3 Dennis Rodman deposits $1 with A 10% RR Total(Actual) Reserves .1090 centsRRExcess ReservesTotal(Actual) ReservesOne DollarPMC = M x ER, so 10 x .90 = $9TMS = PMC[$9] + DD[$1] = $10[MS = currency + DD of public]
4 Rodman’s Bank Borrows $1 From The Fed [10% RR] Total(Actual) Reserves One DollarRRExcess ReservesTotal(Actual) ReservesOne DollarPMC = M x ER, so 10 x $1 = $10TMS [$10] = PMC[$10][MS = currency + DD of public]
5 BALANCE SHEET OF A COMMERCIAL BANK ASSETS [cash] = LIABILITIES[DD][The cash is property of the bank] [“liable”, DDs are owed to depositors]Cash $100, DD $100,000The GoldsmithsFractional Reserve Banking SystemMoney Creation & ReservesBank Panics and Regulation
6 $1,000 DD by Brian [MS=Currency+DD of Public] Katy$1,000.00800.00Dell800.00640.00640.00512.00Sam’s512.00409.60Canon409.60327.70Target5,000.004,000.00MS grows bya multiple of 5Katy
7 $1,000 DD by Tammy [MS=Currency + DD of Public] $1,000.00900.00810.00900.00729.00729.00810.00729.00656.10656.10590.49656.10$9,000$10,000MS growsby a factorof “10”Tammy
8 MS is MS MS RR=20% $10,000 RR = 20% $10,000 $8,000 $6,400 $24,400 MS = DD + Currency of the Public[A DD of $10,000 will incr MS by another $40,000($50,000 MS]RR=20%MS$10,000$8,000$6,400$24,400MS is$10,0004. 2nd Bank lends Sports Shop $6,400.1. Joe Biker deposits $10,000 in his bank.RR = 20%MS$10,000$8,000$18,0002. Suzie Rah Rah borrows $8,0005. Eventually the MS will be $50,000Joe3. Suzie pays $8,000 for a new car.GoNow Auto deposits the $ in 2nd Bank.$10,000+$40,000=$50,000
9 How Banks Create Money [Vocabulary] 1.Fractional Reserve Banking System–a fraction of DD are kept inreserve(say, 10%) at either the banks vault or at the Fed.2.Vault cashcash heldby abank(banks rarely keep more than2%of their in cash)3.Required Reserve(RR)specified percentageofDD that banksmust keep asRR.4.Excess reservestotal reserves(TR)RR. ER is what can be loaned out.Also some ER is used to meet sudden withdrawal demands.5.Actual(Total) reservesRR + ER.6.Deposit Multiplierone/RR or 1/.10 or $1/10 cents or 10Multipliers 1/RR[$1/5 cents = 20]1/5% = /25% = 41/10% = /33.3%= 31/12.5% = /40 = 2.51/20% = /50% = 27.BalanceSheetstatement ofassets & liabilities[assets=liabilities].8.Discount Ratewhenbanks borrow from the Fed.[symbolic-emergencies]“wholesale price of money”9.Federal Funds Ratebanks borrow from other banksfor overnight loans.10.Prime Ratewhen a bank’sprime customers[good credit] get loans.“retail price of money”11.Buying Bonds“buying”bonds means“bigger” supply of moneyand“lower interest rates”.[So,more “C”, “Ig”, and “Xn”]12.Selling Bonds“selling”bonds means“smaller”supply of money and“higher interest rates”.less “C”, “Ig”, and “Xn”]
11 History of Deposit Insurance In , federaldeposit insurancemade its debut at$2,500 to protectthe average family’ssavings and end thebank runs that hadshut down businessesand contributed to theGreat Depression.Through the yearsthe coverage rosein $5,000 incrementsuntil the 70s when itjumped to $40,000.In 1980, it was raisedto $100,000.
12 The Very Early Days Of Banking “Wow, you mean we can create money out of thin air.?”There weremore claimsto gold thanthere wereounces ofgold.The fractional banking systembegan when someone issuedclaims for gold that alreadybelonged to someone else.Once upon a time there was a gold-smithy who offered to store people’sgold in his vault. He issued paper receipts for the gold, and it was not longbefore the townsfolk used the paper to purchase eggs and beer. The smithy’spaper receipts became as “good as gold.”Our Smithy was not stupid. He said to himself. “I have 2000 ounces of goldstored in my vault, but in the last year I was never called upon to pay outmore than 100 ounces in a single day. What harm could it do if I lent out say,half the gold I now have? I’ll still have more than enough to pay off anydepositors that come in for a withdrawal. No one will know the difference. Icould earn 30 additional ounces of gold each week. I think I’ll do it.”“The smithy has invented the Fractional Reserve Banking System.”Advantages of Lending [One disadvantage was the possibility of “bank runs”]1. Depositors haven’t lost money [Goldsmiths paid them instead of other way]2. With the interest you earned you could give some to depositors.3. The loans benefited the community thru loans
13 Birth of a COMMERCIAL BANK In Lovelady, TexasLIABILITIES AND NET WORTHASSETSTRANSACTION 1Creating a bank$250,000 CashforCapital Stock
14 FORMATION OF A COMMERCIAL BANK In Lovelady, TexasLIABILITIES AND NET WORTHASSETSCash $250,000Capital Stock $250,000Deposit Added to Vault Cash
15 Birth OF A COMMERCIAL BANK In Lovelady, TexasLIABILITIES ANDNET WORTHASSETSCash $250,000Capital Stock $250,000TRANSACTION 2Acquiring Property andEquipment$240,000 Cash
16 Birth OF A COMMERCIAL BANK In Lovelady, TexasLIABILITIES AND NET WORTHASSETSCash $ 10,000Property ,000Capital Stock $250,000Lovelady Bank
17 Birth OF A COMMERCIAL BANK In Lovelady, TexasLIABILITIES AND NET WORTHASSETSCash $ 10,000Property ,000Capital Stock $250,000$250,000$250,000TRANSACTION 3AcceptingDeposits$100,000 Cash
18 Birth OF A COMMERCIAL BANK In Lovelady, TexasLIABILITIES AND NET WORTHASSETSWas $10,000Cash $110,000Property ,000DD $100,000Capital Stock ,000
19 Birth OF A COMMERCIAL BANK In Lovelady, TexasASSETSLIABILITIES AND NET WORTHWas $10,000Cash $110,000Property ,000DD $100,000Capital Stock ,000$350,000$350,000
20 FORMATION OF A COMMERCIAL BANK In Lovelady, TexasLIABILITIES ANDNET WORTHASSETSCash $110,000Property ,000DD $100,000Capital Stock ,000$350,000$350,000TRANSACTION 4A $50,000 check is written against the bank
21 Birth OF A COMMERCIAL BANK In Lovelady, TexasLIABILITIES ANDNET WORTHASSETSWas $110,000Cash $ 60,000Property ,000DD $ 50,000Capital Stock ,000$300,000$300,000
22 Birth OF A COMMERCIAL BANK In Lovelady, TexasNOTES:Banks create moneyby lending ER anddestroy money byloan repayment.Purchasing bondsfrom the public alsocreates money.
23 Birth OF A COMMERCIAL BANK In Lovelady, TexasLIABILITIES ANDNET WORTHASSETSCash $ 60,000Property ,000DD $ 50,000Capital Stock ,000TRANSACTION 5Make a loan from excess reservesof $50,000
24 FORMATION OF A COMMERCIAL BANK In Lovelady, TexasASSETSLIABILITIES AND NET WORTHCash $ 60,000Loans ,000Property ,000DD $100,000Capital Stock ,000Making the loancreated money!
25 Birth OF A COMMERCIAL BANK In Lovelady, TexasLIABILITIES AND NET WORTHASSETSCash $ 60,000LoansProperty ,000DD $ 50,000Capital Stock ,000After a check for the $50,000is written against the bank
26 (a) Joe Bozo pays Best Buy a $50,000 check DallasBig “D”Lovelady BankHateman Bank(a) Joe Bozo pays Best Buya $50,000 check
27 Birth OF A COMMERCIAL BANK In Lovelady, TexasLIABILITIES AND NET WORTHASSETSReserves $ 10,000Loans ,000Property ,000DD $ 50,000Capital Stock ,000TRANSACTION 6Repaying a loan with cash$50,000
28 Birth OF A COMMERCIAL BANK In Lovelady, TexasLIABILITIES AND NET WORTHASSETSReserves $ 10,000LoansProperty ,000DD $ 0Capital Stock ,000$50,000 in money supplyis destroyed!
29 MULTIPLE DEPOSIT EXPANSION PROCESS RR= 20%BankAcquired reservesand depositsRequiredreservesExcessAmount bankcan lend - Newmoney createdABCDEFGHIJKLMNOther banks$100.0080.0064.0051.2040.9632.7726.2220.9816.7813.4210.748.596.875.5021.97$20.0016.0012.8010.248.196.5518.104.22.1682.682.151.721.371.104.40$80.0017.57Paris Hilton1st10$357ofthe$400Susie RahRahRonald McDonaldPotential Money Creation in the banking system$400.00Manuel LaborTMS = $500.00
30 THE DEPOSIT MULTIPLIER RR1=The deposit multiplier is the reciprocalof the reserve requirement.Potential moneyCreation in theBanking System[PMC]Maximumcheckable-depositexpansion=ERxMD
31 Ashley Olsen Deposits $1,000 in her bank RR = 20%$1,000New reserves$800Excessreserves$200RRAshley Olsendeposits $1,000$4,000PMC thru bank lending$1,000InitialDepositMoney CreatedTMS = $5,000
32 Fed Buys A $1,000 Bond From Ashley’s Bank New reserves$1,000ExcessReserves20% RR$5,000PMC thru Bank LendingTMS is $5000
33 OUTCOME OF MONEY EXPANSION $100New reserves$20RequiredreservesLeakages exist...Currency DrainsExcess Reserves$80Excessreserves$400Bank system lending$100InitialDepositMoney Created
34 NS 31-35 AP Econ [MS = Currrency+DD of Public] RR+ER=TR; TR-RR=ER; TR-ER=RR; MXER=PMC; PMC(Public)+DD=TMS; PMC(Fed)=TMSExcess Reserves prior to new currency deposit (DD) = $0Britney Spears deposits in the banking system = $40 billionLegal Reserve Requirement [RR] = 20%31. The $40 billion deposit of Currency into DDwill result in MS staying at ($8/$40/$160) billion.32. The $40 billion deposit of currency intochecking accounts will create ER of ($20/$32/$40) billion.33. The Potential Money Creation of the banking systemthrough loans is ($40/$160/$$200) bil. The Potential TMS[all DD of the public] could be as much as ($40/$160/$200)34. The RR applies to checkable deposits at (banks/S&Ls/credit unions/ all depository institutions).35. If the Duck National Bank has ER of $6,000 & DD of $100,000what is the size of the bank’s TR if the RR is 25%?($25,000/$75,000/$31,000) [RR($____)+ER($___)+TR($____)25,0006,00031,000
35 NS 36-45 AP Econ [MS = Currrency+DD of Public] 36. A stranger deposits $1,000 in a bank that has a RR of 10%. Themaximum possible change in the dollar value of the local bank’s loans wouldbe $______. PMC[M X ER] in the banking system is $_____. Potential TMScould become as high as $_______.37. Suppose a commercial bank has DD of $100,000 and the RR is 10%.If the bank’s RR & ER are equal, then its TR are ($10,000/$20,000/$30,000).38. Total Reserves (minus/plus) RR = ER.39. Suppose the Thunderduck Bank has DD of $500,000 & the RR is 10%.If the institution has ER of $4,000 then its TR are ($46,000/$54,000/$4,000).40. If ER in a bank are $4,000, DD are $40,000, & the RR is 10%, thenTR are ($4,000/$8,000).41. The main purpose of the RR is to (have funds for emergency withdrawals/influence the lending ability of commercial banks).42. If I write you a check for $1 & we both have our checking accts at thePoorman Bank, the bank’s balance sheet will (increase/decrease/be unchanged).43. Banks (create/destroy) money when they make loans and repaying bankloans (create/destroy) money.44. When a bank loan is repaid the MS is (increased/decreased).45. The Fed Funds rate is a loan by one bank (to another bank/from the Fed).RR+ER=TR; TR-RR=ER; TR-ER=RR; MXER=PMC; PMC(Public)+DD=TMS; PMC(Fed)=TMS9009,00010,000
36 NS 46-47 AP Econ [MS = Currrency+DD of Public] RR+ER=TR; TR-RR=ER; TR-ER=RR; MXER=PMC; PMC(Public)+DD=TMS; PMC(Fed)=TMS46. If the RR was lowered [say, from 50% to 10%], the size of themonetary multiplier [MM] would (increase/decrease).Leakages(limitations) of the Money Creating Process1. Cash leakages [taking part of loan in cash]2. ER (banks don’t loan it or we don’t borrow]47. If borrowers take a portion of their loans as cash, the maximum amount bywhich the banking system increases the MS by lending will (increase/decrease).