How Banks Create Money [ MS ] MS = Currency + DD of Public

1. Give me a loan so there will be more DD in the system. How Banks CreateMoney[MS] MS = Currency + DD of Public Banks [thru loans] Create More DD

2. 1. Fractional Reserve Banking System – a fraction of DD are kept in reserve(say, 10%) at either the bank’s vault or at the Fed. 2. Vault cash – cash held bank by a (banks rarely keep more than 2% of their in cash) 3. Required Reserve(RR) – specified percentage DD that banks RR. must keep as of 4. Excess reserves – total reserves(TR) – RR. ER is what can be loaned out. Also some ER is used to meet sudden withdrawal demands. 5. Actual(Total) reserves – RR + ER. 6. Deposit Multiplier – one/RR or 1/.10 or $1/10 cents or 10 Multipliers 1/RR[$1/5 cents = 20] 1/5% = 20 1/25% = 4 1/10% = 10 1/33.3%= 3 1/12.5% = 8 1/40 = 2.5 1/20% = 5 1/50% = 2 Balance Sheet 7. – statement of assets & liabilities[assets=liabilities]. 8. Discount Rate – when banks borrow from the Fed. [symbolic - emergencies] “wholesale price of money” Federal Funds Rate 9. – banks borrow from other banks for overnight loans. 10. Prime Rate – when a bank’s prime customers [good credit] get loans. “retail price of money” 11. Buying Bonds – “buying” bonds means “bigger ” supply of money and “lower interest rates”. [So, more “C”, “Ig”, and “Xn” ] Selling Bonds – 12. “selling” bonds mea ns “smaller” supply of money and “higher interest rates”. [So, less “C”, “Ig”, and “Xn”] How Banks Create Money [Objectives & Vocabulary]

3. How Banks and Thrifts CreateMoney

4. Dennis Rodmandeposits $1with A 10% RR Rodman’s .10 90 cents Excess Reserves RR Total (Actual) Reserves One Dollar One bank’s loan becomes another bank’s DD. PMC = M x ER, so 10 x .90 =$9 TMS = PMC[$9] + DD[$1] = $10 [MS= Currency+ DD of Public]

5. Rodman’s Bank Borrows $1 From The Fed [10% RR] Rodman’s Bank Fed One Dollar 0 Excess Reserves RR Total(Actual) Reserves One Dollar PMC = M x ER, so 10 x $1 = $10 TMS [$10] = PMC[$10] [MS = Currency+ DD of Public]

6. BALANCE SHEET OF A COMMERCIAL BANK ASSETS [cash]=LIABILITIES[DD] [The cash is property of the bank][“liable”, DDs are owed to depositors] Cash $100,000DD $100,000 The Goldsmiths Fractional Reserve Banking System Money Creation & Reserves [The current 10% RR is kept in a bank’s vault or in a Fed vault.] Bank Panicsand Regulation

7. Money Creation

8. $1,000DDby Calli[MS=Currency+DDofPublic] New Deposits [New Reserves] DD New Required Reserves RR=10% DDCreated By New Loans [equal to new ER] Bank Dog that can YoYo $1,000.00 A $100.00 900.00 900.00 One year “all u can eat” hot wings at Hooters B $90.00 900.00 810.00 C $81.00 810.00 729.00 $729.00 for a “cat bodyguard” $72.90 729.00 D 656.10 PMC = $9,000.00 PMC = ER[$900] x M[10] Smoking cat Erin’s DD + PMC = TMS $1,000.00 +$9,000.00 =$10,000.00 MSgrows by multiple of10

9. $1,000DDby Marie[MS=Currency+DDofPublic] Hair care for 1 year New Deposits [New Reserves] DD New Required Reserves RR=20% DD Created By New Loans [equal to new ER] Bank Purchase of a donkey $1,000.00 A $200.00 800.00 800.00 B $160.00 800.00 640.00 C $128.00 640.00 512.00 TwoMonkeys $102.40 512.00 D 409.60 PMC = $4,000.00 PMC = ER[$800 x M[5] A chauffeur dog Marie’s DD + PMC = TMS $1,000.00 + $4,000.00 = $5,000.00 MSgrows by multiple of5

10. $1,000DDby Emily[MS=Currency+DDofPublic] Shark to keep in bathtub New Deposits [New Reserves] DD New Required Reserves RR=25% DD Created By New Loans [equal to new ER] Bank $1,000.00 Prom date w. Linda Blair A $250.00 750.00 750.00 B $188.00 750.00 562.00 Frog with teeth C $140.00 562.00 422.00 Teach Stuart Little how to brush his teeth $105.00 422.00 D 317.00 E $80.00 237.00 317.00 Cat with human teeth PMC = ER[$750] x M[4] PMC = $3,000.00 Em’s DD + PMC = TMS $1,000.00 + $3,000.00 = $4,000.00 MSgrows by multiple of4

11. MS = DD + Currency of the Public [A DD of $10,000 will increase MS by another $40,000($50,000 MS] RR=20% MS $10,000 $8,000 $6,400 $24,400 MSis $10,000 4. 2nd Bank lends Sports Shop$6,400. 1. Joe Biker deposits $10,000 in his bank. RR = 20% MS $10,000 $8,000 $18,000 2. Suzie Rah Rah borrows $8,000 5. Eventually the MS will be $50,000 Joe 3. Suzie pays $8,000 for a new car. GoNow Auto deposits the $ in 2nd Bank. $10,000+$40,000=$50,000

12. Most Famous “Panic Run”in MovieHistory

13. Another Famous “Panic Run”in MovieHistory The children wanted to use their tuppance to buy bread crumbs to feed the pigeons, instead of investing it at the bank. When they said, “We want our money”,the other depositors thought it was a “bank run”. [nominated for a record 13 academy awards - won 6]

14. History of Deposit Insurance In 1934, federal deposit insurance made its debut at $2,500to protect the average family’s savings and end the bank runsthat had shut down businesses and contributed to the Great Depression. Through the years the coverage rose in $5,000 increments until the 70swhen it jumped to$40,000. In 1980,it was raised to$100,000.

15. The Very Early Days Of Banking Greatest invention since sliced bread “Wow, you mean we can create money out of thin air.?” There were more claims to gold than there were ounces of gold. The fractional banking system began when someone issued claims for gold that already belonged to someone else. Once upon a time there was a gold-smithy who offered to store people’s gold in his vault. He issued paper receiptsfor the gold, and it was not long before the townsfolk used the paper to purchase eggs and beer. The smithy’s paper receipts [first checks] became as “good as gold.” Our Smithy was not stupid. He said to himself. “I have 2000 ounces of gold stored in my vault, but in the last year I was never called upon to pay out more than 100 ounces in a single day. What harm could it do if I lent out say, half the gold I now have? I’ll still have more than enough to pay off any depositors that come in for a withdrawal. No one will know the difference. I could earn 30 additional ounces of gold each week. I think I’ll do it.” “The smithy has invented the Fractional Reserve Banking System.” Advantages of Lending [One disadvantagewas the possibility of “bank runs”] 1. Depositors haven’t lost money [Goldsmiths paid theminstead ofother way] 2. With the interest you earned you could give some to depositors. 3. The loans benefited the community thru loans

16. TRANSACTION 1 Creating a bank $250,000 Cash for Capital Stock FORMATION OF A COMMERCIAL BANK In Lovelady, Texas [owe] ASSETS LIABILITIES & NET WORTH [own]

17. FORMATION OF A COMMERCIAL BANK In Lovelady, Texas [owe] ASSETS [own] LIABILITIES & NET WORTH Cash$250,000 Capital Stock$250,000 DepositAdded to Vault Cash

18. TRANSACTION 2 Acquiring Property and Equipment $240,000 Cash FORMATION OF A COMMERCIAL BANK In Lovelady, Texas ASSETS LIABILITIES & NET WORTH [owe] [own] Cash$250,000 Capital Stock$250,000

19. Birth OF A COMMERCIAL BANK In Lovelady, Texas ASSETS [own] LIABILITIES & NET WORTH [owe] Cash$ 10,000 Property 240,000 Capital Stock$250,000 Lovelady Bank

20. TRANSACTION 3 Accepting Deposits $100,000 Cash FORMATION OF A COMMERCIAL BANK In Lovelady, Texas Lovelady Bank ASSETS LIABILITIES and NET WORTH Cash $ 10,000 Property240,000 Capital Stock $250,000 $250,000 $250,000

21. FORMATION OF A COMMERCIAL BANK In Lovelady, Texas Lovelady Bank ASSETS LIABILITIES and NET WORTH [Was$10,000] Cash$110,000 Property$240,000 DD$100,000 Capital Stock250,000

22. FORMATION OF A COMMERCIAL BANK In Lovelady, Texas Lovelady Bank ASSETS LIABILITIES and NET WORTH Cash $110,000 Property 240,000 DD$100,000 Capital Stock 250,000 [Was$10,000] $350,000 $350,000

23. TRANSACTION 4 A $50,000 check is written against the bank FORMATION OF A COMMERCIAL BANK In Lovelady, Texas Lovelady Bank ASSETS LIABILITIES & NET WORTH Cash$110,000 Property 240,000 DD$100,000 Capital Stock250,000 $350,000 $350,000

24. FORMATION OF A COMMERCIAL BANK In Lovelady, Texas Lovelady Bank ASSETS LIABILITIES & NET WORTH [was$110,000] Cash $ 60,000 Property 240,000 DD$ 50,000 Capital Stock250,000 $300,000 $300,000

25. NOTES: Banks create money by lending ERand destroy money by loan repayment. Purchasing bonds from the public also creates money. FORMATION OF A COMMERCIAL BANK In Lovelady, Texas

26. TRANSACTION 5 Make a loan from excess reserves of $50,000 FORMATION OF A COMMERCIAL BANK In Lovelady, Texas Lovelady Bank ASSETS LIABILITY and NET WORTH Cash$ 60,000 Property 240,000 DD$ 50,000 Capital Stock 250,000

27. Making the loan created money! FORMATION OF A COMMERCIAL BANK In Lovelady, Texas Lovelady Bank LIABILITIES and NET WORTH ASSETS Cash $ 60,000 Loans 50,000 Property 240,000 DD$100,000 Capital Stock250,000

28. After a check for the $50,000 is written against the bank FORMATION OF A COMMERCIAL BANK In Lovelady, Texas Lovelady Bank ASSETS LIABILITIES AND NET WORTH Cash $ 60,000 Loans 0 Property 240,000 DD$ 50,000 Capital Stock250,000

29. Joe Bozo Dallas Big “D” Lovelady Bank Hateman Bank (a) Joe Bozo pays Best Buy a $50,000 check

30. And What Happens If A Turtle Doesn’t Keep Up with His Mortgage Payments

31. This turtle is subject to foreclosure on his house. Here, he has lost his house.

32. TRANSACTION 6 Repaying a loan with cash $50,000 FORMATION OF A COMMERCIAL BANK In Lovelady, Texas Lovelady Bank ASSETS LIABILITIES and NET WORTH Reserves $ 10,000 Loans 50,000 Property 240,000 DD$ 50,000 Capital Stock250,000

33. $50,000 in money supply is destroyed! FORMATION OF A COMMERCIAL BANK In Lovelady, Texas Lovelady Bank ASSETS LIABILITIES and NET WORTH Reserves $ 10,000 Loans 0 Property 240,000 DD$0 Capital Stock250,000

34. Amount bank can lend - New money created Acquired reserves and deposits Required reserves Excess reserves Bank $80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.57 A B C D E F G H I J K L M N Other banks $100.00 80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 21.97 $20.00 16.00 12.80 10.24 8.19 6.55 5.24 4.20 3.36 2.68 2.15 1.72 1.37 1.10 4.40 $80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.57 MULTIPLE DEPOSIT EXPANSION PROCESS RR= 20% 1st 10 $357 of the $400 $400.00 PMC in the banking system [MxER] TMS = $500.00

35. 1 = MM RR Maximum checkable- deposit expansion x = ER THE Money [Deposit] MULTIPLIER The MM is the reciprocal of the RR. Potential money Creation in the Banking System [PMC] MM

36. Ashley OlsenDeposits $1,000in herbank RR = 25% $1,000 New reserves $750 Excess reserves Ashley Olsen’s $250 RR Ashley Olsen deposits$1,000 $3,000 PMC thru bank lending $1,000 Initial Deposit TMS = $4,000

37. FedBuys A $1,000 Bond FromAshley’s Bank New reserves Ashley Olsen’s $1,000 Excess Reserves 25% RR $4,000 PMC thru Bank Lending TMS is $4000

38. NS 31-35 AP Econ[MS = Currrency + DD of Public] RR+ER=TR; TR-RR=ER;TR-ER=RR; MXER=PMC; PMC(Public)+DD=TMS; PMC(Fed)=TMS Excess Reserves prior to new currency deposit (DD) = $0 Britney Spears deposits in the banking system = $40million Legal Reserve Requirement[RR] = 20% 31. The $40 million depositof Currencyinto DDwould result in MS staying at ($8/$40/$160) million. [MS composition changed from currency to DD] 32. The $40 million deposit of currency into checking accounts will create ER of ($20/$32/$40) million. 33. The Potential Money Creation of the banking system through loans is ($40/$160/$$200) mil. The Potential TMS [all DDof the public] could be as much as ($40/$160/$200) mil. 34. The RR applies to checkable deposits at (banks/S&Ls/ credit unions/ all depository institutions). 35. If the Duck National Bank has ER of $6,000 & DDof $100,000 what is the size of the bank’s TR if the RR is 25%? ($25,000/$75,000/$31,000) [RR($____)+ER($___)+TR($____) 25,000 31,000 6,000

39. NS 36-45 [MS = Currrency+DD of Public] 36. A stranger deposits$1,000 in a bank that has a RR of 10%. The maximum possible change in the dollar value of the local bank’s loans would be $______. PMC[MXER] in the banking system is $_____. Potential TMS could become as high as $_______. 37. Suppose a commercial bank hasDD of $100,000 and the RR is 10%. If the bank’s RR & ER are equal, then its TR are ($10,000/$20,000/$30,000). 38. Total Reserves (minus/plus) RR = ER. 39. Suppose the Thunderduck Bank has DDof $500,000& theRR is 10%. If the institution has ER of $4,000 then its TR are ($46,000/$54,000/$4,000). 40. If ER in a bank are $4,000, DDare$40,000, & the RR is 10%, then TR are ($4,000/$8,000). 41. The main purpose of the RR is to (have funds for emergency withdrawals/ influence the lending ability of commercial banks). 42. If I write you a check for $1 & we both have our checking accts at the Poorman Bank, the bank’s balance sheet will (increase/decrease/be unchanged). 43. Banks (create/destroy) money when they make loans and repaying bank loans (create/destroy) money. 44. When a bank loan is repaid the MS is (increased/decreased). 45. The Fed Funds rate is a loan by one bank (to another bank/from the Fed). RR+ER=TR; TR-RR=ER;TR-ER=RR; MXER=PMC; PMC(Public)+DD=TMS; PMC(Fed)=TMS 900 9,000 10,000

40. NS 46-47 [MS = Currrency+DD of Public] RR+ER=TR; TR-RR=ER;TR-ER=RR; MXER=PMC; PMC(Public)+DD=TMS; PMC(Fed)=TMS 46. If the RR was lowered [say, from 50% to 10%], the size of the monetary multiplier [MM] would (increase/decrease). Leakages (limitations) of the Money Creating Process 1. Cash leakages [taking part of loan in cash] 2. ER (banks don’t loan it or we don’t borrow] 47. If borrowers take a portion of their loans as cash, the maximum amount by which the banking system increases the MS by lending will (increase/decrease).

41. Money Supply=DD +Currencyof thePublic • “PMC”“PMC” “TMS” • ER Loans Crea. In “Potential” • $100[10%RR][1st Bank][1st Bank]SystemTotal MS • Banks/PublicDD [$100] $90$90 $900 $1,000 • Fed /Public/BanksDD[$100] $90$90 $900 $1,000 • [*Fedbuys bonds frompublicwho put the money in theirDD] • Banks/FedFedLoan[$100] $100$100 $1,000 $1,000 • [or sells bonds toFed] • “PMC” “PMC” “TMS” • ER Loans Crea. In “Potential” • $100 [20%RR] [1st Bank][1st Bank]SystemTotal MS • Banks/PublicDD [$100] $80 $80 $400 $500 • Fed/Public/BanksDD[$100]$80$80 $400 $500 • [*Fed buys bonds frompublicwho put the money in theirDD] • Banks/FedFedLoan[$100] $100$100 $500 $500 • [or sells bonds toFed] Long Run Short Run

42. SanjayaDeposits$1,000In HisBank [RR is 20%] Sanjaya’s New reserves $800 Excess Reserves $200 RR Sanjaya [member of the public] $1000 Initial Deposit $4000 PMC thru Bank Lending TMS is$5,000

43. Fedbuys a $1,000Bond fromSanjaya’s Bank New reserves 20% RR Fed $1,000 Excess Reserves Sanjaya’s $5,000 PMC thru Bank System Lending TMSis $5000

44. Eva LongoriaDeposits$1 with a 20% RR Eva Longoria’s .20 80 cents Excess Reserves RR Total(Actual) Reserves One Dollar PMC = M x ER, so 5 x .80 = $4 TMS = PMC[$4] + DD[$1] = $5 [MS = Currency + DD of Public]

45. Eva’s Bank Borrows $1 From The Fed [20% RR] Fed Eva Longoria’s 0 One Dollar RR Excess Reserves Total(Actual) Reserves One Dollar PMC = M x ER, so 5 x $1 = $5 TMS [$5] = PMC [$5] [MS = currency + DD of Public]

46. Money Creation Practice Review

47. $1,000DDby Katy[MS=Currency+DDofPublic] Duck that can dance New Deposits [New Reserves] DD New Required Reserves RR=50% DD Created By New Loans [equal to new ER] Dance Lessons w. Laura Bush Bank $5,000.00 A $2,500.00 2,500.00 2,500.00 B $1,250.00 2,500.00 1,250.00 Hunting with Dick Cheney C $625.00 1,250.00 625.00 $312.50 625.00 D 312.50 Prom Dance lessons with N. Dynamite $5,000.00 PMC = PMC = ER[$2,500 x M[2] Katy’s DD + PMC = TMS $5,000.00 + $5,000.00 = $10,000.00 MSgrows by multiple of2

48. Money Creation Formulas [MS = Currency + DD of public] RR+ER=TR TR - RR = ER TR - ER = RR Public Public:Student deposits$1.00in abank 1.ER [DD-RR] x MM = PMC 2.PMC + 1stDD =TMS Fed • No Public: [Fedgives $1.00 loan to abank] • ER x MM = PMC & TMS

49. Banks and the Fed [RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC(Public)+1stDD=TMS; PMC(Fed)=TMS] MS = Currency + DD of Public [Money borrowed from the Fed[or gained thru bond sales] is ER & can be loaned out] 9. RR is 25%; Econ Bank borrows $25,000 from the Fed; its ER are increased by $______. Potential Money Creationin thesystem is $_______. Potential TMS is $_______. 10. RR is 50%; a bank borrows $20,000 from theFed; thisone bank’s ER are increased by $_____. PotentialMoney Creationin the system is $______. Potential TMS is $______ 11. RR is 20%; the Duck Bank sells $10 M of bonds to the Fed; Duck Bank’s ER are increased by $___million. PMC in the system is $__________. TMS is $__________. 12. RR is 20%; Fed buys $50,000 of securities from Keynes Bank. Its ER are increased by $___________. Potential Money Creation in the banking system is $______________. Potential TMS is $___________. 13.25% RR; Fed buys $400 million of bonds from the Friar Bank. This one bank’s ER are increased by $_____million. 14. RR is 50%; the Fed sells $200 million of bonds to a bank; its ER are (increased/decreased) by $_______. Potential Money Creation in the banking system is (increased/decreased) by $________. 15. RR is 10%; a bank borrows $10 million from the Fed; this one bank’s ER are increased by $_______ million. PMC in the banking system is $_______million. Potential TMS is $_______million. 100,000 25,000 100,000 40,000 40,000 20,000 10 50 million 50 million 50,000 250,000 250,000 400 200 M 400 M 10 100 100

50. Banksand thePublic RR+ER=TR; TR-RR=ER; TR-ER=RR; M x ER=PMC; PMC(Public)+1stDD=TMS; PMC(Fed)=TMS Banks & Public(allDD of Publicare subject to the RR; rest is ER & can be loaned out) 1. No ER & RR is 20%; DD of $10 M is made in the Thunder Bank. MS is $___million. ER increase by $___million. Potential Money Creation in the banking system is $_____M. Potential TMS is $____million. 2. There are no ER & RR is 25% & $16,000 is depositedin theDuck Bank. MS is $_______. This one bank can increase its loans by a maximum of $_______. Potential Money Creation in the banking system is $_______. Potential Total Money Supply could be $__________. 3. Econ Bankhas ER of $5,000; DD are $100,000; RR is 25%. TR are $_______. 4. DDare $10,000; ER are $1,000; TR are $3,000; RR are _________. [TR-ER=RR]. 5. Nomics Bank has ER of $10,000; DD of $100,000; RR of 40%. TR are _________. With ER above, Potential Money Creation in the banking system is $__________. 6. Friar Bank has DD of $100,000; RR is 20%; RR & ER are equal. TR are $________. 7. If ER in a bank are $10,000;DD are $200,000, & the RR are 10%. TR are $_______. 8. No ER & RR is 25%. DD of $100,000is made. MS is $_______. This single bank can increase its loans by $_______. PMC in thesystem is $________. TMS is $________. MS = currency + DD of Public 10 8 50 40 16,000 48,000 12,000 64,000 30,000 $2,000 $50,000 25,000 40,000 30,000 100,000 75,000 300,000 400,000