1. Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. Contemporary Economics: An Applications Approach By Robert J. Carbaugh 3rd Edition Chapter 14: Money and the Banking System

2. Carbaugh, Chap. 14 2 How the payments system works The Banking System Check processing systems: 1) Within a bank 2) Local clearinghouses 3) Correspondent banks 4) the Federal Reserve System's check collection network: A consumer in Albany, NY buys a painting from a gallery in Sacramento, CA. The buyer sends a check written on her account in an Albany bank. The gallery deposits the check in their account in a Sacramento bank. The Sacramento bank deposits the check for credit in its account at the FRB of San Francisco. The FRB of San Francisco sends the check to the FRB of New York for collection. The FRB of New York sends the buyer's check to her bank in Albany, which deducts the amount from her account there. The Albany bank tells the FRB of New York to deduct the amount of the check from its account. The FRB of New York pays FRB of San Francisco from its share in the inter-district settlement fund. FRB of San Francisco adds the amount to the Sacramento bank's account, and the gallery's account is increased.

3. Carbaugh, Chap. 14 3 Measuring the money supply Money Component$ billions% of total Currency619.851 Demand deposits295.925 Other checkable deposits277.823 Traveler's checks7.71 Total1,201.2100 The M1 measure of US money supply, January 2003 M1 = currency in the hands of the public + demand deposits + other checkable deposits + traveler's checks Source: Federal Reserve Bulletin, March 2003

4. Carbaugh, Chap. 14 4 500 525 551 579 608 10,000 10,500 11,025 11,576 12,155 12,763 9,500 10,000 10,500 11,000 11,500 12,000 12,500 13,000 012345 Year Compound interest: how money grows over time Money The future value of $10,000 compounded annually at 5% interest Future value of money ($) Original $10,000 deposit

5. Carbaugh, Chap. 14 5 Future value of $10,000 compounded annually Money interest ratestartyear 1year 2year 3year 4year 5 9%10,00010,90011,88112,95014,11615,386 7%10,00010,70011,44912,25013,10814,026 5%10,000 10,50011,02511,57612,15512,763 3%10,000 10,30010,60910,92711,25511,593 0%10,000 10,00010,00010,00010,000 10,000 Future value of a $10,000 savings deposit

6. Carbaugh, Chap. 14 6 The business of banking Banking AssetsLiabilities and net worth Reserves317.7Deposits4,497.8 Loans4,124.1 Checking deposits660.4 Commercial/industrial971.3Savings/time deposits3,837.4 Real estate1,981.4Borrowings1,340.7 Consumer172.2All other liabilities561.4 Other999.2Total liabilities6,399.9 Securities1,664.0Net worth (assets-liabilities)469.2 US Government991.2 Other672.8 All other assets763.3 Total assets6,869.1 Source: Federal Reserve Bulletin, March 2003 Consolidated balance sheet for all US commercial banks, December 2002 ($ bill.)

7. Carbaugh, Chap. 14 7 Process of money creation Money (a) Wells Fargo Bank AssetsLiabilities Required reserve =$100Checking deposits =$1,000 Loans =$900 (b) U.S. Bank AssetsLiabilities Required reserve =$90Checking deposits =$900 Loans =$810 (c) Rainier Bank AssetsLiabilities Required reserve =$81Checking deposits =$810 Loans =$729 Money multiplier = 1/required reserve ratio