a substantial amount of money in the economy is held by deposit-takers someone deposits money into...
TRANSCRIPT
A substantial amount of money in the economy is held by deposit-takers
Someone deposits money into their bank, they pay little interest to them, they lend that money to someone else, while charging a higher interest rate, so they make a profit
This process is done by the roles played by cash reserves and profit motive
12.3 - Money Creation
Desired Reserves are the minimum amount of cash necessary that chartered banks are required to have to satisfy anticipated withdrawal demands
The Reserve Ratio: The deposit taker must hold a certain portion of deposits in the form of cash reserves EX. If a bank has a reserve ratio of 0.10, and the bank
has deposits of $100 million, then it will hold 10% of this dollar value as desired reserves
Money Creation
๐ ๐๐ ๐๐๐ฃ๐๐๐๐ก๐๐=๐๐๐ ๐๐๐๐ ๐๐๐ ๐๐๐ฃ๐๐
๐๐๐๐๐ ๐๐ก๐ =$ 10๐๐๐๐๐๐๐$ 100๐๐๐๐๐๐๐
=0.10
Different types of reserves have different reserve ratios
EX. Banks want to hold higher reserves against demand deposits than against notice deposits
Excess Reserves exist when deposit-takers find that their cash reserves exceed desired levels
Money Creation
Idle cash reserves no profit, so deposit-takers will try to transform any excess reserves into income-producing assets as soon as possible
Letโs see how lending out excess reserves creates more money
Assume: (1) Public money is in the form of deposits and all payments are made by cheque; (2) All deposits are made to one type of deposit-taker (banks); (3) Reserve ratio is 0.10 (10%)
Note: a bankโs main assets are its cash reserves and loans A bankโs main liabilities are its customersโ deposits
The Money Creation Process
1. At Cabot Bank, cash reserves = desired reserves 2. Saver A makes $1000 and deposits it into Cabot
Bank 3. Cabot Bank now has new cash assets and
deposit liabilities of $1000
First Transaction
Cabot BankAssets Liabilities
Cash Reserves + $1000
Saver Aโs Deposit + $1000
Cabot Bank only wants to keep 10% of the $1000 = $100 on hand
Cabot Bank now has an excess of $900 Cabot Bank now lends $900 to Borrower X
Second Transaction
Cabot BankAssets Liabilities
Cash Reserves $1000
Saver Aโs Deposit $1000
Loan to Borrower X + $900
Borrower Xโs Deposit + $900
The money supply has now risen by $900.
Borrower X withdraws the $900 from his deposit Cabot Bankโs cash assets and deposit liabilities
each fall by $900
Third Transaction
Cabot BankAssets Liabilities
Cash Reserves $100 (=$1000 - $900)
Saver Aโs Deposit $1000
Loan to Borrower X $900
Borrower Xโs Deposit $0 (=$900 - $900)
Borrower X bought something for $900 from Saver B
Saver B deposits the $900 in her account at Fraser Bank
Fraser Bankโ cash assets and deposit liabilities increase by $900
Thus, the $900 deposit originally created by Cabot Bank has simply moved to Fraser Bank โ no change in money supply
Fourth Transaction
Fraser BankAssets Liabilities
Cash Reserves + $900
Saver Bโs Deposit + $900
Since Saver B deposits money to Fraser Bank, Fraser Bankโs desired reserves should increase by $90 (= $900 x 0.10)
Since the $900 also increases cash reserves, there are now excess reserves of $810 ( = $900 - $900
Fraser Bank lends the $810 to Borrower Y This created added loans assets and deposit liabilities of
$810 Since Borrower Yโs new deposit is money, the money
supply increases by $810
Fifth Transaction
Fraser BankAssets Liabilities
Cash Reserves $900
Saver Bโs Deposit $900
Loan to Borrower Y $810
Borrower Yโs Deposit $810
The number of possible transactions are endless We saw the process of money creation in the few
transactions that we saw Notice how the process of money creation is similar
to the process of the spending multiplier (Ch. 11) In the money creation process, an initial change in
money has a magnified effect on the money supply Money Multiplier is the value by which the amount
of excess reserves is multiplied to give the maximum total change in money supply
The Money Multiplier
h๐ถ ๐๐๐๐ ๐๐๐๐๐๐๐ฆ ๐ ๐ข๐๐๐๐ฆ= h๐ ๐๐๐๐ ๐๐๐๐ฅ๐๐๐ ๐ ๐๐๐ ๐๐๐ฃ๐๐ ร๐๐๐๐๐ฆ๐๐ข๐๐ก๐๐๐๐๐๐
Recall that the spending multiplier is the reciprocal of the marginal propensity to withdraw (MPW) This is how much is taken out of the income-spending
stream with each spending cycle In money creation, the multiplier is the reciprocal of
the reserve ratio Recall, in our previous example, the reserve ratio was
0.10
The Multiplier Formula
Recall, we assumed that all money is in the form of deposits, and that there is only one form of deposit-taker These assumptions do not hold true in reality
Public-Held Currency Rather than all money going to deposit-takers, some
money does circulate and is unaffected by the money multiplier
Differences in Deposit There are a wide range of deposit types, so not all
deposits will be reflected as an increase in the money supply
Adjustments to the Money Multiplier
The money multiplier represents the maximum possible effect of money creation
If someone deposits $9000, the money multiplier formula allows us to specify the maximum amount of $9000 by which the quantity of money rises as a result of the infusion of $900 in new excess cash reserves
Money Multiplier in the Canadian Economic System