Presentation is loading. Please wait.

Presentation is loading. Please wait.

Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-1 Chapter 10 How banks create.

Similar presentations


Presentation on theme: "Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-1 Chapter 10 How banks create."— Presentation transcript:

1 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-1 Chapter 10 How banks create money

2 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-2 Learning objectives Describe the simplified balance sheets of a single bank and the banking system Explain the money-creating abilities of a single bank that is part of a multibank system Explain the money-creating abilities of the banking system as a whole through multiple-deposit expansion, and compare this with the money- creating abilities of the single bank

3 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-3 Learning objectives (cont.) Define the monetary (or credit) multiplier Discuss some of the limitations on the banking systems ability to create deposits and expand the money supply Describe how the banks lending activities may contribute to financial instability and to increased fluctuations in the level of economic activity

4 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-4 Balance sheet A statement of assets and claims that summarises the financial position of a firm at a point in time Each side balances: –Assets are items of economic and financial value –Assets = Liabilities + Net worth

5 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-5 Formation of a bank Transaction (1): The birth of a bank –New owners sell $250 000 worth of shares in the bank

6 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-6 Formation of a bank (cont.) Transaction (2): Becoming a going concern –Acquisition of property and equipment

7 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-7 Formation of a bank (cont.) Transaction (3): Accepting deposits –Citizens and businesses deposit $100 000 –Change in composition not total supply of money

8 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-8 Formation of a bank (cont.) Required reserve ratio –The ratio of reserves to deposits to meet official liquidity requirements Transaction (4): Setting aside required reserves –Assume reserve ratio is 20% –Bank must keep $20 000 (required reserves) Reserve ratio = banks required reserve banks deposit liabilities

9 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-9 Formation of a bank (cont.) –Bank decides to keep $110 000 (actual reserves), which is $90 000 more than required (excess reserves) –Banks required reserves are 20% of $100 000

10 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-10 Formation of a bank (cont.) Transaction (5): Drawing a cheque –A citizen who has substantial deposits in the bank draws a cheque for $50 000 to buy goods –The seller of the goods deposits the cheque in another bank –The banking system as a whole has not lost or gained

11 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-11 Formation of a bank (cont.) Transaction (5): Drawing a cheque (cont.)

12 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-12 Creating money Transaction (6): Granting a loan –A company borrows $50 000 from the bank –Money is created –Balance sheet after loan is negotiated:

13 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-13 Creating money (cont.) Balance sheet after cheque drawn on loan has been cancelled: Now, bank has no excess reserves

14 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-14 Creating money (cont.) Transaction (7): Buying government bonds –Bank buys $50 000 of government bonds instead of lending $50 000 –Money is created

15 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-15 The banking system Multiple banks: multiple-deposit expansion Money is created by a multiple of the banking systems excess reserves

16 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-16 Multiple-deposit expansion Assume initially: 20% reserve requirement Bank A –Accepts a deposit for $100 Does not alter money supply Excess reserves of $80 –A loan of $80 is negotiated

17 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-17 Multiple-deposit expansion (cont.) Balance sheet: Bank A

18 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-18 Multiple-deposit expansion (cont.) Loan cheque of $80 is drawn on Bank A and deposited in Bank B Bank B –Gains $80 in reserves and deposits –Excess reserves of $64 –Loans $64

19 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-19 Multiple-deposit expansion (cont.) Bank B Loan cheque of $64 is drawn on Bank B and deposited in Bank C, and so on …

20 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-20 Multiple deposit expansion process Bank Acquired reserves and deposits Required reserves Excess reserves $80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.57 A B C D E F G H I J K L M N Other banks $100.00 80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 21.97 $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 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.57 $400.00 Total amount of money created by the banking system New money created

21 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-21 Multiple-deposit expansion (cont.) Total banking system has created $400 How? –Via the monetary multiplier –Where m is the monetary multiplier 1R1R 1 reserve ratio monetary multiplier = m =

22 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-22 Multiple-deposit contraction The multiple credit expansion process is reversible and leads to a multiple reduction in the level of deposits and hence the supply of money if reserves are withdrawn

23 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-23 Current Australian system The reserve ratio is based on the level of prime assets that are to be held by banks against their liabilities Indicated in the prime asset ratio (PAR) Currently, the PAR is not set at a specific level Arrived by a process of negotiation between APRA and each bank

24 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-24 Possible leakages Currency drains –Loan may be paid in cash and remain in circulation Transfer of deposits to non-bank financial institutions Excess reserves –Individual banks may choose to have larger reserves than required (say 25% instead of 20%)

25 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-25 Willingness to borrow For the full multiplier effect to take place: –Borrowers must be willing and able to utilise the loans –Borrowing is likely to be low during a recession

26 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-26 Banks and financial instability Banks may contribute to business fluctuations Can exacerbate recession, by holding back on credit expansion May amplify inflationary pressures, by increasing lending and credit creation, during recovery and business cycle peaks


Download ppt "Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides prepared by Muni Perumal 10-1 Chapter 10 How banks create."

Similar presentations


Ads by Google