Transcript David Mayer AP Macroeconomics Winston Churchill High School

Multiple Deposit Expansion
and the Federal Reserve
The Federal Reserve System
The Federal Reserve was established in 1913 to regulate the banking system
• There is a Board of Governors of 7 members, appointed by the president for
14 year, staggered terms
• The Federal Open Market Committee includes the 7 governors, and 5 of
the regional Federal Reserve Bank presidents (New York region always
included) and they set policy of the buying and selling of government
bonds
• Federal Advisory Council includes 12 important commerical bankers from
each FED district who advise the Board
Federal Reserve System
• There are 12 district Federal Reserve Banks and 25 regional
banks with 3 functions
• Work with the central bank or FED
• Each is quasi-public: owned by member banks, but controlled by
Federal Reserve Board and profits go to Treasury
• They accept reserve deposits and make loans to banks and other
financial institutions
Functions of the FED
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It issues paper currency
Sets reserve requirements and holds reserves of banks
It lends money to banks and charges them interest
They are a check clearing service for banks
It acts as personal bank for the government
Supervises member banks
Controls the money supply in the economy
How Banks Create Money
• How do banks create money?
• By lening out deposits that are used multiple times
• Where do the loans come from?
• From depositors who take cash and place it in their banks
• How are the amounts of potential loans calculated?
• Using their bank balance sheet, or T-accounts that consist of assets
and liabilities for banks
Bank Liabilities
• Right side of the T-Account Sheet
• #1=Demand Deposits (DD) or checkable deposits
• Cash deposits from the public
• They are liabilities because they belong to depositors
• #2=Owners Equity (stock shares)
• There are values of stocks held by the public ownership of bank shares
• Key concept for AP concerning Liabilities:
• If demand deposit come from someone’s cash holdings, then the DD is
already part of money supply
• If the demand deposit comes in from the purchase of bonds (by the
FED) then this creates new cash and therefore creates new Money
Supply (M-1)
Bank Assets
• Left side of the T-Account Sheet
• #1=Required Reserves (RR)
• These are the percentages of demand deposits that must be held in the vault so
that some depositors have access to their money. This amount can vary, but AP
usually uses 5%, 10%, or 20% for easy calculations
• #2=Excess Reserves (ER)
• These are the source of new loans. These amount are applied to the Monetary
Multiplier/Reserve Multiplier (DD=RR plus ER)
• #3=Bank Property Holdings (buildings and fixtures)
• #4=Securities (Federal Bonds)
• These are bonds purchased by the bank, or new bonds sold to the bank by the
Federal Reserve. These bonds can be purchased from the bank, turned into cash
that immediately becomes available as “excess reserves”
• #5=Customer Loans
• This can be amounts held by banks from previous transactions, owed to the bank by
prior customers
Creating Money (using excess
reserves)
• Banks want to create profit. They generate profit by lending the
excess reserves and collecting interest. Since each loan will go out
into customer’s and business’ accounts, more loans are created in
decreasing amounts (because of reserve requirement). A rough
estimate of the number of loan amounts created by any first loan is
the “money multiplier”.
• The Money Multiplier, a.k.a.: Checkable Deposits Multiplier, Reserve
Multiplier, Loan Multiplier
• The formula: 1 divided by the reserve requirement (ratio)
• RR=10%=1/.1=Monetary Multiplier of 10
• Excess Reserves are multiplied by the Multiplier to create new loans
for the entire banking system and this creates new Money Supply
Summary
• Bank Balance Sheet
• Asses and Liabilities in a T Account
• Liabilities
• DD and Owner’s Equity (Stock Shares)
• Assets
• RR, ER, Bank Property, Securities, Loans
• Assets must equal Liabilities
• DD=RR+ER
• Money is Created through Monetary Multiplier
• ER x 1/RR (Multiplier)=New Loans throughout the banking system
• The Money Suplply is affected
• Cash from citizens becomes a DD, but does NOT change the Money Supply; the
ER from this cash becomes an “immediate” loan amount
• ER x Multiplier become New Loans and DO change the Money Supply
• The Fed Buying bonds creates new loans and changes the Money Supply
• If the Fed buys bonds on the open market, this also beocmes a new DD amount;
if the Fed buys bonds from accounts already held by a particular bank, then the
amount only becomes new Excess Reserves
• Finally, bond “prices” move opposite to the changes in interest rates
• Higher interest rates will push bond prices downward (less money supply)
• Lower interest rates will push bond prices upward more money supply)
The Three Types of Multiple Deposit Expansion
Question
• Type 1: Calculate the initial change in
excess reserves
- a.k.a. the amount a single bank can loan from the
initial deposit
• Type 2: Calculate the change in loans in the
banking system
• Type 3: Calculate the change in the money
supply
• Sometimes type 2 and type 3 will have the same
result (i.e. no Fed involvement)
The Three Types of Multiple Deposit
Expansion Question
•Oops!!!! Type 4: Calculate the change in
demand deposits
Example 1
• Given a required reserve ratio of 20%, assume
the Federal Reserve purchases $100 million
worth of US Treasury Securities on the open
market from a primary security dealer.
Determine the amount that a single bank can
lend from this Federal Reserve purchase of
bonds.
The amount of new demand deposits – required
reserve = The initial change in excess reserves
$100 million – (20% * $100 million)
$100 million – $20 million = $80 million in ER
Example 2
• Given a required reserve ratio of 20%, assume
the Federal Reserve purchases $100 million
worth of US Treasury Securities on the open
market from a primary security dealer. Determine
the maximum change in loans in the banking
system from this Federal Reserve purchase of
bonds.
The initial change in excess reserves * The money
multiplier = max change in loans
$80 million * (1/20%)
$80 million * (5) = $400 million max in new loans
Example 3
• Given a required reserve ratio of 20%, assume
the Federal Reserve purchases $100 million
worth of US Treasury Securities on the open
market from a primary security dealer.
Determine the maximum change in the money
supply from this Federal Reserve purchase of
bonds.
The maximum change in loans + $ amount of Federal
Reserve action
$400 million + $100 million = $500 million max change
in the money supply
Example 4
• Given a required reserve ratio of 20%,
assume the Federal Reserve purchases
$100 million worth of US Treasury Securities
on the open market from a primary security
dealer. Determine the maximum change in
demand deposits from this Federal Reserve
purchase of bonds.
The maximum change in loans + $ amount of
initial deposit
$400 million + $100 million = $500 million max
change in demand deposits
Review
• Required Reserve = Amount of deposit X required reserve ratio
• Excess Reserves = Total Reserves – Required Reserves
• Maximum amount a single bank can loan = the change in excess
reserves caused by a deposit
• The money multiplier = 1/required reserve ratio
• Total Change in Loans = amount single bank can lend X money multiplier
• Total Change in the money supply = Total Change in Loans + $ amount of
Fed action
• Total Change in demand deposits = Total Change in Loans + any cash
deposited