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

2. 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)

3. 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

4. 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

5. 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.

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

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

8. 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

9. 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

10. 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

11. 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

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

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