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AP Economics Mr. Bernstein Module 25: Banking and Money Creation February 26, 2015.

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Presentation on theme: "AP Economics Mr. Bernstein Module 25: Banking and Money Creation February 26, 2015."— Presentation transcript:

1 AP Economics Mr. Bernstein Module 25: Banking and Money Creation February 26, 2015

2 AP Economics Mr. Bernstein Banking and Money Creation Objectives - Understand each of the following: The role of banks in the economy The reasons for and types of banking regulation How banks create money 2

3 AP Economics Mr. Bernstein How Banks Create Money Banks receive deposits Banks make loans Banks hold reserves against those loans If reserves are 10%, loans can be 10x deposits This effectively creates money Demonstrated by T-Account: Fed sets reserve requirements 3

4 AP Economics Mr. Bernstein How Banks Create Money: An Example Similar to the Spending Multiplier 4

5 AP Economics Mr. Bernstein Problem of Bank Runs If public fears a bank may fold and be unable to pay back depositors, they rush to the bank to make withdrawals before others can Since deposits are several times reserves, a bank with solid loans but the subject of rumours may be unable to meet demand for withdrawals Can become a self-fulfilling prophecy Preventing bank runs is a primary reason for bank regulation 5

6 AP Economics Mr. Bernstein Bank Regulation Deposit Insurance Current FDIC insurance is $250,000 per account Capital Requirements (= Assets – Liabilities) Capital Requirements have been rising since 2008 crisis Reserve Requirements Currently 10% in the USA Discount Window Fed stands as short-term lender to banks in need of capital 6

7 AP Economics Mr. Bernstein Reserves, Bank Deposits and the Money Multiplier Money Multiplier = 1 / reserve ratio…MM = 1/rr Excess Reserves = Total Reserves - rr MM tells us how much money can be created from each $ of Excess Reserves In reality, MM is not 10 – its now < 1. Why? 7


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