Download presentation
Presentation is loading. Please wait.
1
How Banks and Thrifts Create Money
14 C H A P T E R How Banks and Thrifts Create Money
2
Fractional Reserve Banking System Money Creation & Reserves
BALANCE SHEET OF A COMMERCIAL BANK ASSETS = LIABILITIES + NET WORTH The Goldsmiths Fractional Reserve Banking System Money Creation & Reserves Bank Panics & Regulation
3
FORMATION OF A COMMERCIAL BANK
LIABILITIES AND NET WORTH ASSETS TRANSACTION 1 Creating a bank $250,000 Cash for Capital Stock
4
FORMATION OF A COMMERCIAL BANK
LIABILITIES AND NET WORTH ASSETS Cash $250,000 Capital Stock $250,000 Deposit Added to Vault Cash
5
Acquiring Property and
FORMATION OF A COMMERCIAL BANK LIABILITIES AND NET WORTH ASSETS Cash $250,000 Capital Stock $250,000 TRANSACTION 2 Acquiring Property and Equipment $240,000 Cash
6
FORMATION OF A COMMERCIAL BANK
LIABILITIES AND NET WORTH ASSETS Cash $ 10,000 Property ,000 Capital Stock $250,000
7
FORMATION OF A COMMERCIAL BANK
LIABILITIES AND NET WORTH ASSETS Cash $ 10,000 Property ,000 Capital Stock $250,000 TRANSACTION 3 Accepting Deposits $100,000 Cash
8
FORMATION OF A COMMERCIAL BANK
LIABILITIES AND NET WORTH ASSETS Cash $110,000 Property ,000 Checkable Deposits $100,000 Capital Stock ,000
9
FORMATION OF A COMMERCIAL BANK
NOTES: Bank deposits are subject to a reserve requirement. Reserve ratio Commercial bank’s required reserves checkable-deposit liabilities = LIABILITIES AND NET WORTH ASSETS Cash $110,000 Property ,000 Checkable Deposits $100,000 Capital Stock ,000
10
FORMATION OF A COMMERCIAL BANK
LIABILITIES AND NET WORTH ASSETS Cash $110,000 Property ,000 Checkable Deposits $100,000 Capital Stock ,000 Three Important Issues... 1 - Excess Reserves = Actual Reserves - Required Reserves (assume 20% reserve requirement) $110, ,000 = $90,000 2 - Control 3 - Asset and Liability
11
FORMATION OF A COMMERCIAL BANK
LIABILITIES AND NET WORTH ASSETS Cash $110,000 Property ,000 Checkable Deposits $100,000 Capital Stock ,000 TRANSACTION 4 Deposits at the FED $110,000 Cash
12
FORMATION OF A COMMERCIAL BANK
LIABILITIES AND NET WORTH ASSETS Cash $ Reserves ,000 Property ,000 Checkable Deposits $100,000 Capital Stock ,000
13
A check is drawn against the bank
FORMATION OF A COMMERCIAL BANK LIABILITIES AND NET WORTH ASSETS Cash $ Reserves ,000 Property ,000 Checkable Deposits $100,000 Capital Stock ,000 TRANSACTION 5 A check is drawn against the bank $50,000
14
FORMATION OF A COMMERCIAL BANK
LIABILITIES AND NET WORTH ASSETS Cash $ Reserves ,000 Property ,000 Checkable Deposits $ 50,000 Capital Stock ,000
15
FORMATION OF A COMMERCIAL BANK
NOTES: Banks create money by lending excess reserves and destroy it by loan repayment. Purchasing bonds from the public also creates money. LIABILITIES AND NET WORTH ASSETS Cash $ Reserves ,000 Property ,000 Checkable Deposits $ 50,000 Capital Stock ,000
16
Make a loan from excess reserves
FORMATION OF A COMMERCIAL BANK LIABILITIES AND NET WORTH ASSETS Reserves $ 60,000 Property ,000 Checkable Deposits $ 50,000 Capital Stock ,000 TRANSACTION 6 Make a loan from excess reserves $50,000
17
FORMATION OF A COMMERCIAL BANK
LIABILITIES AND NET WORTH ASSETS Reserves $ 60,000 Loans ,000 Property ,000 Checkable Deposits $100,000 Capital Stock ,000 Making the loan created money!
18
FORMATION OF A COMMERCIAL BANK
LIABILITIES AND NET WORTH ASSETS Reserves $ 10,000 Loans ,000 Property ,000 Checkable Deposits $ 50,000 Capital Stock ,000 After a check for the $50,000 is drawn against the bank
19
Repaying a loan with cash
FORMATION OF A COMMERCIAL BANK LIABILITIES AND NET WORTH ASSETS Reserves $ 10,000 Loans ,000 Property ,000 Checkable Deposits $ 50,000 Capital Stock ,000 TRANSACTION 7 Repaying a loan with cash $50,000
20
FORMATION OF A COMMERCIAL BANK
LIABILITIES AND NET WORTH ASSETS Reserves $ 10,000 Loans Property ,000 Checkable Deposits $ Capital Stock ,000 $50,000 in money supply is destroyed!
21
(Assume previous balance sheet)
FORMATION OF A COMMERCIAL BANK LIABILITIES AND NET WORTH ASSETS Reserves $ 60,000 Securities ,000 Property ,000 Checkable Deposits $100,000 Capital Stock ,000 TRANSACTION 8 (Assume previous balance sheet) Buy Government Securities $50,000
22
Bankers pursue two conflicting goals:
FORMATION OF A COMMERCIAL BANK LIABILITIES AND NET WORTH ASSETS Reserves $ 60,000 Securities ,000 Property ,000 Checkable Deposits $100,000 Capital Stock ,000 Bankers pursue two conflicting goals: Profits and Liquidity Note use of Federal Funds Market... Federal Funds Rate
23
MULTIPLE DEPOSIT EXPANSION PROCESS
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 Total amount of money created by the banking system $400.00
24
Money destruction works in exactly the same multiple way!
MULTIPLE DEPOSIT EXPANSION PROCESS Bank Acquired reserves and deposits Required reserves Excess Amount bank can lend - New money created Money destruction works in exactly the same multiple way! 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 Total amount of money created by the banking system $400.00
25
= x = THE MONETARY MULTIPLIER 1 Required reserve ratio Monetary
Maximum checkable- deposit expansion = Excess reserves x Monetary Multiplier
26
OUTCOME OF MONEY EXPANSION
$100 New reserves $20 Required reserves $80 Excess reserves $400 Bank system lending $100 Initial Deposit Money Created
27
Leakages exist... Currency Drains Excess Reserves
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
28
Need for Monetary Control Chapter Conclusions
29
fractional reserve system vault cash required reserves reserve ratio
balance sheet fractional reserve system vault cash required reserves reserve ratio excess reserves actual reserves Federal funds rate monetary multiplier KEY TERMS BACK END Copyright McGraw-Hill/Irwin, 2002
30
Next... Monetary Policy Chapter 15
Similar presentations
