money creation chapter 32 mcgraw-hill/irwin copyright © 2009 by the mcgraw-hill companies, inc. all...
TRANSCRIPT
MoneyCreation
Chapter 32
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Objectives
• “Fractional Reserve” system• Actual reserves vs. required
reserves• How banks create money through
granting loans• Multiple expansion of loans and
money by the banking system• The monetary multiplier
32-2
Fractional Reserve Banking
• The Goldsmiths–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”
32-3
Fractional Reserve System
• Balance sheet–Assets = Liabilities + Net Worth–Both sides balance
• Necessary transactions–Create a bank–Accept deposits –Lend excess reserves
32-4
Assets Liabilities and Net Worth
Creating a Bank
• Transaction #1• Vault cash: cash held by the
bankCreating a Bank
Balance Sheet 1: Wahoo Bank
Cash $250,000 Stock Shares $250,000
32-5
Assets Liabilities and Net Worth
Creating a Bank
• Transaction #2• Acquiring property and equipment
Acquiring Property and EquipmentBalance Sheet 2: Wahoo Bank
Cash $10,000 Stock Shares $250,000Property 240,000
32-6
Assets Liabilities and Net Worth
Creating a Bank
• Transaction #3• Commercial bank functions
–Accepting deposits–Making loans
Accepting DepositsBalance Sheet 3: Wahoo Bank
Cash $110,000 Checkable Deposits $100,000Property 240,000Stock Shares 250,000
32-7
Creating a Bank
• Transaction #4• Depositing reserves in a Federal
Reserve bank–Required reserves–Reserve ratio
Reserveratio =
Commercial bank’sRequired reserves
Commercial bank’sCheckable-deposit liabilities
32-8
Reserve Requirements
Type of DepositCurrent
RequirementStatutory
Limits
Checkable deposits:
$0-$9.8 Million$9.3-$43.9 MillionOver $43.9 Million
Noncheckable nonpersonalsavings and time deposits
0% 310
3% 38-14
0 0-9
• Fed can establish and vary reserve ratio within limits set by Congress
• Required reserves help Fed control lending abilities of commercial banks
32-9
Assets Liabilities and Net Worth
Creating a Bank
Depositing Reserves at the FedBalance Sheet 4: Wahoo Bank
Cash $0 Checkable Deposits $100,000
Property 240,000 Stock Shares 250,000
Reserves 110,000
• Transaction #4• Assume the bank deposits all
cash on reserve at the Fed
32-10
Reserve Requirements
• Excess reserves–Actual reserves - required reserves
• Required reserves–Checkable deposits x reserve ratio
• Example:–Checkable deposits $100,000–Reserve ratio 20%
32-11
Assets Liabilities and Net Worth
Creating a Bank
• Transaction #5• Clearing a check
–$50,000 check reduces reserves and checkable deposits
Clearing a CheckBalance Sheet 5: Wahoo Bank
Checkable Deposits $50,000
Property 240,000 Stock Shares 250,000
Reserves $60,000
32-12
Assets Liabilities and Net Worth
Money Creating Transactions
• Transaction #6a
• Granting a loan–$50,000 loan deposited to checking
When a Loan is NegotiatedBalance Sheet 6a: Wahoo Bank
Checkable Deposits $100,000
Property 240,000 Stock Shares 250,000
Reserves $60,000
Loans 50,000
32-13
Assets Liabilities and Net Worth
Money Creating Transactions
• Transaction #6b• Using the loan
–$50,000 loan cashed
After a Check is Drawn on the Loan Balance Sheet 6b: Wahoo Bank
Checkable Deposits $50,000
Property 240,000 Stock Shares 250,000
Reserves $10,000
Loans 50,000
A single bank can only lend an amountequal to their preloan excess reserves
32-14
Assets Liabilities and Net Worth
Money Creating Transactions
• Transaction #7• Bank buys government securities
from dealer–Deposits payment into checking
Buying Government SecuritiesBalance Sheet 7: Wahoo Bank
Checkable Deposits $100,000
Property 240,000 Stock Shares 250,000
Reserves $60,000
Securities 50,000
New money is created 32-15
Commercial Banks
• Conflicting goals• Earn profit
–Make loans to earn interest–Buy securities to earn interest
• Maintain liquidity• Alternative?
–Overnight bank loans–Federal funds rate
32-16
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
32-17
Bank
(1)AcquiredReserves
and Deposits
(2)RequiredReserves
(3)Excess
Reserves(1)-(2)
(4)Amount Bank CanLend; New Money
Created = (3)
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…
The Banking System
32-18
Bank ABank BBank CBank DBank EBank FBank GBank HBank IBank JBank KBank LBank MBank NOther Banks
Bank
(1)AcquiredReserves
and Deposits
(2)RequiredReserves(Reserve
Ratio = .2)
(3)Excess
Reserves(1)-(2)
(4)Amount Bank CanLend; New Money
Created = (3)
$100.0080.0064.0051.2040.9632.7726.2120.9716.7813.4210.748.596.875.50
21.99
$20.0016.0012.8010.248.196.555.244.203.362.682.151.721.371.104.40
$80.0064.0051.2040.9632.7726.2120.9716.7813.4210.748.596.875.504.40
17.59
$80.0064.0051.2040.9632.7726.2120.9716.7813.4210.748.596.875.504.40
17.59$400.00
The Banking System
32-19
The Monetary Multiplier
Monetarymultiplier =
1
required reserve ratio
New Reserves$100
$20RequiredReserves
$80Excess
Reserves
$100Initial
Deposit
$400Bank System Lending
Money Created
GraphicExample
=1
R
32-20
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
32-21
Bank Panics of 1930-1933
• Before deposit insurance• Bank failure led to mass withdrawals • Forced loan reduction• 25-33% decline in money supply• 1933 national bank holiday to
evaluate all banks• Contributed to the Great Depression• Regulation protects the system today
32-22
Key Terms
• fractional reserve banking system• balance sheet• vault cash• required reserves• reserve ratio• excess reserves• actual reserves• Federal funds rate• monetary multiplier
32-23
Next Chapter Preview…
Interest Ratesand MonetaryPolicy
32-24