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4. The Fractional Reserve System Example Transactions Showing How a Bank Can Create Money The Money Multiplier in Theory The Money Multiplier in Reality Creating Money The Monetary System > Creating Money Free to share, print, make copies and changes. Get yours at www.boundless.com www.boundless.com/economics?campaign_content=book_5770_section_116&campaign_term=Economics&utm_campaign=powerpoint&utm_me dium=direct&utm_source=boundless

5. The main way that banks earn profits is through issuing loans. Because their depositors do not typically all ask for the entire amount of their deposits back at the same time, banks lend out most of the deposits they have collected. The fraction of deposits that a bank keeps in cash or as a deposit with the central bank, rather than loaning out to the public, is called the reserve ratio. A minimum reserve ratio (or reserve requirement) is mandated by the Fed in order to ensure that banks are able to meet their obligations. Because banks are only required to keep a fraction of their deposits in reserve and may loan out the rest, banks are able to create money. A lower reserve requirement allows banks to issue more loans and increase the money supply, while a higher reserve requirement does the opposite. The Fractional Reserve System Free to share, print, make copies and changes. Get yours at www.boundless.com www.boundless.com/economics/textbooks/alternative-to-economics-3rd-paul-krugman-robin-wells-1464128731-9781464128738/the-monetary- system-29/creating-money-116/the-fractional-reserve-system-458- 12552?campaign_content=book_5770_section_116&campaign_term=Economics&utm_campaign=powerpoint&utm_medium=direct&utm_source= boundless Money Creation in a Fractional Reserve System View on Boundless.com The Monetary System > Creating Money

6. When a deposit is made at a bank, that bank must keep a portion the form of reserves. The proportion is called the required reserve ratio. Loans out a portion of its reserves to individuals or firms who will then deposit the money in other bank accounts. Theoretically, this process will until repeat until there are no excess reserves left. The total amount of money created with a new bank deposit can be found using the deposit multiplier, which is the reciprocal of the reserve requirement ratio. Multiplying the deposit multiplier by the amount of the new deposit gives the total amount of money that may be created. Example Transactions Showing How a Bank Can Create Money Free to share, print, make copies and changes. Get yours at www.boundless.com www.boundless.com/economics/textbooks/alternative-to-economics-3rd-paul-krugman-robin-wells-1464128731-9781464128738/the-monetary- system-29/creating-money-116/example-transactions-showing-how-a-bank-can-create-money-459- 12553?campaign_content=book_5770_section_116&campaign_term=Economics&utm_campaign=powerpoint&utm_medium=direct&utm_source= boundless Money Creation and Reserve Requirements View on Boundless.com The Monetary System > Creating Money

7. The total supply of commercial bank money is, at most, the amount of reserves times the reciprocal of the reserve ratio (the money multiplier). When banks have no excess reserves, the supply of total money is equal to reserves times the money multiplier. Theoretically, banks will never have excess reserves. According to the theory, a central bank can change the money supply in an economy by changing the reserve requirements. The Money Multiplier in Theory Free to share, print, make copies and changes. Get yours at www.boundless.com www.boundless.com/economics/textbooks/alternative-to-economics-3rd-paul-krugman-robin-wells-1464128731-9781464128738/the-monetary- system-29/creating-money-116/the-money-multiplier-in-theory-460- 12554?campaign_content=book_5770_section_116&campaign_term=Economics&utm_campaign=powerpoint&utm_medium=direct&utm_source= boundless Money Creation and the Money Multiplier View on Boundless.com The Monetary System > Creating Money

8. Some banks may choose to hold excess reserves, leading to a money supply that is less than that predicted by the money multiplier. Customers may withdraw cash, removing a source of reserves against which banks can create money. Individuals and businesses may not spend the entire proceeds of their loans, removing the multiplier effect on money creation. The Money Multiplier in Reality Free to share, print, make copies and changes. Get yours at www.boundless.com www.boundless.com/economics/textbooks/alternative-to-economics-3rd-paul-krugman-robin-wells-1464128731-9781464128738/the-monetary- system-29/creating-money-116/the-money-multiplier-in-reality-461- 12555?campaign_content=book_5770_section_116&campaign_term=Economics&utm_campaign=powerpoint&utm_medium=direct&utm_source= boundless U.S. Monetary Base View on Boundless.com The Monetary System > Creating Money

9. Free to share, print, make copies and changes. Get yours at www.boundless.com Appendix

10. Key terms central bank The principal monetary authority of a country or monetary union; it normally regulates the supply of money, issues currency and controls interest rates. commercial bank A type of financial institution that provides services such as accepting deposits, making business loans, and offering basic investment products to the public. currency Paper money. deposit Money placed in an account. deposit multiplier The maximum amount of commercial bank money that can be created by a given unit of reserves. money multiplier The maximum amount of commercial bank money that can be created by a given unit of central bank money. reserve requirement The minimum amount of deposits each commercial bank must hold (rather than lend out). reserves Banks' holdings of deposits in accounts with their central bank, plus currency that is physically held in the bank's vault. Free to share, print, make copies and changes. Get yours at www.boundless.com The Monetary System

11. Money Creation in a Fractional Reserve System The diagram shows the process through which commercial banks create money by issuing loans. Free to share, print, make copies and changes. Get yours at www.boundless.com Wikipedia. "Money-creation." CC BY-SA http://en.wikipedia.org/wiki/File:Money-creation.gif View on Boundless.comCC BY-SAhttp://en.wikipedia.org/wiki/File:Money-creation.gifView on Boundless.com The Monetary System

12. U.S. Monetary Base The monetary base is the sum of currency and reserves held in accounts at the central bank. After the financial crisis the monetary base increased dramatically: the result of banks starting to hold excess reserves as well as the central bank increasing the supply of reserves. Free to share, print, make copies and changes. Get yours at www.boundless.com Wikimedia. "U.S.Monetary base." CC BY-SA http://commons.wikimedia.org/wiki/File:U.S._Monetary_base.png View on Boundless.comCC BY-SAhttp://commons.wikimedia.org/wiki/File:U.S._Monetary_base.pngView on Boundless.com The Monetary System

13. Money Creation and Reserve Requirements The graph shows the total amount of money that can be created with the addition of $100 in reserves, using different reserve requirements as examples. Free to share, print, make copies and changes. Get yours at www.boundless.com Wikimedia. "Fractional-reserve banking with varying reserve requirements." Public domain http://commons.wikimedia.org/wiki/File:Fractional- reserve_banking_with_varying_reserve_requirements.gif View on Boundless.comPublic domainhttp://commons.wikimedia.org/wiki/File:Fractional- reserve_banking_with_varying_reserve_requirements.gifView on Boundless.com The Monetary System

14. Money Creation and the Money Multiplier The graph shows the theoretical amount of money that can be created with different reserve requirements. Free to share, print, make copies and changes. Get yours at www.boundless.com Wikipedia. "Fractional reserve lending varyingrates 100base." Public domain http://en.wikipedia.org/wiki/File:Fractional_reserve_lending_varyingrates_100base.jpg View on Boundless.comPublic domainhttp://en.wikipedia.org/wiki/File:Fractional_reserve_lending_varyingrates_100base.jpg View on Boundless.com The Monetary System

15. Free to share, print, make copies and changes. Get yours at www.boundless.com The Monetary System The higher the ______, the ________ is created. A) minimum reserve; more money B) reserve requirement; less money C) desired reserves; more money D) vault cash; more funds

16. Free to share, print, make copies and changes. Get yours at www.boundless.comwww.boundless.com Boundless - LO. "Boundless." CC BY-SA 3.0 http://www.boundless.com/CC BY-SA 3.0http://www.boundless.com/ The Monetary System The higher the ______, the ________ is created. A) minimum reserve; more money B) reserve requirement; less money C) desired reserves; more money D) vault cash; more funds

17. Free to share, print, make copies and changes. Get yours at www.boundless.com The Monetary System Why is there a reserve requirement for all commercial banks? A) To ensure that they have some cash available B) To allow them to compete with other commercial banks C) To ensure that they can meet their obligations D) To ensure an equal debit and credit balance on the balance sheet

18. Free to share, print, make copies and changes. Get yours at www.boundless.comwww.boundless.com Boundless - LO. "Boundless." CC BY-SA 3.0 http://www.boundless.com/CC BY-SA 3.0http://www.boundless.com/ The Monetary System Why is there a reserve requirement for all commercial banks? A) To ensure that they have some cash available B) To allow them to compete with other commercial banks C) To ensure that they can meet their obligations D) To ensure an equal debit and credit balance on the balance sheet

19. Free to share, print, make copies and changes. Get yours at www.boundless.com The Monetary System If the required reserve ratio is 20%, what would the deposit multiplier be? A) 5 B) 0.2 C) 0.5 D) This cannot be determined with the information provided.

20. Free to share, print, make copies and changes. Get yours at www.boundless.comwww.boundless.com Saylor OER. "Economics « Saylor.org – Free Online Courses Built by Professors." CC BY 3.0 http://www.saylor.org/majors/Economics/CC BY 3.0http://www.saylor.org/majors/Economics/ The Monetary System If the required reserve ratio is 20%, what would the deposit multiplier be? A) 5 B) 0.2 C) 0.5 D) This cannot be determined with the information provided.

21. Free to share, print, make copies and changes. Get yours at www.boundless.com The Monetary System Given that the reserve ratio for any bank operating in Country X is 12.5%, calculate the deposit multiplier. A) 6 B) 8 C) 12 D) 9

22. Free to share, print, make copies and changes. Get yours at www.boundless.comwww.boundless.com Boundless - LO. "Boundless." CC BY-SA 3.0 http://www.boundless.com/CC BY-SA 3.0http://www.boundless.com/ The Monetary System Given that the reserve ratio for any bank operating in Country X is 12.5%, calculate the deposit multiplier. A) 6 B) 8 C) 12 D) 9

23. Free to share, print, make copies and changes. Get yours at www.boundless.com The Monetary System Theoretically, if an economy has $10,000 in reserves and a reserve requirement ratio of 20%, then the money multiplier is ________ and the maximum amount of commercial bank money is _________. A) 0.2; $50,000 B) 5; $20,000 C) 5; $50,000 D) 0.2; $20,000

24. Free to share, print, make copies and changes. Get yours at www.boundless.comwww.boundless.com Boundless - LO. "Boundless." CC BY-SA 3.0 http://www.boundless.com/CC BY-SA 3.0http://www.boundless.com/ The Monetary System Theoretically, if an economy has $10,000 in reserves and a reserve requirement ratio of 20%, then the money multiplier is ________ and the maximum amount of commercial bank money is _________. A) 0.2; $50,000 B) 5; $20,000 C) 5; $50,000 D) 0.2; $20,000

25. Free to share, print, make copies and changes. Get yours at www.boundless.com The Monetary System Which of the following is NOT a reason that the money multiplier works differently in reality than it does in theory? A) Banks may hold excess reserves B) Customers may hold their savings in cash C) The central bank may adjust the supply of reserves D) Loan proceeds may not be spent

26. Free to share, print, make copies and changes. Get yours at www.boundless.comwww.boundless.com Boundless - LO. "Boundless." CC BY-SA 3.0 http://www.boundless.com/CC BY-SA 3.0http://www.boundless.com/ The Monetary System Which of the following is NOT a reason that the money multiplier works differently in reality than it does in theory? A) Banks may hold excess reserves B) Customers may hold their savings in cash C) The central bank may adjust the supply of reserves D) Loan proceeds may not be spent

27. Attribution Wikipedia. "Fractional reserve banking." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Fractional_reserve_bankingCC BY-SA 3.0http://en.wikipedia.org/wiki/Fractional_reserve_banking Wiktionary. "deposit." CC BY-SA 3.0 http://en.wiktionary.org/wiki/depositCC BY-SA 3.0http://en.wiktionary.org/wiki/deposit Wikipedia. "reserves." CC BY-SA 3.0 http://en.wikipedia.org/wiki/reservesCC BY-SA 3.0http://en.wikipedia.org/wiki/reserves Wikipedia. "Money Multiplier." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Money_multiplierCC BY-SA 3.0http://en.wikipedia.org/wiki/Money_multiplier Wikipedia. "Money Creation." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Money_creationCC BY-SA 3.0http://en.wikipedia.org/wiki/Money_creation Wiktionary. "currency." CC BY-SA 3.0 http://en.wiktionary.org/wiki/currencyCC BY-SA 3.0http://en.wiktionary.org/wiki/currency Wikipedia. "deposit multiplier." CC BY-SA 3.0 http://en.wikipedia.org/wiki/deposit%20multiplierCC BY-SA 3.0http://en.wikipedia.org/wiki/deposit%20multiplier Wikipedia. "Money multiplier." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Money_multiplierCC BY-SA 3.0http://en.wikipedia.org/wiki/Money_multiplier Wikipedia. "money multiplier." CC BY-SA 3.0 http://en.wikipedia.org/wiki/money%20multiplierCC BY-SA 3.0http://en.wikipedia.org/wiki/money%20multiplier Wikipedia. "commercial bank." CC BY-SA 3.0 http://en.wikipedia.org/wiki/commercial%20bankCC BY-SA 3.0http://en.wikipedia.org/wiki/commercial%20bank Wiktionary. "central bank." CC BY-SA 3.0 http://en.wiktionary.org/wiki/central+bankCC BY-SA 3.0http://en.wiktionary.org/wiki/central+bank Wikipedia. "Money multiplier." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Money_multiplierCC BY-SA 3.0http://en.wikipedia.org/wiki/Money_multiplier Wikipedia. "reserve requirement." CC BY-SA 3.0 http://en.wikipedia.org/wiki/reserve%20requirementCC BY-SA 3.0http://en.wikipedia.org/wiki/reserve%20requirement Wikipedia. "money multiplier." CC BY-SA 3.0 http://en.wikipedia.org/wiki/money%20multiplierCC BY-SA 3.0http://en.wikipedia.org/wiki/money%20multiplier Free to share, print, make copies and changes. Get yours at www.boundless.com The Monetary System