1. Mr. Bernstein Module 25: Banking and Money Creation February 26, 2015
AP Economics
Mr. Bernstein
Module 25:
Banking and Money Creation
February 26, 2015

2. AP Economics Mr. Bernstein
Banking and Money Creation
Objectives - Understand each of the following:
The role of banks in the economy
The reasons for and types of banking regulation
How banks create money

3. AP Economics Mr. Bernstein
How Banks Create Money
Banks receive deposits
Banks make loans
Banks hold reserves against those loans
If reserves are 10%, loans can be 10x deposits
This effectively creates money
Demonstrated by T-Account:
Fed sets reserve requirements

4. AP Economics Mr. Bernstein
How Banks Create Money: An Example
Similar to the Spending Multiplier

5. AP Economics Mr. Bernstein
Problem of Bank Runs
If public fears a bank may fold and be unable to pay back depositors, they rush to the bank to make withdrawals before others can
Since deposits are several times reserves, a bank with solid loans but the subject of rumours may be unable to meet demand for withdrawals
Can become a self-fulfilling prophecy
Preventing bank runs is a primary reason for bank regulation

6. AP Economics Mr. Bernstein
Bank Regulation
Deposit Insurance
Current FDIC insurance is $250,000 per account
Capital Requirements (= Assets – Liabilities)
Capital Requirements have been rising since 2008 crisis
Reserve Requirements
Currently 10% in the USA
Discount Window
Fed stands as short-term lender to banks in need of capital

7. AP Economics Mr. Bernstein
Reserves, Bank Deposits and the Money Multiplier
Money Multiplier = 1 / reserve ratio…MM = 1/rr
Excess Reserves = Total Reserves - rr
MM tells us how
much money can be
created from each $
of Excess Reserves
In reality, MM is not
10 – its now < 1.
Why?