1. 17. Multiple Deposits Creation and Contraction

2. Chapter 17 : main menu 17.1 Assumptions of deposits creation
Concept Explorer 17.1
17.2
The process of multiple deposits creation
Concept Explorer 17.2
Progress Checkpoint 1
17.3
Limitations of credit creation
Theory in Life 17.1
Progress Checkpoint 2
17.4
Multiple contraction of credit
Progress Checkpoint 3

3. Concept Explorer 17.1 The balance sheet of banks
What does the balance sheet of banks show?

4. Concept Explorer 17.1
Banks own assets (資產). These can be in the forms of cash reserves, bank loans to borrowers, shares, foreign currency and bonds purchased, furniture and computers used in a bank office. Some of them are liquid, e.g. cash reserves, while some are illiquid, e.g. bank loans, furniture, etc.
Banks accept deposits from the public. This is one of the banks’ liabilities (負債). Liabilities can be in the forms of deposits, certificate of deposits held by public, loan borrowed from the government, etc.
A balance sheet (資產負債表) is used to present the data of banks’ assets and liabilities. Owing to double entry booking (復式記帳), the total assets must equal total liabilities.

5. Concept Explorer 17.1
The following shows a typical balance sheet of a bank:
The balance sheet of a bank
Assets ($)
Liabilities ($)
Reserves
500
Deposits
2,000
Loan
1,500
Total
If the bank holds no excess reserves, its actual reserves equals required reserves.
$500_
The minimum reserve ratio is
x 100%
= 25%
$2000
The bank loan lent out is $1,500.

6. Concept Explorer 17.2
Maximum change in deposits Vs maximum change in money supply
In the above example, the maximum change in deposits is $40,000 while the maximum change in money supply is only $30,000. Why are they different?

7. Concept Explorer 17.2
Before the $ is deposited by Patrick in HSBC,
Ms = Cp + Dd Dd = $0 (i.e. no deposits)
= $10,000 + $0= $10,000
When the $ is deposited by Patrick in HSBC,
Ms = Cp + Dd Dd = $ 10,000 (i.e.newly accepted deposits)
= $0 + $10,000
= $10,000

8. Concept Explorer 17.2
Thus, the first round change in Ms is $0, because there is only a redistribution of the component in money supply from cash in public circulation to deposits by $10,000.
However, the first round change in deposits is $10,000, because initially the $10,000 cash is not a part of deposits. Hence the maximum change in deposits is greater than that of money supply by the amount of initial deposits.

9. Concept Explorer 17.2
The formula on finding the maximum change in money supply is applicable to the cases where the new deposits come from the cash component of money supply. If the newly accepted deposits come from :
- the issuing of new currency from the government, or
- remittance overseas,
then the maximum change in deposits and money supply will be the same. This is because the initial cash deposit is not originally included in the money supply. When the newly printed or remitted cash is deposited, both deposits and money supply rise by the same amount.

10. Progress Checkpoint 1
Q17.1 Suppose the deposits in a bank is $5,000 and the required reserves is $1,000. What is the implied minimum reserve ratio?

11. Progress Checkpoint 1 Minimum reserve ratio = = 20% $1,000 x 100%
$5,000
= 20%

12. Progress Checkpoint 1
Q17.2 The following shows the consolidated balance sheet of a bank:
Assets ($)
Liabilities ($)
Reserves
600
Deposits
4,000
Loan
3,400
Total
Suppose the minimum reserve ratio is 10%.
If Tom deposits $2,000 into the bank, find the amount of excess reserve
of the bank immediately after Tom’s deposits.

13. Progress Checkpoint 1
If Tom deposits $2,000 into the bank, deposits will become $6,000 while actual reserves will become $2,600. Required reserves is $6,000 x 10% = $600. Excess reserves is $2,600 - $600 =$2,000.

14. Progress Checkpoint 1
Q17.3 Suppose in a certain economy all the banks keep no excess reserves,
and their balance sheet is as follows:
Assets ($)
Liabilities ($)
Reserves
500
Deposits
2,000
Loan
1,500
Total
Suppose someone deposits $1,000 cash into his bank.
(a) Calculate the minimum reserve ratio.
(b) Calculate the maximum change in deposits (including the initial deposit).
(c) Calculate the maximum change in money supply.
Are the maximum change in deposits and maximum change in money supply the same?
Explain.
(e) Calculate the maximum change in bank loan.
Show how the balance sheet of the whole banking system will be after the multiple
deposit creation process is completed.

15. Progress Checkpoint 1 required reserves x 100%
(a) Minimum reserve ratio (ra) =
x 100%
total deposits
$500_ =
x 100%
$2,000
= % 1_
(b) Maximum change in deposits = Initial change in deposits x rm
1__
= x
25%
= $4,000

16. Progress Checkpoint 1 1_
(c) Maximum change in money supply = Initial change in excess reserves x rm
1__
= x
25%
= $3,000
No, they are not the same. Before the initial deposit was made, the $1,000 cash was
included in money supply but not in deposits. When the deposit was made, deposits
immediately increased by $1,000 while money supply did not change.
Hence the total change in deposits is greater than that of money supply.

17. Progress Checkpoint 1 1_
(e) Maximum change in bank loan = Initial change in bank loan x rm
1__
= x
25%
= $3,000
 (f) The balance sheet of the banking system will become:
Assets ($)
Liabilities ($)
Reserves
1,500
Deposits
6,000
Loan
4,500
Total

18. Theory in Life 17.1 Actual banking multiplier
Suppose a banking system accepts an initial deposits of $2,000m, and
keeps a required reserve of $200m. Then :
required reserves
Minimum reserve ratio (ra) =
x 100%
total deposits
$200m_ =
x 100%
$2,000m
= % 1_ 1_
Maximum banking multiplier = =
= 10 rm
10%

19. Theory in Life 17.1 1_
Maximum change in deposits = Initial change in deposits x rm 1_
= $2,000m x
= $20,000m
10%
The banking system can at maximum create a total deposits of $20,000m, 10 times the
amount of initial deposits. The balance sheet of the banking system will be:
Assets ($)
Liabilities ($)
Reserves
2,000
Deposits
20,000
Loan
18,000
Total
Table The balance sheet of a banking system without excess reserves

20. Theory in Life 17.1
However, if the banking system keeps an actual reserves of $800m
(i.e. excess reserves = $800m - $200m = $600m), then we can define the
actual reserve ratio (ra) (實際儲備率):
actual reserves
Actual reserve ratio (ra) =
x 100%
total deposits
$800m_ =
x 100%
= 40%
$2,000m
The actual reserve ratio shows the ratio of total deposits that a banking system
actually holds as reserves.

21. Theory in Life 17.1
We can find the actual banking multiplier (實際銀行乘數): 1_ 1_
Actual banking multiplier = =
= 2.5 ra
40%
The actual banking multiplier shows the actual change in deposits resulting from an
initial change in deposits in the banking system. 1_
Actual change in deposits = Initial change in deposits x ra 1_
= 2,000m x
= $5,000m
40%

22. Theory in Life 17.1
The banking system can actually create a total deposits of $5,000m, just 2.5 times the
amount of initial deposits. Hence, we can see that if banks keep excess reserves,
the credit creation ability of the banking system will be reduced.
The balance sheet of the whole banking system will be:
Assets ($)
Liabilities ($)
Reserves
2,000
Deposits
5,000
Loan
3,000
Total
Table The balance sheet of a banking system with actual reserve ratio equals 40%.

23. Theory in Life 17.1 Reminder :
The maximum banking multiplier varies inversely with the minimum reserve ratio.
Even if banks keep excess reserves, so long as the actual reserve ratio is not 100%, they can still create money.

24. Progress Checkpoint 2
Q17.4 Given the following consolidated balance sheet of a certain bank:
Assets ($)
Liabilities ($)
Reserves
5,000
Deposits
20,000
Loan
15,000
Total
Suppose the required reserves of the bank is $4,000 only. Find
the minimum reserve ratio,
the maximum banking multiplier,
the actual reserve ratio, and
the actual banking multiplier.

25. Progress Checkpoint 2 minimum reserves
(a) Minimum reserve ratio (ra) =
x 100%
total deposits
$4,000_ =
x 100%
= 20%
$20,000 1_ 1_
(b) Maximum banking multiplier = =
= 5 rm
20%
actual reserves
(c) Actual reserve ratio (ra) =
x 100%
total deposits
$5,000_ =
x 100%
= 25%
$20,000 1_ 1_
(d) Actual banking multiplier = =
= 4 ra
25%

26. Progress Checkpoint 2
Q17.5 If a banking system does not keep excess reserve, then the maximum banking multiplier is equal to the actual banking multiplier. Do you agree?
Yes. If no excess reserve is kept, the minimum reserves equals actual reserves. Then the minimum reserve ratio equals the actual reserve ratio, and the maximum banking multiplier equals the actual banking multiplier.

27. Progress Checkpoint 2 Q17.6 Which of the following is true? Why?
(a) A bank-run may occur because banks’ total assets is less than their total liabilities.
(b) A bank-run may occur because banks’ liquid assets is less than their total liabilities.
(a) This statement is false. This is because banks’ total assets (e.g. reserves, loans, investment, etc.) must equal their total liabilities.
(b) This statement is true. This is because banks’ assets like reserves or short-term loan may be less than their liabilities, and if they have insufficient cash reserves to support withdrawals, a bank-run may occur.

28. Progress Checkpoint 2
Q17.7 If banks keep excess reserves, can they create money?
So long as the actual reserve ratio is less than 100%, they can still create money.

29. Progress Checkpoint 3
Q17.8 The following shows the balance sheet of Bank A on a certain date:
Assets ($)
Liabilities ($)
Reserves
3,000
Deposits
16,000
Loan
13,000
Total
Suppose the minimum reserve ratio is 20%. Calculate how much shortage of reserve is if a customer withdraws $1,000 from the bank.
Show how the resulting balance sheet of Bank A will change.

30. Progress Checkpoint 3
If a customer withdraws $1,000, the balance sheet of the bank will immediately become:
Assets ($)
Liabilities ($)
Reserves
2,000
Deposits
15,000
Loan
13,000
Total
The minimum reserve is $15,000 x 20% = $3,000. As the actual reserves is only $2,000,
the shortage of reserves is $1,000.

31. Progress Checkpoint 3
Q17.9 Given the following balance sheet of a fully loaned up banking system:
Assets ($)
Liabilities ($)
Reserves
2,000
Deposits
5,000
Loan
3,000
Total
If the public withdraws $400 from the banking system,
(a) calculate the maximum change in deposits
(b) calculate the maximum change in money supply
(c) calculate the maximum change in bank loan, and
show how the balance sheet of the banking system will become after
deposit contraction has completed.

32. Progress Checkpoint 3 (a) Maximum change in deposits =
Initial change in deposits x
_1_ rm
-$400 x
1__
= -$1,000
40%
(b)
Maximum change in money supply
Initial change in excess reserves
_ 1_
-$240 x
= -$600
(c)
Maximum change in bank loan
Initial change in bank loan

33. Progress Checkpoint 3
(d) The balance sheet of the banking system will become:
Assets ($)
Liabilities ($)
Reserves
1,600
Deposits
4,000
Loan
2,400
Total

34. End of Chapter 17