1. The Fractional Reserve System or Banking and How Money is Created
psst: it’s magic!

2. I. The Goldsmith’s:
- The original bankers and creators of the fractional
reserve system.

3. II. Bank Balance Sheet:
- It is a snapshot of the financial condition of
bank at one particular time. (see next slide)

4. Assets Liabilities cash also. **** Demand Deposits Are checking
Cash $ Demand Deposits **** $ 500
Reserves at Fed * $ Time & Savings Deposits $ 500
Loans ** $ 600
Securities *** $ 150
Buildings/Equipment $ Net Worth $ 100
Total $1,100 Total $1,100
Reserves at the Fed represent
cash also.
**** Demand Deposits Are checking
accounts, Time Deposits are CD’s, and
Net Worth = owner’s original
investment and retained profits.
** Loans are assets because they
earn money for banks.
***Securities are Govt (or Treasury
Securities, not stocks and bonds.
U.S. banks cannot invest in the
stock market.

5. III. The Fractional Reserve System:
- A primary function of the Federal
Reserve is to limit the growth of the
money supply.
How do they do it? (again, this is the part where the class asks the question)
A. Required Reserves: demand deposits
that cannot be loaned out by banks.
B. Excess Reserves: demand deposits that
may be loaned out by banks.
C. Actual Reserves: Required Reserves +
Excess Reserves.
D. The Reserve Requirement: The % of
demand deposits banks may not lend. -

6. F. Money Destruction: When loans are paid back.
E. Money Creation: When loans are made.
F. Money Destruction: When loans are paid
back.

7. IV. The Tools of Monetary Policy:
A. Reserve Requirement:
1. Reducing it increases the money supply,
an expansionary action (fights recession).
2. Increasing it reduces the money supply, a
contractionary action (fights inflation).
B. Discount Rate: (interest rate the Fed
charges banks when they borrow from the
Fed.)

8. 1. Buying Treasury Securities: (mainly
C. Open Market Operations:
1. Buying Treasury Securities: (mainly
bonds). Buying them from the public
increases the money supply, an expansionary
action (fights recession).
2. Selling Treasury Securities: Selling them
to the public reduces the money supply, a
contractionary action (fights inflation).
Here the money goes from the Fed to the public.
Here the money goes from the public to the Fed.

9. V) Federal Funds Rate: A) The interest rate charged by banks when they borrow from each other. It is not set by the Federal Reserve, but the Federal Reserve influences the Federal Funds Rate via Open Market Operations. B) If the Fed wishes to decrease the Federal Funds Rate to fight recession, it would buy bonds from the public to increase the money supply. With more money on deposit, banks can loan out money to each other at lower interest rates.

10. C) If the Fed wishes to increase the Federal Funds Rate to fight inflation, it would sell bonds to the public in order to decrease the money supply. With less money on deposit, banks would only loan money out to each other at higher interest rates.