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

2. The Goldsmith’s:
- The original bankers and creators of the
fractional reserve system.
But how, you ask, did they do it? (at this point the class is supposed to ask this question)

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

4. Assets Liabilities Cash $ 50 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. 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 can be loaned out by
banks.
C. Actual Reserves.
- Required Reserves + Excess Reserves
D. The Reserve Requirement.
- The percentage of demand deposits banks may
not lend out.

6. E. Money Creation. When loans are made. F. Money Destruction
E. Money Creation. When loans are made. F. Money Destruction. When loans are paid back, both principal and interest.

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

8. C. Open Market Operations: 1
C. Open Market Operations: 1. Selling Treasury Securities: (government bills, notes, and bonds) Selling them to the public decreases the money supply, a contractionary action (fights inflation). 2. Buying Treasury Securities: (mainly bonds) Buying them from the public increases the money supply, an expansionary action (fights recession).

9. Federal Funds Rate:
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.
If the Fed wishes to decrease the Federal Funds Rate to fight recession, it would buy bonds from the public to expand the money supply. With more money on deposit, banks can loan out money to each other at lower interest rates.
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.