1 Objective – Students will be able to answer questions regarding how banks and thrifts create money. SECTION 1 Chapter 13, 14- Multiple Deposit Expansion © 2001 by Prentice Hall, Inc.

The Federal Reserve (“The Fed”) There are 12 Federal Reserve district banks that collectively serve as the nation’s central bank. This Federal Reserve system has many responsibilities, including controlling the $ supply, supervising member banks, and acting as a lender of last resort. These banks are centrally governed by the Federal Reserve Board of Governors. The Federal Open Market Committee (FOMC) assists the Board by conducting open market operations.

Reserve Requirement The Fed requires banks to always have some money readily available to meet consumers’ demand for cash. The amount, set by the Fed, is the Required Reserve Ratio. The Required Reserve Ratio is the % of demand deposits (checking account balances) that must not be loaned out. Typically the Required Reserve Ratio = 10% ER=TR-RR or TR = ER +RR

The Money Multiplier Similar to the spending multiplier, the money multiplier shows us the impact of a change in demand deposits on loans and eventually the money supply. To calculate the money multiplier, divide 1 by the required reserve ratio. Money multiplier = 1 / reserve ratio Ex. If the reserve ratio is 25%, then the multiplier = 4. Why? 1 /.25 = 4

The Three Types of Multiple Deposit Expansion Questions Type 1: Calculate the initial change in excess reserves (ER=TR-RR or TR = ER +RR) - a.k.a. the amount a single bank can loan from the initial deposit Type 2: Calculate the change in loans in the banking system Type 3: Calculate the total change in the money supply or demand deposit (checkable deposit) creation.

Example 1 Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the amount that a single bank can lend from this Federal Reserve purchase of bonds. The amount of new demand deposits – required reserve = The initial change in excess reserves $100 million – (20% * $100 million) $100 million – $20 million = $80 million in ER

Example 2 Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the maximum total change in loans in the banking system from this Federal Reserve purchase of bonds. The initial change in excess reserves * The money multiplier (ER*1/RRR) = max change in loans $80 million * (1/20%) $80 million * (5) = $400 million max in new loans

Example 3 Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the maximum total change in the money supply (checkable deposit creation) from this Federal Reserve purchase of bonds. The maximum change in loans + $ amount of Federal Reserve action $400 million + $100 million = $500 million max change in the money supply or use TR * 1/RRR = $100 millon *5 = $500 million

Review Required Reserve = Amount of deposit X required reserve ratio Excess reserves = Total reserves – Required Reserves Maximum amount a single bank can loan = the change in excess reserves caused by a deposit The money multiplier = 1/required reserve ratio Total change in loans = amount single bank can lend X money multiplier. Total change in the money supply = Total Change in Loans + $ amount of Fed action.

13 Section 1 Assessment Given a required reserve ratio of 10%, assume the Federal Reserve purchases $200 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the maximum total change in loans in the banking system from this Federal Reserve purchase of bonds. 2. Given a required reserve ratio of 10%, assume the Federal Reserve purchases $200 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the maximum total change in the money supply from this Federal Reserve purchase of bonds.

14 Summary: In a paragraph, describe what you have learned today.