Transcript Principles of Macroeconomics Supplement to Chapter 9

Principles of Macroeconomics
Supplement to Chapter 9
How Banks Create Money
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
TRANSACTION 1
Creating a bank
$250,000 Cash
for
Capital Stock
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Cash
$250,000
Capital Stock
$250,000
Deposit Added to Vault Cash
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Cash
$250,000
TRANSACTION 2
Acquiring
Property and
Equipment
$240,000 Cash
Capital Stock
$250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Cash
Property
$ 10,000
240,000
Capital Stock
$250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Cash
Property
$ 10,000
240,000
TRANSACTION 3
Accepting
Deposits
$100,000 Cash
Capital Stock
$250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Cash
Property
$110,000
240,000
Checkable
Deposits
Capital Stock
$100,000
250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Cash
Property
$110,000
NOTES:
Checkable
240,000
Deposits
Bank deposits
are Stock
Capital
subject to a reserve
requirement.
Reserve
ratio
=
Commercial bank’s
required reserves
Commercial bank’s
checkable-deposit
liabilities
$100,000
250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Cash
Property
$110,000
240,000
Checkable
Deposits
Capital Stock
$100,000
250,000
Three Important Issues...
1 - Excess Reserves = Actual Reserves Required Reserves
(assume 20% reserve requirement)
$110,000 - 20,000 = $90,000
2 – Control of Lending Ability
3 - Asset or Liability to Which Bank?
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Cash
Property
$110,000
240,000
TRANSACTION 4
Deposits
at the FED
$110,000 Cash
Checkable
Deposits
Capital Stock
$100,000
250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Cash
Reserves
Property
$
0
110,000
240,000
Checkable
Deposits
Capital Stock
$100,000
250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Cash
$
0
Reserves
110,000
TRANSACTION
Property
240,0005
A check is drawn
against the bank
$50,000
Checkable
Deposits
Capital Stock
$100,000
250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Cash
Reserves
Property
$
0
60,000
240,000
Checkable
Deposits
Capital Stock
$ 50,000
250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Cash
Reserves
Property
$
0
NOTES:
Checkable
60,000
Deposits
Banks 240,000
create money
Capital Stock
by lending excess
reserves and destroy
it by loan repayment.
Purchasing bonds
from the public also
creates money.
$ 50,000
250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Reserves
Property
$ 60,000
240,000
TRANSACTION 6
Make a loan from
excess reserves
$50,000
Checkable
Deposits
Capital Stock
$ 50,000
250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Reserves
Loans
Property
$ 60,000
50,000
240,000
Checkable
Deposits
Capital Stock
Making the loan
created money!
$100,000
250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Reserves
Loans
Property
$ 10,000
50,000
240,000
Checkable
Deposits
Capital Stock
$ 50,000
250,000
After a check for the $50,000
is drawn against the bank
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Reserves
Loans
Property
$ 10,000
50,000
240,000
TRANSACTION 7
Repaying a loan
with cash
$50,000
Checkable
Deposits
Capital Stock
$ 50,000
250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Reserves
Loans
Property
$ 10,000
0
240,000
Checkable
Deposits
Capital Stock
$
0
250,000
$50,000 in money supply
is destroyed!
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Reserves
Securities
Property
$ 60,000
50,000
240,000
TRANSACTION 8
(Assume previous
balance sheet)
Buy Government
Securities
$50,000
Checkable
Deposits
Capital Stock
$100,000
250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
ASSETS
Reserves
Securities
Property
$ 60,000
50,000
240,000
Checkable
Deposits
Capital Stock
$100,000
250,000
Bankers pursue two conflicting goals:
Profits and Liquidity
Use of Federal Funds Market
Federal Funds Rate
MULTIPLE DEPOSIT EXPANSION PROCESS
Bank
Acquired reserves
and deposits
A
$100.00
B
80.00
C
64.00
D
51.20
E
40.96
F
32.77
G
26.21
H
20.97
I
16.78
J
13.42
K
10.74
L
8.59
M
6.87
N
5.50
Other banks 21.99
Required
reserves
Excess
reserves
$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
26.21
20.97
16.78
13.42
10.74
8.59
6.87
5.50
4.40
17.59
Total amount of money created by the banking system
Amount bank
can lend - New
money created
$80.00
64.00
51.20
40.96
32.77
26.21
20.97
16.78
13.42
10.74
8.59
6.87
5.50
4.40
17.59
$400.00
MULTIPLE DEPOSIT EXPANSION PROCESS
Bank
Acquired reserves
and deposits
A
$100.00
B
80.00
C
64.00
D
51.20
E
40.96
F
32.77
G
26.21
H
20.97
I
16.78
J
13.42
K
10.74
L
8.59
M
6.87
N
5.50
Other banks 21.99
Required
reserves
Excess
reserves
$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
26.21
20.97
16.78
13.42
10.74
8.59
6.87
5.50
4.40
17.59
Money
destruction works
in exactly the same
multiple way!
Total amount of money created by the banking system
Amount bank
can lend - New
money created
$80.00
64.00
51.20
40.96
32.77
26.21
20.97
16.78
13.42
10.74
8.59
6.87
5.50
4.40
17.59
$400.00
THE DEPOSIT MULTIPLIER
Deposit
Multiplier
Maximum
checkabledeposit
creation
1
= Required reserve ratio
=
Excess
reserves
x
Deposit
Multiplier
OUTCOME OF MONEY EXPANSION
$100
New reserves
$80
Excess
reserves
$400
Bank system lending
Money Created
$20
Required
reserves
$100
Initial
Deposit
OUTCOME OF MONEY EXPANSION
$100
New reserves
$80
Excess
reserves
Leakages exist...
$20
Required
reserves
Currency Drains
Excess Reserves $100
$400
Bank system lending
Money Created
Initial
Deposit