Economic Forces in American History Fractional Reserve Banking Simulation

Economic Forces in American History Introduction Fractional Reserve Banking is a fundamental part of all modern economies. First introduced in Europe in the 16th Century, bankers ever since have made sure to lend out most - but not all - of the deposits held by their institutions. Originally the reason for holding a fraction in reserve was to protect the bank in case many or most of its depositors needed cash at the same time. Today there are reserve requirements imposed on American banks by the Federal Reserve System in its ongoing effort to manage the nation's money supply.

Economic Forces in American History Objectives After this lesson students will be able to Calculate the amount of money created by banks in the classroom economy. Appreciate the role of banks as creators of money. Understand the importance of fractional reserve banking in the process of money creation.

Economic Forces in American History Sequence First, introduce the idea of banking and money. Why do we even have banks? What do they offer? Second, explain that today we’ll be doing a banking simulation. Third explain the roles. Fourth, assign the roles (hand out the role sheets). Fifth, go over the rules. Sixth, go through three rounds, debriefing after each round. Seventh, do a final debriefing on the game.

Economic Forces in American History Roles for the Simulation Bankers Goal: To lend 80% of your assets in every round. Rules to Follow: - You cannot lend more than 80% - You must fill out your balance sheet every round - You must follow the credit rating guidelines for each round Borrowers Goal: To borrow your goal amount over three rounds - When asked your risk level you MUST tell the truth. - You must fill out your balance sheet at the end of each round. - You must deposit your loan funds in a bank each round.

Economic Forces in American History Tips for Bankers You want to lend money to low-risk borrowers if you can. You earn more points for many small loans than for one big loan. You can only lend 80% of your new deposits. You want to get as many deposits as you can each round. You cannot accept deposits from people to whom you lent money.

Economic Forces in American History Tips for Borrowers Your goal is to borrow the whole amount over three rounds - so a partial loan in round one is okay. You must deposit your funds into a bank OTHER THAN the one that lent you money.

Economic Forces in American History Rounds 1-3 Debriefing Who was able to borrow in this round? Did anyone borrow all of their funds in one round? Did any bankers reach their 80% target in this round? Most important, for those people who borrowed money - what will you need to do in order to spend it? Bankers - how did you decide whether to lend to someone or not?

Economic Forces in American History Charting the Money Supply Round 1 - Deposits = $40,000 Round 2 - Deposits = Round 3 - Deposits =

Economic Forces in American History Final Debriefing Questions We started with only $40,000 in deposits, but we ended with a whole lot more than that. Where did all the extra money come from? What would all those borrowers do with the money? Would that be helpful to the economy? Why or why not? In our simulation all of our loans were good loans because borrowers will pay them back. What happens when banks have to deal with loans that don’t get paid back?

Economic Forces in American History Final Debriefing Questions 2 Our reserve requirement was 20%. What would happen to the money available for borrowing if we raised it to 30%? How about lowering in to 10%? Most economics textbooks say that banks “create” money. After this simulation would you agree or disagree? Why or why not?

Economic Forces in American History Teaching Tips - 1 Separate borrowing and depositing in round 1. Because banks can only lend 80% of their new deposits, you don’t want them lending until they know how many new deposits they’ll have. Reward all borrowers who achieve the goal. This is not really a competition for borrowers.

Economic Forces in American History Teaching Tips - 2 Allow banks to compete for new deposits - this mirrors the real economy. Encourage bankers to have and use a calculator. Stay focused on the main point of the exercise - the growth in deposits over three rounds. Interest rates make the game hopelessly complex.

Economic Forces in American History Teaching Tips 3 Increase the amount to borrow for each of the three borrowing roles by $10,000. This will keep kids in the game longer. Make most of your borrowers medium risk – you only want two or three low risk and two or three high risk in a class of 30.