1 © ©1999 South-Western College Publishing PowerPoint Slides prepared by Ken Long Principles of Economics 2nd edition by Fred M Gottheil

2 Chapter 26 Money Creation and the Banking System 11/4/2015 © ©1999 South-Western College Publishing

3 This chapter discusses principles associated with The Federal Deposit Insurance Corporation (FDIC) © ©1999 South-Western College Publishing Bank Failure The Potential Money MultiplierDemand Deposits & Bank Loans A Bank’s Balance Sheet, its Assets and Liabilities The Legal Reserve Requirement The Fractional Reserve System

4 Who were the first bankers? Goldsmiths in the Middle Ages © ©1999 South-Western College Publishing

5 What is a Fractional Reserve Banking System? A banking system that provides people immediate access to their deposits, but allows banks to hold only a fraction of those deposits in reserve © ©1999 South-Western College Publishing

6 How do banks make profit? They pay depositors a lower rate of interest and lend a fraction of the deposits out at a higher interest rate © ©1999 South-Western College Publishing

7 What is a Bank’s Balance Sheet? The bank’s statement of liabilities (what it owes) and assets (what it owns) © ©1999 South-Western College Publishing

8 What happens when you write a check against your bank? It’s assets decrease © ©1999 South-Western College Publishing

9 What happens when you deposit a check in a bank? Its assets increase © ©1999 South-Western College Publishing

10 Find out about cyberspace banking: html © ©1999 South-Western College Publishing

11 What determines how much a Bank can lend? The legal reserve requirement determines what fraction of a bank’s deposits they can lend © ©1999 South-Western College Publishing

12 What is a Legal Reserve Requirement? The percentage of demand deposits banks and other financial intermediaries are required to keep in cash reserves © ©1999 South-Western College Publishing

13 What are Excess Reserves? Deposits that a bank has above its required reserves © ©1999 South-Western College Publishing

14 How does the banking system create money? One bank’s loan becomes another bank’s deposit which allows it to loan as well and this loan-deposit process continues. © ©1999 South-Western College Publishing

15 What is the Potential Money Multiplier? The increase in the money supply that is potentially generated by a change in demand deposits © ©1999 South-Western College Publishing

16 What is the money multiplier with a reserve requirement of 1/10? 10 © ©1999 South-Western College Publishing

17 $100 $90 $81 $74 $63 $1,000 original deposit total money © ©1999 South-Western College Publishing...

18 What is the Money Multiplier formula? 1/Required reserve ratio © ©1999 South-Western College Publishing

19 If the required reserve ratio is 1/10 and all banks hold no excess reserves - how do we calculate the money multiplier? © ©1999 South-Western College Publishing

20 One divided by one tenth equals = 1 X 1 = Multiplier 10 © ©1999 South-Western College Publishing 20

21 Does this multiplication process work in reverse? Yes! For every dollar deposit withdrawn from the bank, there is a multiple effect on the money supply © ©1999 South-Western College Publishing

22 Can a Bank fail? Yes. When a significant part of its loan portfolio consists of high risk loans that end up defaulted. © ©1999 South-Western College Publishing

23 How do we Safeguard the Banking System? The Federal Deposit Insurance Corporation (FDIC) © ©1999 South-Western College Publishing

24 What is the FDIC? A government insurance agency that provides depositors 100% coverage on their first $100,000 of deposits © ©1999 South-Western College Publishing

25 What else does the FDIC do? It audits and examines banks to detect any weaknesses in its operation © ©1999 South-Western College Publishing

26 Despite the FDIC, can banks still fail? Yes! There were many bank failures as recently as the 1980’s and 1990’s © ©1999 South-Western College Publishing

27 27 © ©1999 South-Western College Publishing

28 What is a Fractional Reserve Banking System?What is a Fractional Reserve Banking System? How do banks make profit? What is a Legal Reserve Requirement? What are Excess Reserves? How do Banks multiply money? What is the money multiplier formula? What is the FDIC?

29 ENDEND © ©1999 South-Western College Publishing