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Bob the Goldsmith
Bob the Goldsmith
Assets Liabilities + Owners' Equity
Gold coins $100,000 Demand Deposits $100,000
Bob the Goldsmith
Assets Liabilities + Owners' Equity
Gold coins $100,000 Demand Deposits $100,000
Suppose Bob makes a $1000 loan. Assume he gives the loan in
currency.
The money supply increases by $1000.
Assets Liabilities + Owners' Equity
Gold coins $99,000 Demand Deposits $100,000
Loan $1000
Bob the Goldsmith
What if Bob had made the loan as a checking account
balance?
The money supply still increases by
$1000.Assets Liabilities + Owners' Equity
Gold coins $100,000 Demand Deposits $101,000
Loan $1000
General Principle of money and banking:
Whenever a bank makes a loan the
money supply increases by the
amount of the loan.
What happens when the loan is
paid back?
What happens when the loan is paid back?
Assume the loan was made in
currency (gold coins) and is
repaid with currency.
Assets Liabilities + Owners' Equity
Gold coins $99,000 Demand Deposits $100,000
Loan $1000
Before the loan is repaid.
After the loan is repaid with currency.
Assets Liabilities + Owners' Equity
Gold coins $100,000 Demand Deposits $100,000
Result:
The money supply
decreases by $1000.
What happens when the loan is
paid back?
What happens when the loan is paid back?
Assume the loan was made in
currency (gold coins) and is
repaid with a check.
Assets Liabilities + Owners' Equity
Gold coins $99,000 Demand Deposits $100,000
Loan $1000
Before the loan is repaid.
After the loan is repaid with a check.
Assets Liabilities + Owners' Equity
Gold coins $99,000 Demand Deposits $99,000
The money supply
decreases by $1000.
Result:
What happens when the loan is
paid back?
What happens when the loan is paid back?
Assume the loan was made as
a checking account balance
and is paid back with a check.
Assets Liabilities + Owners' Equity
Gold coins $100,000 Demand Deposits $101,000
Loan $1000
Before the loan is repaid.
After the loan is repaid with a check.
Assets Liabilities + Owners' Equity
Gold coins $100,000 Demand Deposits $100,000
Result:
The money supply
decreases by $1000.
What happens when the loan is
paid back?
What happens when the loan is paid back?
Assume the loan was made as
a checking account balance
and is paid back with currency.
Assets Liabilities + Owners' Equity
Gold coins $100,000 Demand Deposits $101,000
Loan $1000
Before the loan is repaid.
After the loan is repaid with currency
Assets Liabilities + Owners' Equity
Gold coins $101,000 Demand Deposits $101,000
Result:
The money supply
decreases by $1000.
General Principle of money and banking:
When a loan of a financial institution is
repaid, the money supply decreases by the amount of the loan repayment.
These first two general principles
imply a third.
Individual banks create and destroy money one a
one-to-one basis with their loans. Every dollar created through loans is destroyed when the loans are repaid.
Fractional Reserve Banking
Reserves = Vault Cash + Deposits with the Fed
Reserves = Vault Cash + Deposits with the Fed
Required Reserves = r x (Demand Deposit Liabilities)
r = required reserve ratio
Total Reserves = Required Reserves + Excess Reserves
Let's impose a 20 percent reserve requirement on Bob
(i.e., r=.2).
Assets Liabilities +Owners' Equity
Reserves = $100,000 Demand Deposits $100,000
Required = .2 ($100,000)
= $20,000Excess = $80,000
Since Bob has excess reserves of $80,000, let's have him make an
$80,000 loan.
Since Bob has excess reserves of $80,000, let's have him make an
$80,000 loan.
Assets Liabilities +Owners' Equity
Reserves = $100,000
Loan = $80,000
Demand Deposits $180,000
Required = .2 ($180,000)
= $36,000Excess = $64,000
Assume Bob makes the loan as a checking account balance.
Note that Bob still has excess reserves of $64,000.
It looks like Bob could make another $64,000 loan.
But........
What if the person Bob made the $80,000 loan to writes a check for $80,000
to a person who has an account at another bank?
Let's go to the board and see what happens to Bob's
balance sheet.
