1. CONTEMPORARY ECONOMICS© Thomson South-Western 17.1 How Banks Work SLIDE 1 Money Creation, the Federal Reserve System, and Monetary Policy 17 17.1How Banks Work 17.2Monetary Policy in the Short Run 17.3Monetary Policy in the Long Run

2. CONTEMPORARY ECONOMICS© Thomson South-Western 17.1 How Banks Work SLIDE 2 How does the Fed create money? Why don’t you demand all the money you can get your hands on? What’s the price of holding money? How does the supply of money in the economy affect your chances of finding a job, your ability to finance a new car, and the interest rate you pay on credit cards? What’s the impact of changes in the money supply on the economy in the short run and in the long run? CONSIDER

3. CONTEMPORARY ECONOMICS© Thomson South-Western 17.1How Banks Work  Discuss what’s involved in getting a new bank up and running.  Describe how the banking system can expand the money supply by a multiple of excess reserves. Objectives

4. CONTEMPORARY ECONOMICS© Thomson South-Western 17.1How Banks Work  net worth  asset  liability  balance sheet Key Terms  required reserve ratio  required reserves  excess reserves  money multiplier

5. CONTEMPORARY ECONOMICS© Thomson South-Western 17.1 How Banks Work SLIDE 5 Operating a Bank Getting a charter Bank balance sheet Reserve accounts

6. CONTEMPORARY ECONOMICS© Thomson South-Western 17.1 How Banks Work SLIDE 6 Getting a Charter Charter—the right to operate Net worth—assets minus liabilities, also called owners’ equity Asset—any physical property or financial claim owned by the bank

7. CONTEMPORARY ECONOMICS© Thomson South-Western 17.1 How Banks Work SLIDE 7 Bank Balance Sheet Liability—an amount owed Balance sheet—a financial statement showing assets, liabilities and net worth at a given time; assets must equal liabilities plus net worth, so the statement is in balance Assets = Liabilities + Net worth

8. CONTEMPORARY ECONOMICS© Thomson South-Western 17.1 How Banks Work SLIDE 8 Reserve Accounts Required reserve ratio—a Fed regulation that dictates the minimum fraction of deposits each bank must keep in reserve Required reserves—the dollar amount that must be held in reserve; checkable deposits multiplied by the required reserve ratio Excess reserves—bank reserves in excess of required reserves

9. CONTEMPORARY ECONOMICS© Thomson South-Western 17.1 How Banks Work SLIDE 9 Money Multiplier Money multiplier—the multiple by which the money supply can increase as a result of an increase in excess reserves in the banking system The Fed makes a move Round one Round two and beyond Reserve requirements and money expansion Limitations on the multiplier