Bank’s Balance Sheet Typical items in US Bank’s balance sheet –Checking Deposits (D) $1000 million –Bonds (US gov’t securities) $190 million –Loans $700.

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Presentation transcript:

Bank’s Balance Sheet Typical items in US Bank’s balance sheet –Checking Deposits (D) $1000 million –Bonds (US gov’t securities) $190 million –Loans $700 million –Reserves (R) $110 million What are reserves? deposits that banks hold at the Fed plus cash in the bank’s vault

Bank’s Balance Sheet US Bank’s Balance sheet Assets Liabilities D $1000 millionBonds $190 million Loans $700 million R $110 million

Reserves and excess reserves Excess Reserves and Loans Loaned up = Total Reserves minus Required Reserves When excess reserves = 0, the bank is “loaned up” or “fully loaned” and can’t make any new loans. Banks loan out excess reserves because loans earn interest, but reserves don’t

Deposit expansion Suppose that r = 0.10 (bank must hold 10% of its deposits as reserves) In our example, does US Bank hold any excess reserves? Required reserves =.1 ($1000 mil) = $100 mil Excess reserves = $110 mil - $100 mil = $10 mil. YES, US Bank has excess reserves of $10 mil.

Deposit expansion What to do with excess reserves? US Bank loans P&G $10 mil. to buy computers - P&G gives loan check to Dell - Dell deposits check in Union Planters Bank

Deposit expansion Changes in balance sheets US Bank Assets Liabilities Union Planter’s Bank Assets Liabilities R - $10 mil L + $10 mil R + $10 milD + $ 10 mil

Deposit expansion Did deposits rise? Did deposits fall? Deposits rose by $10 mil. but did not fall in any other bank so M1 rose $10 mil.

Deposit expansion Not the end of the story Does Union Planter’s now have any excess reserves? Required reserves =.1 (+10 mil) = $1 mil Excess reserves = + 10 mil. – 1 mil. = + $9 mil. YES, Union Planter’s has excess reserves of $9 mil.

Deposit expansion What to do with excess reserves? Union Planters loans Southeast Hospital $9 mil. for an addition - Southeast Hospital gives loan check to contractor - Contractor deposits check in FirstBank

Deposit expansion Changes in balance sheets Union Planters Bank Assets Liabilities FirstBank Assets Liabilities D + $9 mil R + $9 mil R - $9 mil L + $9 mil

Deposit expansion Did deposits rise? Did deposits fall? Deposits rose by another $9 mil. but did not fall in any other bank M1 rose $9 mil. $10 mil + $9 mil = $19 mil. increase in M1 so far

Deposit expansion Not the end of the story Does FirstBank now have any excess reserves? Required reserves =.1 (+ 9 mil) = $.9 mil. Excess reserves = $9 mil. - $.9mil. = $8.1 mil. YES, FirstBank has excess reserves of $8.1 mil.

Deposit expansion Process continues --- and so on and so on and so on Deposit expansion multiplier is (1 / r) The maximum change in the money supply = Deposit Expansion Multiplier x initial excess reserves

Deposit expansion In our example, what is the maximum change in the money supply? Deposit expansion multiplier = 1/r = 1/.10 = 10 Initial excess reserves = + $10 mil Maximum change in money supply = 10 x (+ $10 mil.) = + $100 mil.