part 4: money, banking, and monetary policy · create (or destroy) money through loans to the...
TRANSCRIPT
CHAPTER 12
Money, Banking, and Money
Creation
1
Slides prepared by Bruno Fullone, George Brown College
© 2010 McGraw-Hill Ryerson Limited
PART 4: MONEY, BANKING,
AND MONETARY POLICY
Chapter 12 2
• Learning Objective 12.1: The definition and functions of money
• Learning Objective 12.2: What constitutes the supply of money
• Learning Objective 12.3: What backs Canada’s money supply
• Learning Objective 12.4: About the structure of the Canadian financial system
• Learning Objective 12.5: How a chartered bank can create (or destroy) money through loans to the public
• Learning Objective 12.6: About the multiple deposit expansion of the entire chartered banking system
• Learning Objective 12.7: What the monetary multiplier is and how to calculate it
In This Chapter You Will Learn:
LO12.1 3
“Money is what money does”
• Medium of exchange
• Measure of value
• Store of value
12.1 The Definition and Functions
of Money
LO12.2 4
Money Definition M1 • Currency: Coins + Paper Money
– token money – Bank of Canada notes
• Demand Deposits – about 3/4 of M1
• Institutions That Offer Demand Deposits – chartered banks are the primary depository institutions
• Two Qualifications: currency held by the Bank of Canada and chartered banks
is excluded from M1 and other measures of the money supply
also excluded from the money supply are any deposits of the federal government or the Bank of Canada that are held by chartered banks
12.2 The Components of the Money Supply
LO12.2 5
Money Definition M2
• M1 + near monies
– Near monies are highly liquid financial assets that do not directly function as a medium of exchange but can be readily converted into currency
The Components of the Money
Supply
LO12.2 6
Currency (coins & paper money)
plus Demand deposits
equals M1 plus Personal savings deposits,
plus Non-personal notice
deposits
equals M2
Table 12-1
(billions of dollars) December, 2005
M1
529
M2
939
The Components of the Money Supply
LO12.2 7
Money Definition M2+
• M2+ is M2 plus
– deposits at trust & mortgage loan companies
– deposits at caisses populaires & credit unions & other non-bank deposit-taking institutions
– money market mutual funds
Money Definition M2++
• M2++ is M2 plus Canadian saving bonds and non-money market mutual funds
The Components of the Money
Supply
LO12.2 8
Currency (coins & paper money)
plus Demand deposits
equals M1
plus Personal savings deposits,
plus Nonpersonal notice deposits
equals M2
plus Deposits: Other intermediaries
equals M2+ plus Canadian saving bonds plus non-money market mutual funs equals M2++
M1 M2+
1277
M2
(billions of dollars) December, 2005
939
529
M2++
1811 Table 12-1
The Components of the Money Supply
LO12.3 9
• Money as Debt
• Value of Money – Acceptability
– Legal Tender
– Relative Scarcity
• Money and Prices – Purchasing Power of the Dollar
– Inflation and Acceptability
– Stabilizing the Purchasing power of money
What Backs the Money Supply?
LO12.4 10
• The Evolution of the Canadian Banking System
• Canadian Chartered Banks
• Making Loans
• Other Financial Intermediaries
• Cheque Clearing
12.4 The Canadian Financial System
LO12.4 11
12.1 Global Perspective
LO12.5 12
• The creation of money is done with the help of Canada’s chartered banks
• The Fractional Reserve System
12.5 Chartered Banks and the
Creation of Money
LO12.5 13
• Goldsmiths accepted gold deposits and issued paper receipts
• Paper receipts were used as a medium of exchange
• 100% reserve system
ð eventually led to fractional reserve system
Illustrating the Idea: the Goldsmiths
LO12.5 14
• Fractional Reserve System
– Money creation & reserves
– Bank panics & regulation
Significant Characteristics of
Fractional Reserve Banking
LO12.5 15
ASSETS LIABILITIES AND
NET WORTH Vancouver Bank
TRANSACTION 1
Creating a bank
$250,000 Cash
for
Capital Stock
Formation of a Chartered Bank
LO12.5 16
ASSETS LIABILITIES AND
NET WORTH
Cash $250,000 Capital Stock $250,000
Vancouver Bank
Formation of a Chartered Bank
LO12.5 17
ASSETS LIABILITIES AND
NET WORTH Vancouver Bank
TRANSACTION 2
Acquiring
property and
equipment
$240,000
buildings and
equipment
Acquiring Property and Equipment
Cash $250,000 Capital Stock $250,000
LO12.5 18
ASSETS LIABILITIES AND
NET WORTH
Cash $ 10,000
Property 240,000
Capital Stock $250,000
Vancouver Bank
Acquiring Property and Equipment
LO12.5 19
ASSETS LIABILITIES AND
NET WORTH
Cash $ 10,000
Property 240,000
Capital Stock $250,000
Vancouver Bank
TRANSACTION 3
Accepting
Deposits
Demand
$100,000
Deposits
Accepting Deposits
LO12.5 20
ASSETS LIABILITIES AND
NET WORTH
Cash $110,000
Property 240,000
Demand
Deposits $100,000
Capital Stock 250,000
Vancouver Bank
Accepting Deposits
LO12.5 21
ASSETS LIABILITIES AND
NET WORTH
Cash $110,000
Property 240,000
Demand
Deposits $100,000
Capital Stock 250,000
Note: demand
deposits
are LIABILITIES
to the bank
Vancouver Bank
Accepting Deposits
LO12.5 22
ASSETS LIABILITIES AND
NET WORTH
Reserves $ 110,000
Property 240,000
Demand
Deposits $100,000
Capital Stock 250,000
Vancouver Bank
Note:
cash is part of the
bank’s reserves
- Desired Reserves
Reserves
LO12.5 23
ASSETS LIABILITIES AND
NET WORTH
Reserves $110,000
Property 240,000
Demand
Deposits $100,000
Capital Stock 250,000
Vancouver Bank
Reserves
Demand Deposits are subject to Desired Reserve
Ratio
sliabilitie deposit-demands bank' chartered
reserves desired bank' chartered
ratioreserve
Desired
LO12.5 24
ASSETS LIABILITIES AND
NET WORTH
Demand
Deposits $100,000
Capital Stock 250,000
Reserves $110,000
Property 240,000
Two Important Points...
1. Excess Reserves (E)
= Actual Reserves - Desired Reserves
• Assume 20% Desired Reserve Requirement
• FIND THE EXCESS RESERVES
desired reserves
= 20% X $100,000
=$20,000
actual reserves
Vancouver Bank
Excess Reserve
LO12.5 25
ASSETS LIABILITIES AND
NET WORTH
Demand
Deposits $100,000
Capital Stock 250,000
Reserves $110,000
Property 240,000
Two Important Points...
1. Excess Reserves (E)
= Actual Reserves - Desired Reserves
• Assume 10% Desired Reserve Requirement
• E = $110,000 - 20,000 = $90,000
Vancouver Bank
Excess Reserve
LO12.5 26
ASSETS LIABILITIES AND
NET WORTH
Demand
Deposits $100,000
Capital Stock 250,000
Reserves $110,000
Property 240,000
Two Important Points...
1. Excess Reserves (E)
= Actual Reserves - Desired Reserves
• Assume 10% Desired Reserve Requirement
• E = $110,000 - 10,000 = $100,000
2. Bank of Canada can influence the lending ability
of banks through reserves
Vancouver Bank
Excess Reserve
LO12.5 27
ASSETS LIABILITIES AND
NET WORTH
Reserves $110,000
Property 240,000
Demand
Deposits $100,000
Capital Stock 250,000
TRANSACTION 4
Clearing a
cheque drawn
against the
bank
= $50,000
Vancouver Bank
Clearing a Cheque
LO12.5 28
ASSETS LIABILITIES AND
NET WORTH
Reserves $ 60,000
Property 240,000
Demand
Deposits $50,000
Capital Stock 250,000
TRANSACTION 4
This bank
loses reserves
and
deposits to the
Bank of
Manitoba
Vancouver Bank
After Cheque Clearing
LO12.5 29
• The maximum amount of new money which can be created by a single bank is equal to its excess reserves
– The bank creates money when it creates new loans
– Money is destroyed when loans are repaid
– Banks create money when they buy government bonds from the public
Money Creation: Single Bank
LO12.5 30
ASSETS LIABILITIES AND
NET WORTH
Reserves $ 60,000
Property 240,000
Demand
Deposits $ 50,000
Capital Stock 250,000
Bank has excess
reserves of how
much?
of HOW MUCH?
Use a 20% reserve
ratio
Vancouver Bank
Granting a New Loan
LO12.5 31
ASSETS LIABILITIES AND
NET WORTH
TRANSACTION 5
Reserves $ 60,000
Property 240,000
Demand
Deposits $ 50,000
Capital Stock 250,000
Bank makes a
loan to Grisley
Company equal to
the excess reserves
$50,000
Vancouver Bank
Granting a New Loan
LO12.5 32
ASSETS LIABILITIES AND
NET WORTH
Reserves $ 60,000
Loans 50,000
Property 240,000
Demand
Deposits $100,000
Capital Stock 250,000
Vancouver Bank
A new loan & a new
deposit of $50,000 are
created
When a Loan is Negotiated
LO12.5 33
ASSETS LIABILITIES AND
NET WORTH
Reserves $ 60,000
Loans 50,000
Property 240,000
Demand
Deposits $100,000
Capital Stock 250,000
Vancouver Bank
Grisley Co. writes a
cheque worth $50,000
payable to Quickbuck
Co. which banks at the
Manitoba Bank
Before a Cheque is Drawn on the Loan
LO12.5 34
ASSETS LIABILITIES AND
NET WORTH
Reserves $ 10,000
Loans 50,000
Property 240,000
Demand
Deposits $50,000
Capital Stock 250,000
Vancouver Bank
Note that after clearing,
the Vancouver Bank has
no more excess
reserves!
After a Cheque is Drawn on the Loan
LO12.5 35
ASSETS LIABILITIES AND
NET WORTH
Reserves $ 10,000
Loans 50,000
Property 240,000
Demand
Deposits $50,000
Capital Stock 250,000
New Loan After Cheque Clearing
Vancouver Bank
A bank MUST have
excess reserves to
create
loans
35
LO12.5 36
ASSETS LIABILITIES AND
NET WORTH
TRANSACTION 6
Reserves $ 60,000
Property 240,000
Demand
Deposits $ 50,000
Capital Stock 250,000
Bank buys
securities from the
public for an
amount equal to
the excess reserves
Vancouver Bank
Buying Government Securities
LO12.5 37
ASSETS LIABILITIES AND
NET WORTH
Reserves $ 60,000
Securities 50,000
Property 240,000
Demand
Deposits $100,000
Capital Stock 250,000
Vancouver Bank
Once again, the money
supply has increased by
$50,000
Buying Government Securities
LO12.5 38
• Bond purchases from the public by the chartered banks increases the money supply
• Bond sales to the public decreases the money supply
Government Securities
LO12.5 39
• Bankers have two conflicting goals:
– Profit
– Liquidity
• Overnight loans rate paid on overnight loans to cover temporary shortages of reserves
Profits, Liquidity, and the
Overnight Lending Rate
LO12.6 40
• A single bank can lend one dollar for each dollar of excess reserves
• The banking system can lend (create money) by a multiple of its excess reserves
12.6 The Banking System: Multiple-
Deposit Expansion
LO12.6 41
Bank
Acquired reserves
and deposits
Desired
reserves
Excess
reserves
Amount bank
can lend. New
money created
A
$100.00
$ 20.00
Multiple-Deposit Expansion Process
1.A Junkyard owner deposit $100
2.Bank adds the $100 in its
reserves
3.20% is the desired reserve ratio
LO12.6 42
Bank
Acquired reserves
and deposits
Desired
reserves
Excess
reserves
Amount bank
can lend. New
money created
A
$100.00
$ 20.00
$80.00
Money is created
once the loan is
made
$80.00
Multiple-Deposit Expansion Process
LO12.6 43
Bank
Acquired reserves
and deposits
Desired
reserves
Excess
reserves
Amount bank
can lend. New
money created
A
$100.00
$ 20.00
$80.00
$80.00
Multiple-Deposit Expansion Process
Loan recipient now spends the money. He/she buys something; Seller deposits proceeds in his/her bank.
LO12.6 44
Bank
Acquired reserves
and deposits
Desired
reserves
Excess
reserves
Amount bank
can lend. New
money created
A
B
$100.00
80.00
$ 20.00
$80.00
$80.00
Multiple-Deposit Expansion Process
New deposit means excess reserves in seller’s bank; process repeats…
LO12.6 45
Bank
Acquired reserves
and deposits
Desired
reserves
Excess
reserves
Amount bank
can lend. New
money created
A
B
C
$100.00
80.00
64.00
$ 20.00
16.00
12.80
$80.00
64.00
51.20
$80.00
64.00
51.20
Multiple-Deposit Expansion Process
LO12.6 46
Bank
Acquired reserves
and deposits
Desired
reserves
Excess
reserves
Amount bank
can lend. New
money created
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
$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 Total amount of money created by the bank system = $400.00
Multiple-Deposit Expansion Process
Monetary destruction works the same way in reverse
LO12.7 47
Maximum
demand-deposit
creation = Excess
reserves x Monetary
multiplier
Monetary multiplier = 1/desired reserve ratio
R
1
= = .20
1 = 5
12.7 The Money Multiplier
LO12.7 48
Table 12-3 Expansion of the Money Supply by
the Chartered Banking System
• 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
Slide prepared by Bruno Fullone, George Brown College 49
The Last Word: The U.S. Bank
Panics of 1930 to 1933
Chapter 12 50
12.1 The Definition and Functions of Money
12.2 The Components of the Money Supply
12.3 What Backs the Money Supply?
12.4 The Canadian Financial System
12.5 Chartered Banks and the Creation of Money
12.6 The Banking System: Multiple-Deposit Expansion
12.7 The Monetary Multiplier
Chapter 12 Summary