1. Ch 13.Money Creation

2. A.Balance sheet – statement of assets and claims on assets. 1.Liabilities 2.Net worth -- This chapter shows how commercial banks and thrifts create checkable deposits by issuing loans. -- A Thrift institution is a savings and loan association, mutual savings bank, or credit union. A balance sheet must be balanced! Assets = Liabilities + Net worth

3. B.Fractional reserve banking system 1.Money creation & reserves 2.Bank panics & regulation -- Fractional = only a fraction of the total money supply is held in reserve as currency. -- Started with the Goldsmiths who held gold in their vaults for a fee and issued receipts to the depositor, the first kind of paper money. -- $1 mill in gold; issued another $1 mill in paper = $2 mill total (fractional) -- Banks create money through lending, limited by currency reserves/laws. -- Vulnerable to ‘runs’ but unlikely due to system of deposit insurance.

4. C.Commercial Bank 1.Balance sheet 2. $ creation -- Creating a bank: 1) secure state or national charter, 2) selling capital stock (equity shares) to buyers of about $250K. Then the bank exists on paper. -- Has $250K in cash (vault cash or till money) and capital stock outstanding. Creating a Bank Balance Sheet 1: Latimer’s Bank Assets Liabilities & Net worth Cash $250KCapital Stock $250K There are about 7,600 commercial banks in the U.S.

5. 3.Acquiring property & equipment -- The Board of Directors, representing the owners, need to acquire property/equipment Acquiring Property/equipment Balance Sheet 2: Latimer’s Bank Assets Liabilities & Net worth Cash $10K Capital Stock $250K Property 240K

6. 4.Accepting deposits Accepting deposits Balance Sheet 3: Latimer’s Bank Assets Liabilities & Net worth Cash $120K Checkable deposits $110K Property 240K Capital Stock 250K -- Customers and businesses deposit $110K into the bank. -- These checkable deposits (checking account entries) are claims that the depositors have against the assets of Latimer’s Bank and are therefore a new liability account.

7. 5.Depositing reserves in a Federal Reserve bank a) Required reserves b) Reserve ratio -- All commercial banks and thrifts that provide checkable deposits are required by law to keep required reserves (amount of funds equal to a specified % of the bank’s own deposit liabilities. -- Required reserves must be kept at the Fed Res bank in district or as cash in the bank’s vault. -- Reserve ratio is specified % that is set by the Fed Res. -- If the Feds want to tighten spending or reduce money in society, they can increase the required reserve or the reserve ratio. commercial bank’s Reserve Ratio = required reserves commercial bank’s checkable-deposit liabilities Actual reserves = $100,000 Required reserves = 10,000 Excess reserves = $ 90,000

8. -- The usual reserve ration is around 10% ($11K), but if the bank grows, it will need to meet the higher reserve ratio. Type of CurrentStatutory Deposit RequirementLimits Checkable Deposits: $0-6 million 0%3% $6-42.1 million 33 Over $42.1 mill 108-14 Noncheckable nonpersonal savings & time deposits 00-9 Depositing Reserves in the Fed Balance Sheet 4: Latimer’s Bank Assets Liabilities & Net worth Cash $110K Checkable deposits $110K Reserves 10K Capital Stock 250K Property 240K Reserve Requirements (reserve ratio) for banks & thrifts, 2003

9. Depositing Reserves in the Fed Balance Sheet 4: Latimer’s Bank Assets Liabilities & Net worth Cash $60K Checkable deposits $60K Reserves 10K Capital Stock 250K Property 240K -- Bradshaw (w/ Wahoo Bank) writes a check to Ajax Comp (w/ Surprise Bank) for $50K. -- $110K – 50K = $60K.

11. 6.Granting a Loan a) Creates money; gets interest When a bank makes loans, it creates money. When a Loan is Negotiated Balance Sheet 5: Latimer’s Bank Assets Liabilities & Net worth Cash $60K Checkable deposits $110K Reserves 10K Capital Stock 250K Loans 50K Property 240K -- A customer gets approved for a $50K loan and gives a “promissory note” or IOU to the bank; instead of getting cash, the customer gets a $50K increase in its checkable-deposits account. -- When the loan is paid-off, money is destroyed.

12. “Banks make loans on excess reserves” -- The Fed raises the RR to take money out of the system (fewer loans) during inflation. -- Banks A & B loaned/created $58K in new money. -- The Fed has $16K as a reserve. RR = Reserve Requirement to the Fed (10% of $ bank has on hand) DD = Demand Deposit DR = Discount Rate A BC Fed Assets Liabilities A L A L A L DD $100K $100K DD $40K $40K DD $18K $18K Bank A RR $ 10K RR 4K RR 2K $10K $10K $ 90K 36K16K Bank B $ 4K $ 4K DD 50K Loan $18K Bank C RR 10K $ 2K $ 2K Loan $40K $16K $16K

13. D.Money Multiplier: checkable-deposit multiplier. Monetary multiplier = 1 required reserve ratio OR M = 1 RR -- Excess reserves (E) are monies left over in the checkable-deposits (D) after required reserve ratio. -- Spending multiplier = 1/MPS, or, 1 over 1-MPC Maximum excess monetary checkable-deposit = reserves X multiplier creation OR D = E x M

14. If the Reserve Ratio is 10% & the central bank sells $100 million in gov’t securities, what is the max possible Δ in $ supply? 1. MM = 1 (MM = 1 ) = 10 RR.10 2. Use equation: D = E x M (D = $90m x 10) = $900m 3.+ $100m $1,000m ‘D’ is checkable deposits ‘E’ is excess reserves Original securities sale Total Δ in → $ supply Ms2 Ms1 Md M2 M1 Nominal Ir Quantity of $ Ir2 Ir1 ↑ ← Initial Δ in banking system → ContractionaryPolicy ($ taken out)

15. The Monetary Multiplier Monetary Multiplier or Checkable-Deposit Multiplier Monetary Multiplier = 1 Required Reserve Ratio or in Symbols… m = 1 R New Reserves $100 $20 Required Reserves $80 Excess Reserves $100 Initial Deposit $400 Bank System Lending Money Created Graphic Example

16. E.Liquidity – ex: cash F.Federal funds rate – interest The Federal funds rate is the interest banks charges other banks for overnight loans out of their excess reserves.