2. By: Miss Chan Chin Hung, Amy Sec 1-9-01 F.5 Economics Deposit Creation

5. The above processes repeat through Banks D,E,F… until excess reserve equals zero. The Money Flow in Simulation Game MARY Bank A $1000 Deposits JOHN $750 Shoe Seller LOAN $750 PAY Bank B $750 Deposits ANN $187.5 LOAN rrr = 0.25

6. 1st round:$1000 2nd round:$750 Increase in deposits after 2 rounds = ?????

9. Assumptions §Fractional reserve system §Banks offer demand deposits only §There is no cash leakage §Banks will lend all their excess reserves §There is sufficient demand for bank loans

10. §Fractional reserve system: a system under which banks are required to keep a fraction of its deposits as reserves §Minimum required reserve ratio (rrr): minimum ratio of reserves to deposits which banks are required by law to keep

11. §Excess reserves: Reserves in excess of the required

12. §rrr = 25% §Mary puts $1000 into her account in Bank A. This is the initial deposits into the banking system. MARY Bank A $1000 Deposits

14. PUBLIC BANK

15. PUBLIC BANK $1000

17. PUBLIC BANK $1000 $750

18. PUBLIC BANK $1000 $750

20. $1000 $750 $562.5 $750 PUBLIC BANK

21. $1000 $750 $562.5 $750 PUBLIC BANK $562.5

23. $1000 $750 $562.5 $750 $562.5 $421.9 $421.9 $316.4.... PUBLIC BANK

24. Round 1$1000 Round 2$750 Round 3$562.5 Round 4$421.9 Round ……

25. = $1000 + $750 + $562.5 + … = $1000 + $1000(0.75) + $1000(0.75) 2 +... + $1000(0.75) n-1 = $1000/(1-0.75) = $1000 x 0.25 = $4000

26. Total Deposits Created =Banking multiplier x initial deposits

27. In our example, §Mary deposits $1000 into her account §rrr = 0.25 §Banking multiplier = 1/0.25 = 4 Total Deposits Created = $1000 x 4 = $4000

28. 1. Bank E’s balance sheet: AssetsLiabilities Total Reserves$4000Deposits$9000 Loan$5000 Suppose the minimum required reserve ratio is 0.2. Find Bank E’s excess reserves after Peter deposits $2000 into his account in Bank E.

29. Bank E’s balance sheet after Peter’s deposit of $2000: AssetsLiabilities Total ReservesDeposits Loan$5000 $11000 $6000 x 0.2 = $2200 $6000 - $2200 = $3800 Required Reserves = $11000 Excess Reserves =

30. 2.At r = 0.2, what is the maximum amount of deposits created by the banking system? Maximum deposits created = $2000 x banking multiplier = $2000 x 1/0.2 = $2000 x 5 = $10000

31. Bank multiplier = 1 Required reserve ratio Total deposit increment = initial deposit x banking multiplier