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Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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Page 1: Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Money Creation

15

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Page 2: Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

15-2

Fractional Reserve System

• The Goldsmiths• Stored gold and gave a receipt• Receipts used as money by public• Made loans by issuing receipts

• Characteristics:• Banks create money through

lending• Banks are subject to “panics”

LO1

Page 3: Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

15-3

Fractional Reserve System

• Balance sheet

• Assets = Liabilities + Net Worth

• Both sides balance

• Necessary transactions

• Create a bank

• Accept deposits

• Lend excess reserves

LO1

Page 4: Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

15-4

A Single Commercial Bank

Transaction #1Vault cash: cash held by the bank

Assets Liabilities and Net Worth

Creating a BankBalance Sheet 1: Wahoo Bank

Cash $250,000 Stock Shares $250,000

LO1

Page 5: Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

15-5

A Single Commercial Bank

Transaction #2Acquiring property and equipment

Assets Liabilities and Net Worth

Acquiring Property and EquipmentBalance Sheet 2: Wahoo Bank

Cash $10,000 Stock Shares $250,000Property 240,000

LO1

Page 6: Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

15-6

A Single Commercial Bank

Transaction #3Commercial bank functions

• Accepting deposits

• Making loans

Assets Liabilities and Net Worth

Accepting DepositsBalance Sheet 3: Wahoo Bank

Cash $110,000 Checkable Deposits $100,000Property 240,000Stock Shares 250,000

LO1

Page 7: Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

15-7

A Single Commercial Bank

Transaction #4Depositing reserves in a Federal

Reserve bank• Required reserves

• Reserve ratio

Reserveratio =

Commercial bank’sRequired reserves

Commercial bank’sCheckable-deposit liabilities

LO2

Page 8: Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

15-8

A Single Commercial Bank

• The Fed can establish and vary the reserve ratio within limits set by Congress

• Required reserves help the Fed control lending abilities of commercial banks

LO2

Type of DepositCurrent

RequirementStatutory

Limits

Checkable deposits:

$0-$10.7 Million$10.7-$55.2 MillionOver $55.2 Million

Noncheckable nonpersonalsavings and time deposits

0% 310

3% 38-14

0 0-9

Page 9: Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

15-9

A Single Commercial Bank

Assets Liabilities and Net Worth

Depositing Reserves at the FedBalance Sheet 4: Wahoo Bank

Cash $0 Checkable Deposits $100,000

Property 240,000 Stock Shares 250,000

Reserves 110,000

Transaction #4Assume the bank deposits all cash

on reserve at the Fed

LO2

Page 10: Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

15-10

A Single Commercial Bank

• Excess reserves

• Actual reserves - required reserves

• Required reserves

• Checkable deposits x reserve ratio

• Example:

• Checkable deposits $100,000

• Reserve ratio 20%

LO2

Page 11: Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

15-11

A Single Commercial Bank

Transaction #5

Clearing a check

• $50,000 check reduces reserves and checkable deposits

Assets Liabilities and Net Worth

Clearing a CheckBalance Sheet 5: Wahoo Bank

Checkable Deposits $50,000

Property 240,000 Stock Shares 250,000

Reserves $60,000

LO2

Page 12: Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

15-12

Money Creating Transactions

Transaction #6a

Granting a loan

• $50,000 loan deposited to checking

Assets Liabilities and Net Worth

When a Loan is NegotiatedBalance Sheet 6a: Wahoo Bank

Checkable Deposits $100,000

Property 240,000 Stock Shares 250,000

Reserves $60,000

Loans 50,000

LO3

Page 13: Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

15-13

Money Creating Transactions

Transaction #6b

Using the loan

• $50,000 loan cashed

Assets Liabilities and Net Worth

After a Check is Drawn on the Loan Balance Sheet 6b: Wahoo Bank

Checkable Deposits $50,000

Property 240,000 Stock Shares 250,000

Reserves $10,000

Loans 50,000

A single bank can only lend an amountequal to its preloan excess reserves

LO3

Page 14: Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

15-14

Money Creating Transactions

Transaction #7Bank buys government securities

from a dealer• Deposits payment into checking

Assets Liabilities and Net Worth

Buying Government SecuritiesBalance Sheet 7: Wahoo Bank

Checkable Deposits $100,000

Property 240,000 Stock Shares 250,000

Reserves $60,000

Securities 50,000

• New money is createdLO3

Page 15: Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

15-15

Profits, Liquidity, and the Fed Funds Market

• Conflicting goals

• Earn profit

• Make loans to earn interest

• Buy securities to earn interest

• Maintain liquidity

• Alternative?

• Overnight bank loans

• Federal funds rate

LO3

Page 16: Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

15-16

The Monetary Multiplier

Monetarymultiplier =

1

required reserve ratio=

1

R

LO5


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