1. Money Creation
Chapter 32

2. Fractional Reserve System
Banks in a fractional reserve system can create money
The amount of money that can be created depends on the reserve requirements established by the Fed
The fractional reserve system makes banks vulnerable to bank runs. All of the demand deposits can not be converted to currency
To prevent bank runs the US has a system of deposit insurance. (FDIC)

3. Key Banking Terms
Reserve Requirement – the minimum percentage of checkable deposits that a bank or thrift must keep on reserve (as vault cash or deposited at the Fed)
Required Reserves – The funds that banks must hold to meet the reserve requirement.
Required Reserves = Reserve Ratio x Banks Demand Deposits
Excess Reserves = Actual Reserves – Required Reserves

4. Balance Sheets (T charts)
A balance sheet is a statement of assets and claims on assets (liabilities and net worth) which summarizes the financial position of a firm. A balance sheet must balance. Assets must equal claims on assets.

5. Creating a Bank
After gaining a charter, the entrepreneur sells shares in the bank to raise cash.
The Bank now uses some of its cash to buy property

6. Accepting Deposits The bank accepts deposits of $100,000
The bank deposits its cash in a Federal Reserve bank

7. Clearing a Check Drawn Against the Bank
An account holder of the bank writes a check for $50,000 to an individual who holds an account at another bank.

8. Granting a Loan The bank grants a loan of $50,000.
The granting of the loan has increased the money supply by $50,000. As the loan is paid off money is destroyed.

9. Buying Government Securities (bonds)
The act of buying government securities from the public is the same as granting a loan. Money is created.
Selling securities to the public reduces the money supply

10. Buying Government Securities from the Fed
When a commercial bank buys securities from the Fed there is no immediate change in the money supply. However, there is a decrease in the bank’s excess reserves, and thus there is a decrease in the bank’s ability to grant loans

11. Multiple Bank System
The commercial banking system can lend (create money) by a multiple of its excess reserves even though each bank in the system can lend only “dollar for dollar” with its excess reserves

12. Money Multiplier = 1__________ required reserve ratio
Maximum Demand = Excess Reserves x Money Mult.
Deposit Creation
Two Leakages may weaken the money creating potential of the banking system
Currency drains – individuals holding currency
Some banks may not loan out all of their excess reserves (profitability vs liquidity)