Access Prior Knowledge Provide New Information Analyze New Information

Access Prior Knowledge Provide New Information Analyze New Information
Table of Contents Access Prior Knowledge (Warm Up) Set Goals (Learning Targets) Provide New Information (Lecture) Analyze New Information (Class Activity) Generalize (Conclusion) Homework (Extension Activity) Banks Create Money Learning Targets The Role of Banks The Money Multiplier Learning Targets Bank Runs in History Bank Runs Quiz Bank Regulation How Banks Create Money This lesson follows a format recommended by Jane E. Pollock in “Improving Student Learning: One Teacher at a Time” (2007), which is itself an outgrowth of a book by Robert J. Marzano, Debra J. Pickering, and Jane E. Pollock entitled, “Classroom Instruction that Works: Research-Based Strategies for Increasing Student Achievement” (2001). This format is broken into six parts, each listed as a subheading in bold on this slide. Use this slideshow to guide your class sequentially through each of these six stages. The Money Multiplier Money Supply vs. Monetary Base

Banks Create Money Each student will be assigned the role of either a Banker, a Consumer, or a Vendor. The teacher will make an initial deposit of $1,000 at each bank. Bankers will then loan out a portion of the deposit to a Consumer. Once a Consumer has obtained a loan from a Banker, he/she can purchase an item from one of the Vendors. Upon receiving payment, a Vendor will deposit the money in his/her designated bank. This deposit will then be used by the Banker to make another loan. The process continues until each Banker has no more Money Cards to loan out. Whenever a loan is made, an item is purchased, or money is deposited, each person involved in the transaction will exchange the appropriate cards and record the data in the table on the back of his/her sheet. This Warm Up activity requires a good deal of preparation and organization on the teacher’s part, but it is well worth it. Read the Teacher Instructions document for a detailed explanation on how to make this simulation a success. Each student will be assigned the role of either a Banker, Consumer, or Vendor in a simulation that illustrates how banks create money. It will help students connect today’s concepts to their own lives because most students have deposited money in a bank, and some may even have experience with loans. Be sure that you project this PowerPoint onto the screen, prepare all materials ahead of time, and set up the room properly.

Banks Create Money RULES Bankers
1) Bankers may make a loan to any Consumer, but they can only issue a loan if they get a deposit first. 2) Bankers may only take a deposit from their designated Vendor. 3) The reserve requirement is set at 10%. This means you must loan out 90% of each deposit. 4) Some numbers are rounded. Use the card whose value is within a few pennies (if discrepancies appear). Consumers 1) Consumers may get a loan from any Banker. They do not need anything to obtain a loan, but they may only have one loan at a time. 2) Consumers may purchase an item from any Vendor. 3) The price on the Money Card must match exactly the price of the item the Consumer wants to purchase. 4) Consumers cannot hold any cash. They must spend all of their money. Vendors 1) Vendors may accept payment from any Consumer. 2) Once a sale is made, Vendors must deposit the money in their designated bank before making another sale. 3) Each Vendor will place all 12 Vendor Cards face up on his/her desk so that Consumers can read them. 4) Consumers must pay the Vendor the exact amount for the item. How to Record Data Skip Examples

When receiving a deposit…
Banks Create Money RECORD DATA Bankers # Assets Liabilities Loans Reserves Deposits 1 2 When receiving a deposit… Example for Bankers Example for Consumers Example for Vendors

Banks Create Money RECORD DATA Bankers # Assets Liabilities Loans Reserves Deposits 1 2 NC $1,000 $1,000 When receiving a deposit… a) Write down the amount of the deposit in the Liabilities column. When issuing a loan… b) Write down the amount of the deposit in the Reserves column. c) There is no change in your outstanding loans. Write NC in the Loans column. Example for Bankers Example for Consumers Example for Vendors

Banks Create Money RECORD DATA Bankers # Assets Liabilities Loans Reserves Deposits 1 2 $1000 x .90 NC $1,000 $1,000 $900 $900 -$900 NC When receiving a deposit… When issuing a loan… a) Write down the amount of the deposit in the Liabilities column. a) Because your reserve requirement is 10%, you will make a loan worth 90% of the deposit. b) Write down the amount of the deposit in the Reserves column. b) Write down the amount of the loan in the Loans column. c) There is no change in your outstanding loans. Write NC in the Loans column. c) The value of the loan comes from your Reserves. Write the loan amount as a negative number in this column. d) Since you still owe the depositor, Liabilities do not change. Write NC in the Deposits column. Example for Bankers Example for Consumers Example for Vendors

Banks Create Money RECORD DATA Consumers # Assets Liabilities
Purchases Cash Loans 1 2 When receiving a loan… Example for Bankers Example for Consumers Example for Vendors

When making a purchase…
Banks Create Money RECORD DATA Consumers # Assets Liabilities Purchases Cash Loans 1 2 NC $900 $900 When receiving a loan… a) Write down the amount of the loan in the Liabilities column. When making a purchase… b) Write down the amount of the loan in the Cash column. c) No items were purchased. Write NC in the Purchases column. Example for Bankers Example for Consumers Example for Vendors

When making a purchase…
Banks Create Money RECORD DATA Consumers # Assets Liabilities Purchases Cash Loans 1 2 NC $900 $900 $900 -$900 NC When receiving a loan… When making a purchase… a) Write down the amount of the loan in the Liabilities column. a) Write down the cost of the item in the Purchases column. b) Write down the amount of the loan in the Cash column. b) The money for the item comes from your Cash. Write the cost of the item as a negative number in this column. c) No items were purchased. Write NC in the Purchases column. c) Because you still owe the Banker, there is no change in your Liabilities. Write NC in the Loans column. Example for Bankers Example for Consumers Example for Vendors

Banks Create Money RECORD DATA Vendors # Assets Liabilities Cash
Inventory Deposits Owner Capital 1 2 When making a sale… There is a “Start” row for Vendors to calculate their initial assets and liabilities. This is not included on this PowerPoint. Remind Vendors to fill in the “Start” row using the directions on their sheets. Also, the Liabilities column only gets “NC” entered in it during this simulation. I have included it so that it matches more closely what the Bankers and Consumers are doing. If you have already discussed (or plan to discuss) the Accounting Equation, this helps to reinforce the concept. Example for Bankers Example for Consumers Example for Vendors

Banks Create Money RECORD DATA Vendors When making a sale… # Assets
Liabilities Cash Inventory Deposits Owner Capital 1 2 $900 -$900 NC NC When making a sale… a) Write down the amount of the sale in the Cash column. When making a deposit… b) The item no longer belongs to you, so write its value as a negative number in the Inventory column. c) No cash was put in the bank. Write NC in the Deposits column. d) As the owner, you own just as much as before the sale. Write NC in the Owner Capital column. Example for Bankers Example for Consumers Example for Vendors

Banks Create Money RECORD DATA Vendors When making a sale…
# Assets Liabilities Cash Inventory Deposits Owner Capital 1 2 $900 -$900 NC NC -$900 NC $900 NC When making a sale… When making a deposit… a) Write down the amount of the sale in the Cash column. a) Write down the amount of the deposit in the Deposits column. b) The item no longer belongs to you, so write its value as a negative number in the Inventory column. b) The money for the deposit comes from your Cash. Write the amount as a negative number in this column. c) No cash was put in the bank. Write NC in the Deposits column. c) No changes were made to your Inventory. Write NC in this column. d) As the owner, you own just as much as before the sale. Write NC in the Owner Capital column. d) No changes were made to Owner Capital. Write NC in this column. Example for Bankers Example for Consumers Example for Vendors

Banks Create Money CONCLUSION
Even though each bank started with only $1,000, how much money did you loan out/spend/earn during this simulation? The initial deposit supported much more spending than its value of $1,000. In essence, the banks “created” money during this simulation. How were they able to do this? Click to this slide when the simulation is over. Use the “Sample Data” buttons to help students see how to total each column and to illustrate that assets always equal liabilities. Sample Data Bankers Sample Data Consumers Sample Data Vendors Skip Sample Data

Banks Create Money CONCLUSION Bankers
Even though each bank started with only $1,000, how much money did you loan out/spend/earn during this simulation? # Assets Liabilities Loans Reserves Deposits 1 NC 1,000 2 900 -900 3 4 810 -810 5 6 729 -729 T The initial deposit supported much more spending than its value of $1,000. In essence, the banks “created” money during this simulation. How were they able to do this? Sample Data Bankers Sample Data Consumers Sample Data Vendors 2,439 271 Skip Sample Data 2,710 2,710

Banks Create Money CONCLUSION Consumers
Even though each bank started with only $1,000, how much money did you loan out/spend/earn during this simulation? # Assets Liabilities Purchases Cash Loans 1 NC 900 2 -900 3 810 4 -810 5 729 6 -729 T The initial deposit supported much more spending than its value of $1,000. In essence, the banks “created” money during this simulation. How were they able to do this? Sample Data Bankers Sample Data Consumers Sample Data Vendors 2,439 Skip Sample Data 2,439 2,439

Banks Create Money CONCLUSION Vendors
Even though each bank started with only $1,000, how much money did you loan out/spend/earn during this simulation? # Assets Liabilities Cash Inventory Deposits Owner Capital S NC 6,458.14 1 900 -900 2 3 810 -810 4 5 729 -729 T The initial deposit supported much more spending than its value of $1,000. In essence, the banks “created” money during this simulation. How were they able to do this? Sample Data Bankers Sample Data Consumers Sample Data Vendors 729 4,019.14 1,710 Skip Sample Data 6,458.14 6,458.14

Learning Targets Knowledge
Understand the functions and regulations of the banking system. Reasoning Explain how banks create money. Skill Calculate data using the formulas for the money multiplier. ESSENTIAL QUESTIONS How do savings, investment, and the financial system improve our quality of life? What is the relationship between banks and the Federal Reserve? [Pass out “Notes (The Banking System)” at this time.] Learning targets allow students to know what they are supposed to learn before delving into new material. Using learning targets (similar to objectives, goals, outcomes, etc.) comes from Classroom Assessment for Student Learning” by Richard J. Stiggins, Judith A. Arter, Jan Chappuis, and Stephen Chappuis (2006). Learning targets are broken into five categories: knowledge, reasoning, skill, product, and disposition. To write them, I first examine the national standards from the Council for Economic Education, and then I translate those ideas into student-friendly language, ensuring each category gets addressed. The learning targets listed on this slide are part of a larger set of learning targets that go with the full unit, “The Financial Sector.”

The Role of Banks Banks are financial intermediaries that use the liquid deposits of its customers to finance loans for individuals and firms.

The Role of Banks Banks are financial intermediaries that use the liquid deposits of its customers to finance loans for individuals and firms. 1) Banks can loan out much of what is deposited because only a few depositors withdraw money each day. To illustrate this point, consider the analogy of a rental car lot. Travelers believe they can always find an available car even though the number is limited.

The Role of Banks Banks are financial intermediaries that use the liquid deposits of its customers to finance loans for individuals and firms. 1) Banks can loan out much of what is deposited because only a few depositors withdraw money each day. 2) To satisfy withdrawals, banks keep bank reserves on hand (vault cash and deposits at the Federal Reserve). Required reserves are the amount of money that regulators require banks to keep on hand. Excess reserves are those that exceed the required level.

The Role of Banks Banks are financial intermediaries that use the liquid deposits of its customers to finance loans for individuals and firms. 1) Banks can loan out much of what is deposited because only a few depositors withdraw money each day. Amount of Deposit $1,000 10% Held in Reserves 90% Loaned Out 2) To satisfy withdrawals, banks keep bank reserves on hand (vault cash and deposits at the Federal Reserve). $1000 x .10 $1000 x .90 $100 $900 3) The reserve ratio is the fraction of a bank’s deposits held as reserves. In the Warm Up Activity, the reserve ratio was set at 10%. This meant that 10% of all deposits had to be held as reserves, while 90% could be loaned out.

Bank Runs A bank run is when many depositors, due to a fear of a bank failure, rush to withdraw their money. When multiple bank runs occur, it is called a panic.

Bank Runs A bank run is when many depositors, due to a fear of a bank failure, rush to withdraw their money. When multiple bank runs occur, it is called a panic. 1) Normally, banks have enough cash to satisfy demand, but too many withdrawals can cause a bank failure. RECENT BANK RUNS IN U.S. HISTORY Firm Date Description Bear Stearns Mar. 11 2008 Investment firm whose cash went from $17 billion to $2 billion in 2 days Washington Mutual Sep. 25 $16.7 billion withdrawn in 10 days; largest bank failure in U.S. history Wachovia Sep Lost $5 billion and was forced to sell the company to Wells Fargo Bank runs caused many banks to fail between 2007 and The Great Depression ( ) was more severe, with 9,000 bank failures.

Bank Runs A bank run is when many depositors, due to a fear of a bank failure, rush to withdraw their money. When multiple bank runs occur, it is called a panic. 1) Normally, banks have enough cash to satisfy demand, but too many withdrawals can cause a bank failure. 2) If banks cannot satisfy withdrawals, they will have to liquidate their assets. Banks will quickly sell their other assets (loans) to other investors in order to get cash. They will only be able to sell these assets, however, at a severe loss.

Bank Run in New York City (June 1931)
Bank Runs A bank run is when many depositors, due to a fear of a bank failure, rush to withdraw their money. When multiple bank runs occur, it is called a panic. 1) Normally, banks have enough cash to satisfy demand, but too many withdrawals can cause a bank failure. Bank Run in New York City (June 1931) 2) If banks cannot satisfy withdrawals, they will have to liquidate their assets. 3) Bank runs are a self-fulfilling prophecy. A self-fulfilling prophecy is a prediction that causes itself to become true. This occurs because people alter their behavior based on the prediction. In the case of bank runs, the prediction is that a bank is about to fail. Suppose the bank is actually not about to fail because it is a healthy bank. The only way it could fail is if everyone withdrew their money at once. The prediction about the bank failing, which in this case is irrational, causes people to change their behavior, which means they will withdraw their money. As a result of this prediction, the bank will fail. The only way it could fail is if a prediction about it failing had been made. Thus, the prophecy of failure has come true due to people’s predictions and behavior. Suppose a depositor hears a rumor that his bank is about to fail. Even if he knows it is false, he will not risk losing everything. He will withdraw his money.

Bank Run in Michigan (February 1933)
Bank Runs A bank run is when many depositors, due to a fear of a bank failure, rush to withdraw their money. When multiple bank runs occur, it is called a panic. 1) Normally, banks have enough cash to satisfy demand, but too many withdrawals can cause a bank failure. Bank Run in Michigan (February 1933) 2) If banks cannot satisfy withdrawals, they will have to liquidate their assets. 3) Bank runs are a self-fulfilling prophecy. The table on “Recent Bank Runs in U.S. History” (Slide 24) lists that the bank run on Wachovia happened one day after the bank run on Washington Mutual. 4) Bank runs are contagious. Once one bank run has occurred, it will often set off others. Even banks that are not in financial trouble can be at risk.

Currency in Circulation
Bank Runs A bank run is when many depositors, due to a fear of a bank failure, rush to withdraw their money. When multiple bank runs occur, it is called a panic. 1) Normally, banks have enough cash to satisfy demand, but too many withdrawals can cause a bank failure. Year Currency in Circulation Checkable Deposits M1 (billions) 1929 $3.90 $22.74 $26.64 1930 $3.73 $22.03 $25.76 1931 $4.16 $19.98 $24.14 1932 $4.92 $16.19 $21.11 1933 $5.09 $14.82 $19.91 Total Change + $1.19 - $7.92 - $6.73 Percent Change 31% - 35% - 25% 2) If banks cannot satisfy withdrawals, they will have to liquidate their assets. 3) Bank runs are a self-fulfilling prophecy. 4) Bank runs are contagious. 5) When a bank fails, depositors may lose out on money, but the loss of financing hurts the whole economy. Notice how currency in circulation grew during the Great Depression, but bank deposits decreased. This resulted in a loss of total available money (M1).

Bank Regulation In order to prevent bank runs and other financial catastrophes, the U.S. banking system is regulated by a central bank known as the Federal Reserve.

Bank Regulation In order to prevent bank runs and other financial catastrophes, the U.S. banking system is regulated by a central bank known as the Federal Reserve. 1) Deposit Insurance A guarantee the government will pay depositors if a bank fails. Most Banks are a member of the Federal Deposit Insurance Corporation (FDIC). Currently, deposits will be reimbursed up to $250,000 if the bank fails.

Bank Regulation In order to prevent bank runs and other financial catastrophes, the U.S. banking system is regulated by a central bank known as the Federal Reserve. 1) Deposit Insurance A guarantee the government will pay depositors if a bank fails. 2) Capital Requirements Banks must hold more assets than the value of deposits. Deposit insurance provides an incentive to engage in risky lending. Capital requirements mean any losses will be suffered by the bank first, not the government.

Bank Regulation In order to prevent bank runs and other financial catastrophes, the U.S. banking system is regulated by a central bank known as the Federal Reserve. 1) Deposit Insurance A guarantee the government will pay depositors if a bank fails. 2) Capital Requirements Banks must hold more assets than the value of deposits. 3) Reserve Requirements Banks must retain a percentage of all deposits as bank reserves. The minimum reserve ratio in the U.S. is 10%. Banks keep more money in reserves than they prefer, but it reduces the risk of banks running out of money.

Bank Regulation In order to prevent bank runs and other financial catastrophes, the U.S. banking system is regulated by a central bank known as the Federal Reserve. 1) Deposit Insurance A guarantee the government will pay depositors if a bank fails. 2) Capital Requirements Banks must hold more assets than the value of deposits. 3) Reserve Requirements Banks must retain a percentage of all deposits as bank reserves. 4) Discount Window A bank run will force a bank to sell its assets cheaply in order to satisfy depositors. Because the Fed can make loans, banks can avoid selling off their assets. The Federal Reserve can loan money to banks in need.

How Banks Create Money Banks only keep a portion of deposits as reserves (fractional reserve banking). Because excess reserves are loaned out, money gets “created.” # Currency in Circulation ($) Checkable Deposits ($) Total Money Supply ($) 1 2 3 4 5 T The “Total Money Supply” could also have been referred to as the M1 Money Supply. (The category of Traveler’s Checks is small and often gets merged with the category of Checkable Deposits when discussing the money supply.)

How Banks Create Money Banks only keep a portion of deposits as reserves (fractional reserve banking). Because excess reserves are loaned out, money gets “created.” 1) Stage One Suppose you have $1,000 cash. The total money supply is $1,000. # Currency in Circulation ($) Checkable Deposits ($) Total Money Supply ($) 1 2 3 4 5 T +1,000 1,000 The total money supply is equal to currency in circulation plus checkable deposits. At this stage in the example, the total money supply is $1,000.

How Banks Create Money Banks only keep a portion of deposits as reserves (fractional reserve banking). Because excess reserves are loaned out, money gets “created.” 1) Stage One Suppose you have $1,000 cash. The total money supply is $1,000. # Currency in Circulation ($) Checkable Deposits ($) Total Money Supply ($) 1 2 3 4 5 T +1,000 1,000 2) Stage Two Suppose you deposit your money. No money has been created yet. -1,000 +1,000 NC Most people hold money as both currency and as checkable deposits. This means a large percentage of the money supply is in checkable deposits.

How Banks Create Money Banks only keep a portion of deposits as reserves (fractional reserve banking). Because excess reserves are loaned out, money gets “created.” 1) Stage One Suppose you have $1,000 cash. The total money supply is $1,000. # Currency in Circulation ($) Checkable Deposits ($) Total Money Supply ($) 1 2 3 4 5 T +1,000 1,000 2) Stage Two Suppose you deposit your money. No money has been created yet. -1,000 +1,000 NC +900 NC 1,900 3) Stage Three The bank loans out 90% ($900). The money supply is now $1,900. The current reserve requirement in the U.S. is around 10%. Thus, 90% of deposits can be loaned out, allowing banks to make money on interest payments.

How Banks Create Money Banks only keep a portion of deposits as reserves (fractional reserve banking). Because excess reserves are loaned out, money gets “created.” 1) Stage One Suppose you have $1,000 cash. The total money supply is $1,000. # Currency in Circulation ($) Checkable Deposits ($) Total Money Supply ($) 1 2 3 4 5 T +1,000 1,000 2) Stage Two Suppose you deposit your money. No money has been created yet. -1,000 +1,000 NC +900 NC 1,900 3) Stage Three -900 +900 NC The bank loans out 90% ($900). The money supply is now $1,900. 4) Stage Four The $900 loan is spent and then deposited in the bank. When a loan is spent, the person receiving payment may deposit all of it in the bank. Usually, however, some money will be held as currency in circulation.

How Banks Create Money Banks only keep a portion of deposits as reserves (fractional reserve banking). Because excess reserves are loaned out, money gets “created.” 1) Stage One Suppose you have $1,000 cash. The total money supply is $1,000. # Currency in Circulation ($) Checkable Deposits ($) Total Money Supply ($) 1 2 3 4 5 T +1,000 1,000 2) Stage Two Suppose you deposit your money. No money has been created yet. -1,000 +1,000 NC +900 NC 1,900 3) Stage Three -900 +900 NC The bank loans out 90% ($900). The money supply is now $1,900. +810 NC 2,710 810 1,900 2,710 4) Stage Four The $900 loan is spent and then deposited in the bank. Every time money gets deposited in a bank, it triggers this money creation process. After only a few stages, the $1,000 has already turned into $2,710. 5) Subsequent Stages Each deposit allows the bank to inject money into the economy.

The Money Multiplier The money multiplier calculates the maximum change in checkable deposits due to an increase or a decrease in the amount of excess reserves.

The Money Multiplier The money multiplier calculates the maximum change in checkable deposits due to an increase or a decrease in the amount of excess reserves. 1) Money Multiplier Formula A) Assume all money is deposited and all excess reserves are lent. This assumption will allow us to simplify the situation. It means no money is held as currency in circulation, or that it is a checkable-deposits-only system.

The Money Multiplier The money multiplier calculates the maximum change in checkable deposits due to an increase or a decrease in the amount of excess reserves. 1) Money Multiplier Formula A) Assume all money is deposited and all excess reserves are lent. Description Symbol Reserve Ratio rr Money Multiplier m Checkable Deposits CD Excess Reserves ER Change in ∆ B) Use rr for the reserve ratio and m for the money multiplier. The rr and m symbols are fairly universally accepted when calculating the money multiplier. I have used these other symbols simply to provide clarity. They are not standard. Other symbols we will use in our calculations include CD for Checkable Deposits, ER for Excess Reserves, and ∆ for “change in.” In the example, rr will be 10%.

Amount Checkable Deposits Increase
The Money Multiplier The money multiplier calculates the maximum change in checkable deposits due to an increase or a decrease in the amount of excess reserves. 1) Money Multiplier Formula Rd Amount Checkable Deposits Increase Amount if rr = .10 1 2 3 … ∞ Ttl. A) Assume all money is deposited and all excess reserves are lent. (Initial Amount) $1,000 x (1 - rr)0 $1,000 B) Use rr for the reserve ratio and m for the money multiplier. $1,000 x (1 - rr)1 $900 $1,000 x (1 - rr)2 $810 C) Checkable deposits increase by a smaller amount each round. $1,000 x (1 - rr)3 $729 … … Notice the initial $1,000 of excess reserves at the beginning. If this had been a deposit of $1,000 instead, it would be an initial increase of $900 to excess reserves. Also note that any number raised to the “0” power equals 1. The symbol in the sixth body row stands for infinity. This equation is difficult for students to grasp. Tell them simply to remember back to the Warm Up Activity. Each time a loan was made and the money was deposited, a smaller amount of money could be loaned out the next time. At some point, the amount of the loan will be so small that it will approach zero. This equation is just a way to show that we are adding up all of the loan amounts, all the way down to zero. $1,000 x (1 - rr)∞ $0 The first row is the initial amount of excess reserves, and each successive row represents how much money gets created each time a loan is made.

Amount Checkable Deposits Increase
The Money Multiplier The money multiplier calculates the maximum change in checkable deposits due to an increase or a decrease in the amount of excess reserves. 1) Money Multiplier Formula Rd Amount Checkable Deposits Increase Amount if rr = .10 1 2 3 … ∞ Ttl. A) Assume all money is deposited and all excess reserves are lent. (Initial Amount) $1,000 x (1 - rr)0 $1,000 B) Use rr for the reserve ratio and m for the money multiplier. $1,000 x (1 - rr)1 $900 $1,000 x (1 - rr)2 $810 C) Checkable deposits increase by a smaller amount each round. $1,000 x (1 - rr)3 $729 D) The equation simplifies to… m = 1 / rr … … $1,000 x (1 - rr)∞ $0 $1,000 x (1 / rr) $10,000 Calculus is needed to simplify this equation. For our purposes, simply remember the money multiplier is equal to the reciprocal of the reserve ratio.

The Money Multiplier ∆CD = ∆ER x m ∆CD = ∆ER x (1/rr)
The money multiplier calculates the maximum change in checkable deposits due to an increase or a decrease in the amount of excess reserves. 1) Money Multiplier Formula ∆CD = ∆ER x m A) Assume all money is deposited and all excess reserves are lent. ∆CD = ∆ER x (1/rr) B) Use rr for the reserve ratio and m for the money multiplier. C) Checkable deposits increase by a smaller amount each round. D) The equation simplifies to… m = 1 / rr 2) How Much Money Gets Created? A) ∆Total Checkable Deposits = ∆Excess Reserves x m The money multiplier equation only tells us by what factor checkable deposits change. This equation actually calculates the dollar amount of that change.

The Money Multiplier ∆CD = ∆ER x m ∆CD = ∆ER x (1/rr) ∆CD = ∆ER / rr
The money multiplier calculates the maximum change in checkable deposits due to an increase or a decrease in the amount of excess reserves. 1) Money Multiplier Formula ∆CD = ∆ER x m A) Assume all money is deposited and all excess reserves are lent. ∆CD = ∆ER x (1/rr) B) Use rr for the reserve ratio and m for the money multiplier. ∆CD = ∆ER / rr C) Checkable deposits increase by a smaller amount each round. ∆CD = $1, / D) The equation simplifies to… m = 1 / rr ∆CD = $10,000 2) How Much Money Gets Created? A) ∆Total Checkable Deposits = ∆Excess Reserves x m Note that we can calculate the change in checkable deposits by knowing either the money multiplier or the reserve ratio. The answer will be the same. B) This equation simplifies to… ∆CD = ∆ER / rr

Money Supply vs. Monetary Base
The money multiplier calculates the maximum increase in the money supply. In reality, this increase is much smaller because people hold money as currency.

The money multiplier calculates the maximum increase in the money supply. In reality, this increase is much smaller because people hold money as currency. 1) The Money Supply Money Supply A) Includes currency in circulation and checkable deposits. Currency in Circulation Checkable Deposits When calculating the money multiplier, we use the most liquid measurement of the money supply, or M1. Thus, it does not include any monies from M2.

The money multiplier calculates the maximum increase in the money supply. In reality, this increase is much smaller because people hold money as currency. 1) The Money Supply Money Supply A) Includes currency in circulation and checkable deposits. B) Only includes money that is available for spending. Currency in Circulation Checkable Deposits $1,369 Billion In January 2008, the M1 money supply in the U.S. was $1,369 billion. Much more money was present in the economy, but it was not available for spending.

The money multiplier calculates the maximum increase in the money supply. In reality, this increase is much smaller because people hold money as currency. 1) The Money Supply Money Supply Monetary Base A) Includes currency in circulation and checkable deposits. B) Only includes money that is available for spending. 2) The Monetary Base Currency in Circulation Bank Reserves A) Includes currency in circulation and bank reserves. Checkable Deposits $1,369 Billion Notice that bank reserves are not part of the money supply. This is because vault cash (and money at the Federal Reserve) are not available for spending.

The money multiplier calculates the maximum increase in the money supply. In reality, this increase is much smaller because people hold money as currency. 1) The Money Supply Money Supply Monetary Base A) Includes currency in circulation and checkable deposits. B) Only includes money that is available for spending. 2) The Monetary Base Currency in Circulation Bank Reserves A) Includes currency in circulation and bank reserves. Checkable Deposits B) These are monies controlled by the monetary authorities. $1,369 Billion $848 Billion In January 2008, the monetary base in the U.S. was $848 billion. This meant that $848 billion of currency and reserves was supporting $1,369 billion of money.

The money multiplier calculates the maximum increase in the money supply. In reality, this increase is much smaller because people hold money as currency. 1) The Money Supply Money Supply Monetary Base A) Includes currency in circulation and checkable deposits. B) Only includes money that is available for spending. 2) The Monetary Base Currency in Circulation Bank Reserves A) Includes currency in circulation and bank reserves. Checkable Deposits B) These are monies controlled by the monetary authorities. 3) The Money Multiplier Revisited $1,369 Billion $848 Billion A) The monetary base only supports a slightly larger money supply. In January 2008, the monetary base in the U.S. was smaller than the money supply. From 2009 through 2014, the monetary base has actually been bigger.

The money multiplier calculates the maximum increase in the money supply. In reality, this increase is much smaller because people hold money as currency. 1) The Money Supply Money Supply Monetary Base A) Includes currency in circulation and checkable deposits. B) Only includes money that is available for spending. 2) The Monetary Base Currency in Circulation Bank Reserves A) Includes currency in circulation and bank reserves. Checkable Deposits B) These are monies controlled by the monetary authorities. When the money multiplier is less than one, it means that a dollar in the monetary base supports less than a dollar in reality. This is characteristic of the banking crisis and economic downturn experienced after the 2008 financial crisis. 3) The Money Multiplier Revisited $1,369 Billion / $848 Billion = 1.6 A) The monetary base only supports a slightly larger money supply. The “real” money multiplier tells us how many M1 dollars the monetary base is supporting. Currently (2014), the money multiplier is actually less than one. B) The money multiplier equals… Money Supply / Monetary Base

Directions for the Class Activity
The Money Multiplier Directions for the Class Activity ANALYZING THE FORMULA We have learned the money multiplier is equal to the reciprocal of the reserve ratio. But how do we know this is true? The following problem illustrates the answer. Suppose a bank has $1,000 in excess reserves and a reserve ratio of 40%. Assume no money is held as currency in circulation and all excess reserves are loaned out. Calculate the increase to the money supply each round in the middle column. Then in the right-hand column, keep a running total of how much money has been created. Graph these data points using “Round” on the x-axis and “Total Increase” on the y-axis. Use this information to answer the questions. PRACTICE PROBLEMS 4) Use these reserve ratio values to calculate the money multiplier. 5) Use the following m values to calculate the change in checkable deposits. 6) Use the following rr values to calculate the change in checkable deposits. 7) Suppose the U.S. economy has money in the forms listed on this table. 8) Use the currency drainage formula to calculate the money multiplier. These are the directions for the Class Activity that is included in the download, entitled “The Money Multiplier.” Assign students one of the three versions. Difficulty increases from (a) to (b) to (c), allowing for differentiation, if desired. Students may either self-identify which difficulty to complete, or the teacher can decide. It works best to begin working individually with the students who have the (a) version, and then check in on the progress of the other students.

Learning Targets Knowledge
Understand the functions and regulations of the banking system. Reasoning Explain how banks create money. Skill Calculate data using the formulas for the money multiplier. ESSENTIAL QUESTIONS How do savings, investment, and the financial system improve our quality of life? What is the relationship between banks and the Federal Reserve? Help students make connections between the learning targets and the activities from today. If desired, see if students can answer the Essential Questions. Go to the Quiz Skip Quiz

Quiz DIRECTIONS Version (a)
This quiz covers topics from today’s lesson and is divided into three sections. In the first section, match the correct letter from each definition with each vocabulary word. Then, select the best answer for each question or incomplete statement. Finally, correctly calculate each formula (show your work). Version (b) This quiz covers topics from today’s lesson and is divided into three sections. In the first section, match the correct letter from each definition with each vocabulary word. Then, select the best answer for each question or incomplete statement. Finally, correctly calculate each formula (show your work). Version (c) This quiz covers topics from today’s lesson and is divided into three sections. In the first section, write the definition of each vocabulary word in your own words. Then, write a short response for each question. Finally, correctly calculate each formula (show your work). A short quiz has been included, which can be utilized in different ways. Each student can complete the quiz silently, the teacher can read the questions aloud and call on students for informal answers, or it can be given at the beginning of tomorrow’s class. There are three versions, allowing for differentiation. Difficulty increases from (a) to (b) to (c). Matching / Vocabulary Multiple Choice / Short Response Calculations

Quiz MATCHING / VOCABULARY 1) _____ Deposit Insurance
2) _____ Capital Requirements 3) _____ Reserve Requirements 4) _____ Discount Window Show Answers Multiple Choice / Short Response Calculations

Quiz MATCHING / VOCABULARY 1) _____ Deposit Insurance c
c) This is a guarantee from the government that some or all money kept in a bank will be reimbursed if the bank fails. 2) _____ Capital Requirements b b) Banks must hold assets over and above the value of their loans, which ensures they will experience any losses first. 3) _____ Reserve Requirements a a) A certain percentage of all checkable deposits must be held as currency by the bank at all times. 4) _____ Discount Window d d) To satisfy a rush of withdrawals, a bank can get a loan from the Federal Reserve instead of having to sell off its assets. Matching / Vocabulary Multiple Choice / Short Response Calculations

MULTIPLE CHOICE / SHORT RESPONSE
Quiz MULTIPLE CHOICE / SHORT RESPONSE 5) According to economists, the primary function of the banking system is to 8) Banks are able to “create” money because they 9) A $500 deposit is made at a bank with a reserve requirement of 20%. How much money can the bank initially loan out? 6) If a bank has a reserve ratio of 20%, the bank 7) Once one bank run occurs, it is very likely that 10) The M1 money supply and the monetary base both include Matching / Vocabulary Show Answers Calculations

MULTIPLE CHOICE / SHORT RESPONSE
Quiz MULTIPLE CHOICE / SHORT RESPONSE 5) According to economists, the primary function of the banking system is to 8) Banks are able to “create” money because they d) loan out their excess reserves. d) serve as a financial intermediary between savers and borrowers. 9) A $500 deposit is made at a bank with a reserve requirement of 20%. How much money can the bank initially loan out? 6) If a bank has a reserve ratio of 20%, the bank b) can loan out 80% of its reserves. d) $400. 7) Once one bank run occurs, it is very likely that 10) The M1 money supply and the monetary base both include a) another bank run will occur. c) currency in circulation. Matching / Vocabulary Multiple Choice / Short Response Calculations

Quiz CALCULATIONS 11) What is the money multiplier when the reserve ratio is 8%? 13) What is the change in checkable deposits when the reserve ratio is 30% and the change in excess reserves is $600? 12) What is the change in checkable deposits when the money multiplier is 4 and the change in excess reserves is -$200? 14) What is the actual money multiplier if the M1 money supply is $2,500 million and the monetary base is $1,000 million? Matching / Vocabulary Multiple Choice / Short Response Show Answers

Quiz CALCULATIONS 11) What is the money multiplier when the reserve ratio is 8%? 13) What is the change in checkable deposits when the reserve ratio is 30% and the change in excess reserves is $600? m = 1 / rr m = 1 / .08 m = 12.5 ∆CD = ∆ER / rr ∆CD = $600 / .30 ∆CD = $2,000 12) What is the change in checkable deposits when the money multiplier is 4 and the change in excess reserves is -$200? 14) What is the actual money multiplier if the M1 money supply is $2,500 million and the monetary base is $1,000 million? ∆CD = ∆ER x m ∆CD = -$200 x 4 ∆CD = -$800 m = money supply/monetary base m = $2,500 million / $1,000 million m = 2.5 Matching / Vocabulary Multiple Choice / Short Response Calculations

Directions for the Homework
Bank Runs in History Directions for the Homework DIRECTIONS Over the past several hundred years, numerous bank runs and financial panics have occurred in the United States and elsewhere around the world. Summaries of two banking crises are provided below. Read the summary of each and answer the questions that follow. BANKING CRISIS #1 The Argentine Economic Crisis, BANKING CRISIS #2 The Panic of 1893 These are the directions for the Homework that is included in the download, entitled “Bank Runs in History.” Assign students one of the three versions. Difficulty increases from (a) to (b) to (c), allowing for differentiation, if desired. Students may either self-identify which difficulty to complete, or the teacher can decide.

Resources Slideshow - Data regarding bank runs - Bank Run in New York City (June 1931) - Bank Run in Michigan (February 1933) (Table 3) - Data for M1 money supply - Deposit Insurance - Data for Bank Capital to Assets Ratio - Data for Reserve Requirements (Note that data was obtained some point between ) - Data for M1 - Data for the Monetary Base - Data for the Money Multiplier

Resources Clip Art from the Warm Up activity
COMFY HOME FURNITURE MART - Couch - Pool Table - King Size Bed - Lounge Chair - Foosball Table - Full Size Bed - Desk - Loveseat Sofa - Beach Chair - Chest of Drawers - Coffee Table - End Table EMOTICON ELECTRONICS - Computer - Home Cinema Package - Laptop Computer - Smartphone - Computer with Tower - 42” HD Television - Tablet - Home Theatre Projector - Laser Printer - Sound System - 24” HD Television - Inkjet Printer Clip Art from the Warm Up activity (continued) GOOD SOUNDS MUSIC CENTER - Grand Piano - Electric Guitar - Drum Set - Electric Keyboard - Acoustic Guitar - Bass Guitar - Guitar Amplifier - Discount Electric Guitar - Discount Acoustic Guitar - Discount Bass Guitar - Microphone - Headphones MONTHLY PAYMENT CAR LOT - European Sports Car - American Sports Car - Convertible - Muscle Car - Two-Door Coupe - Sport Utility Vehicle - Luxury Town Car - Sporty Compact Car - Four-Door Sedan - Electric Car - Sports Wagon - City Car

Resources Clip Art from the Warm Up activity (continued)
MONTHLY PAYMENT HOME LOANS - Mansion - Victorian House - Country House - Colonial Style House - House with a Pool - Suburban House - One-Story House - Condominium - Top-Floor Apartment - Cabin on the Lake - Studio Apartment - Cabin THE GREAT OUTDOORS STORE - ATV - Canoe - Mountain Bike - Kayak - Rock Climbing Gear - Four-Person Tent - Horseback Riding Gear - Hiking Equipment - Discount Mountain Bike - Two-Person Tent - Fishing Rod - Backpack Clip Art from the Warm Up activity (continued) THINGAMABOB APPLIANCES - Outdoor Grill - Luxury Refrigerator - Washer and Dryer - Oven - Vacuum Cleaner - Dishwasher - Discount Refrigerator - Espresso Maker - Microwave Oven - Ceiling Fan - Toaster Oven - Blender WEEKEND VACATION SUPERCENTER - Hawaii - California - Texas - Arizona - Florida - New Mexico - Colorado - Nevada - Washington - Ohio - Indiana - Kansas

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