $ 10,000 Loans 0 Property 240,000 DD $ 0 Capital Stock 250,000 $50,000 in money supply is destroyed!

MULTIPLE DEPOSIT EXPANSION PROCESS RR= 20% Bank Acquired reserves and deposits Required reserves Excess Amount bank can lend - New money created A B C D E F G H I J K L M N Other banks $100.00 80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 21.97 $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 17.57 Paris Hilton 1st 10 $357 of the $400 Susie RahRah Ronald McDonald Potential Money Creation in the banking system $400.00 Manuel Labor TMS = $500.00

THE DEPOSIT MULTIPLIER RR 1 = The deposit multiplier is the reciprocal of the reserve requirement. Potential money Creation in the Banking System [PMC] Maximum checkable- deposit expansion = ER x MD

Ashley Olsen Deposits $1,000 in her bank RR = 20% $1,000 New reserves $800 Excess reserves $200 RR Ashley Olsen deposits $1,000 $4,000 PMC thru bank lending $1,000 Initial Deposit Money Created TMS = $5,000

Fed Buys A $1,000 Bond From Ashley’s Bank New reserves $1,000 Excess Reserves 20% RR $5,000 PMC thru Bank Lending TMS is $5000

OUTCOME OF MONEY EXPANSION $100 New reserves $20 Required reserves Leakages exist... Currency Drains Excess Reserves $80 Excess reserves $400 Bank system lending $100 Initial Deposit Money Created

NS 31-35 AP Econ [MS = Currrency+DD of Public] RR+ER=TR; TR-RR=ER; TR-ER=RR; MXER=PMC; PMC(Public)+DD=TMS; PMC(Fed)=TMS Excess Reserves prior to new currency deposit (DD) = $0 Britney Spears deposits in the banking system = $40 billion Legal Reserve Requirement [RR] = 20% 31. The $40 billion deposit of Currency into DD will result in MS staying at ($8/$40/$160) billion. 32. The $40 billion deposit of currency into checking accounts will create ER of ($20/$32/$40) billion. 33. The Potential Money Creation of the banking system through loans is ($40/$160/$$200) bil. The Potential TMS [all DD of the public] could be as much as ($40/$160/$200) 34. The RR applies to checkable deposits at (banks/S&Ls/ credit unions/ all depository institutions). 35. If the Duck National Bank has ER of $6,000 & DD of $100,000 what is the size of the bank’s TR if the RR is 25%? ($25,000/$75,000/$31,000) [RR($____)+ER($___)+TR($____) 25,000 6,000 31,000

NS 36-45 AP Econ [MS = Currrency+DD of Public] 36. A stranger deposits $1,000 in a bank that has a RR of 10%. The maximum possible change in the dollar value of the local bank’s loans would be $______. PMC[M X ER] in the banking system is $_____. Potential TMS could become as high as $_______. 37. Suppose a commercial bank has DD of $100,000 and the RR is 10%. If the bank’s RR & ER are equal, then its TR are ($10,000/$20,000/$30,000). 38. Total Reserves (minus/plus) RR = ER. 39. Suppose the Thunderduck Bank has DD of $500,000 & the RR is 10%. If the institution has ER of $4,000 then its TR are ($46,000/$54,000/$4,000). 40. If ER in a bank are $4,000, DD are $40,000, & the RR is 10%, then TR are ($4,000/$8,000). 41. The main purpose of the RR is to (have funds for emergency withdrawals/ influence the lending ability of commercial banks). 42. If I write you a check for $1 & we both have our checking accts at the Poorman Bank, the bank’s balance sheet will (increase/decrease/be unchanged). 43. Banks (create/destroy) money when they make loans and repaying bank loans (create/destroy) money. 44. When a bank loan is repaid the MS is (increased/decreased). 45. The Fed Funds rate is a loan by one bank (to another bank/from the Fed). RR+ER=TR; TR-RR=ER; TR-ER=RR; MXER=PMC; PMC(Public)+DD=TMS; PMC(Fed)=TMS 900 9,000 10,000

NS 46-47 AP Econ [MS = Currrency+DD of Public] RR+ER=TR; TR-RR=ER; TR-ER=RR; MXER=PMC; PMC(Public)+DD=TMS; PMC(Fed)=TMS 46. If the RR was lowered [say, from 50% to 10%], the size of the monetary multiplier [MM] would (increase/decrease). Leakages(limitations) of the Money Creating Process 1. Cash leakages [taking part of loan in cash] 2. ER (banks don’t loan it or we don’t borrow] 47. If borrowers take a portion of their loans as cash, the maximum amount by which the banking system increases the MS by lending will (increase/decrease).

The End