Presentation Transcript

1. Creation of Money

   Chapter 32
2. Currency Checking deposits Outside banks In commercial $710 billion Banks $330 billion M1 $1361 billion Savings Other deposits checkable $4378 billion deposits $321 billions Money market M1 = $1361 billion mutual funds $704 billion M2 = $6443 billion Two Definitions of the Money Supply, January 2005
3. The Banking System Bank Regulation Deposit insurance (FDIC) Withdraw funds because of bad news regarding the bank’s finances Moral hazard Problem When an individual is insured against risk, he/she puts forth little effort to avoid risk FDIC could make the banking system less safe
4. The Banking System Bank Regulation Bank Supervision Needed to reduce moral hazard problem Ensures banks take only sensible, defensible risks Controls the money supply Reserve Requirements Helps control the money supply
5. The Origins of the Money Supply How Bankers Keep Books Banks keep balance sheets Assets = liabilities + net worth Assets include: Deposits owned by bank Reserves/Loans Liabilities include: Deposits owed to customers.
6. The Money Multiplier Banking system is not just a guard of the money supply It multiplies the amount of money from the Central Bank This multiplying effect is the work of the infamous money multiplier. Each time a bank receives a deposit from a customer, it is required by the reserve requirement ratio set by the Fed (a.k.a. required by law) to keep in its reserves a fraction of the deposit The rest of the deposit can be lent out to potential borrowers. Called “fractional reserve system” Which means that only a fraction of each deposit has to be kept in the bank’s reserves.
7. Fractional Reserve Banking The GoldsmithsPrinciple Stored gold and gave a receipt Receipts used as money by public Made loans by issuing receipts Characteristics Banks create money through lending Banks are subject to “panics”
8. Fractional Reserve System Balance sheet Assets = Liabilities + Net Worth Both sides balance Necessary transactions Create a bank Accept deposits Lend excess reserves
9. Reserve Requirements
10. Assets Liabilities and Net Worth Lets create a bank… in the town of Vossdonium Transaction #1 Vault cash: cash held by the bank Sold stocks to acquire operating funds Balance Sheet 1: Vossome Bank $250,000 Cash $250,000 Stock Shares
11. Assets Liabilities and Net Worth Transaction 2 Acquiring property and equipment Balance Sheet : Vossome Bank Cash $10,000 $250,000 Stock Shares Property 240,000
12. Assets Liabilities and Net Worth Transaction 3 Commercial bank functions Accepting deposits Making loans Balance Sheet 3: VossomeBank Cash $110,000 Checkable Deposits $100,000 Property 240,000 250,000 Stock Shares
13. Commercial bank’s Required reserves Reserve ratio = Commercial bank’s Checkable-deposit liabilities Transaction 4 Depositing reserves in a Federal Reserve bank Required reserves Reserve ratio Fed establishesand variesrr within limits set by Congress rr helps Fed control lending abilities of commercial banks
14. Assets Liabilities and Net Worth Transaction 4 Assume the bank deposits all cash on reserve at the Fed Balance Sheet 4: Vossome Bank Cash $0 Checkable Deposits $100,000 Reserves 110,000 Property 240,000 Stock Shares 250,000
15. Reserve Requirements Excess reserves Actual reserves - required reserves Required reserves Checkable deposits x reserve ratio Example: Checkable deposits $100,000 Reserve ratio 10%
16. Assets Liabilities and Net Worth Transaction 5a Granting a loan Balance Sheet 6: Vossome Bank Reserves $60,000 Checkable Deposits $100,000 Loans 50,000 250,000 Stock Shares Property 240,000
17. Assets Liabilities and Net Worth Transaction 6a Using the loan $50,000 loan cashed Balance Sheet 6b: Vossome Bank Required Reserves $10,000 Checkable Deposits $50,000 Excess Reserves 0 Loans 50,000 Stock Shares 250,000 Property 240,000 Banks can lend money in their vault that is above the minimum required reserve ratio.
18. Assets Liabilities and Net Worth Transaction 6b Bank buys government securities from dealer Deposits payment into checking Balance Sheet 7: Vossome Bank Reserves $60,000 $100,000 Checkable Deposits Securities 50,000 Property 240,000 Stock Shares 250,000 New money is created
19. The Banking System Multiple-deposit expansion Assumptions: 20% required reserves All banks “loaned up” Banks lend all of excess reserves A $100 bill is found and deposited Multiple deposits can be created
20. (3) Excess Reserves (1)-(2) (4) Amount Bank Can Lend; New Money Created = (3) (1) Acquired Reserves and Deposits (2) Required Reserves Bank The Banking System Bank A $100 $20 $80 $80 Bank B $80 $16 $64 $64 Bank C $64 $12.80 $51.20 $51.20 Bank D $51.20 $10.24 $40.96 $40.96 The process will continue…
21. The Banking System
22. 1 Monetary multiplier = required reserve ratio The Monetary Multiplier 1 = R Graphic Example New Reserves $100 $80 Excess Reserves $20 Required Reserves $100 Initial Deposit $400 Bank System Lending Money Created
23. The Monetary Multiplier Maximum amount of new money created by single dollar of excess reserves Higher R, lower m Reversibility Making loans creates money Loan repayment destroys money
24. Another Illustration of Money Creation Assume 20% legal reserve requirement Suppose Nina deposits $1,000 in her checking account at Citibank. T-account of Citibank: ______Assets________________Liabilities____________ Reserves $200 Demand deposits $1,000 Loans 800
25. Kevin borrows $800 from Citibank, and buys a computer at BestBuy BestBuydeposits Kevin’s check at Fleet Bank. Fleet Bank’s T-account: _____Assets________________Liabilities_____________ Required Reserves $160 Demand Deposits $800 Loans (Excess)640
26. Vivian borrows $640 from Fleet Bank and buys a new outfit from Macy’s. Macy’s deposits Vivian’s check at Bank of New York. T-account of Bank of New York: ______Assets____________________Liabilities_______ Required Reserves $128 Demand deposits $640 Loans (Excess)512
27. Total Demand Deposits After Lending and Re-lending by banks BanksDemand Deposits Citibank $1,000 Fleet 800 Bank of New York 640   + other banks + additional deposits ___________ = $ 5,000 Total
28. Banks and Money Creation The Process in Reverse: Multiple Contractions of the Money Supply Deposits (a.k.a money supply) contract when reserves are reduced. Banks reduce their loan commitments Contraction in the money supply utilizes the same formula as for money expansion.
29. The Need for Monetary Policy Left uncontrolled, banks would: Reduce the money supply in a recession Increase the money supply during boom periods Changes in the money supply would exacerbate the business cycle One reason for monetary policy: Prevent this behavior on the part of banks.