money creation. creation of money the deposit of funds into a bank does not change the size of the...
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Money CreationMoney Creation
Creation of MoneyCreation of Money
The deposit of funds into a bank does not change the size of the money supply.
It changes the composition of the money supply (transfers from cash to transaction deposits).
Deposit Creation Deposit Creation
When a bank lends someone money, it simply credits that individual’s bank account.
Deposit Creation Deposit Creation
Deposit creation is the creation of transactions deposits by bank lending.
When a bank makes a loan, it effectively creates money because transactions-account balances are counted as part of the money supply.
Deposit Creation Deposit Creation
There are two basic principles of the money supply:
Transactions-account balances are a large portion of our money supply.
Banks can create transactions-account balances by making loans.
Bank RegulationBank Regulation
The deposit-creation activities of banks are regulated by the government.
The Federal Reserve System limits the amount of bank lending, thereby controlling the basic money supply.
A Monopoly BankA Monopoly Bank
Assume a student deposits $100 from their piggy bank into the monopoly band and receives a new checking account.
A Monopoly BankA Monopoly Bank
When someone deposits cash or coins in a bank, they are changing the composition of the money supply, not its size.
The Initial LoanThe Initial Loan
The monopoly bank loans $100 to the Campus Radio station and issues a checking account.
This loan is accomplished by a simple bookkeeping entry.
The Initial LoanThe Initial Loan
Total bank reserves have remained unchanged.
Bank reserves are assets held by a bank to fulfill its deposit obligations.
The Initial LoanThe Initial Loan
Money has been created because the checking account is considered to be money.
Secondary DepositsSecondary Deposits
In a one bank system, when Campus Radio uses the loan, the money supply does not contract, rather ownership of deposits change.
Fractional ReservesFractional Reserves
Bank reserves are only a fraction of total transaction deposits.
The reserve ratio is the ratio of a bank's reserves to its total deposits.
Fractional ReservesFractional Reserves
The Federal Reserve System requires banks to maintain some minimum reserve ratio.
The T-account of the BankThe T-account of the Bank
The books of a bank must always balance, because all of the assets of the bank must belong to someone (its depositors or its owners).
Money CreationMoney Creation
Assets Liabilities
University Bank
+$100.00 in coins
+$100.00 in deposits
Money Supply
Cash held by the public –$100Transactions deposits
at bank +$100
Change in M 0
Money CreationMoney Creation
Assets Liabilities
University Bank
+$100.00 in coins
+$100 in loans
+$100.00 in your account
+$100.00 in borrower’s
account
Cash held by the public no changeTransactions deposits
at bank +$100
Change in M +$100
Money Supply
Required ReservesRequired Reserves
Required reserves are the minimum amount of reserves a bank is required to hold by government regulation; Equal to required reserve ratio times transactions deposits.
Required reserves = minimum reserve ratio X total deposits
Required ReservesRequired Reserves
The minimum reserve requirement directly limits deposit-creation possibilities.
A Multibank WorldA Multibank World
In reality, there is more than one bank.
The ability of banks to make loans depends on access to excess reserves.
A Multibank WorldA Multibank World
Example: If a bank is required to hold $20 in reserves but has $100 currently, it can lend out the $80 excess.
Excess ReservesExcess Reserves
Excess reserves are bank reserves in excess of required reserves.
Excess reserves = Total reserves – Required reserves
Excess ReservesExcess Reserves
So long as a bank has excess reserves, it can make loans.
Excess reserves are reserves a bank is not required to hold.
Changes in the Money Changes in the Money SupplySupply
The creation of transaction deposits via new loans is the same thing as creating money.
More Deposit CreationMore Deposit Creation
As the excess reserves are loaned out again, more deposits are created and thus more money is created.
Deposit CreationDeposit Creation
Assets Liabilities
University Bank
Required Reserves $20Excess Reserves $80
Youraccount $100
Total Assets $100
Total Liabilities $100
Assets Liabilities
Eternal Savings
Total Assets Total Liabilities
© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin
Deposit CreationDeposit Creation
Assets Liabilities
University Bank
Required Reserves $36Excess Reserves $64Loans $80
Youraccount $100Campus Radio account $ 80
Total Assets $180
Total Liabilities $180
Assets Liabilities
Eternal Savings
Total Assets Total Liabilities
© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin
Deposit CreationDeposit Creation
Assets Liabilities
University Bank
Required Reserves $20Excess Reserves $ 0Loans $80
Youraccount $100Campus Radio account $ 0
Total Assets $100
Total Liabilities $100
Assets Liabilities
Eternal Savings
Required Reserves $16Required Reserves $64
Atlas Antenna account $80
Total Assets $80
Total Liabilities $80
© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin
Deposit CreationDeposit Creation
Assets Liabilities
University Bank
Required Reserves $20Excess Reserves $ 0Loans $80
Youraccount $100Campus Radio account $ 0
Total Assets $100
Total Liabilities $100
Assets Liabilities
Eternal Savings
Required Reserves $29Required Reserves $51 Loans $64
Atlas Antenna account $80Herman’sHardwareaccount $64
Total Assets $144
Total Liabilities $144
© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin
The Money MultiplierThe Money Multiplier
In a multi-bank system, deposits created by one bank invariably end up as reserves in another bank.
The Money MultiplierThe Money Multiplier
This process can theoretically continue until all banks have zero excess reserves (no more loans can be made).
The Money MultiplierThe Money Multiplier
This is known as the money-multiplier process.
The Money MultiplierThe Money Multiplier
The money multiplier is the number of deposit (loan) dollars that the banking system can create from $1 of excess reserves.
The Money MultiplierThe Money Multiplier
When a new deposit enters the banking system, it creates both excess and required reserves.
The Money MultiplierThe Money Multiplier
The required reserves represent leakage from the flow of money, since they cannot be used to create new loans.
The Money MultiplierThe Money Multiplier
Excess reserve can be used for new loans.
Once those loans are made, they typically become transactions deposits elsewhere in the banking system.
The Money MultiplierThe Money Multiplier
Some additional leakage into required reserves occurs, and further loans are made.
The Money MultiplierThe Money Multiplier
The entire banking system can increase the volume of loans by the amount of excess reserves multiplied by the money multiplier.
The Money Multiplier ProcessThe Money Multiplier Process
Required reserves
Excess reserves
Leakage into
The public
Excess Reserves as Lending Excess Reserves as Lending PowerPower
Each bank may lend an amount equal to its excess reserves and no more.
Excess Reserves as Lending Excess Reserves as Lending PowerPower
The entire banking system can increase the volume of loans by the amount of excess reserves multiplied by the money multiplier.
The Money Multiplier at The Money Multiplier at WorkWork
Original deposit = $ 100.00Bank A loans: = $ 80.00 [=0.8 x $100.00]Bank B loans = $ 64.00 [=0.8 x $80.00]Bank C loans = $ 51.20 [=0.8 x $64.00]
Total money supply = $ 500.00