1. How Banks Create Money[MS] MS = Currency + DD of Public
Give me a loan so there will be more DD in the system.
How Banks Create Money[MS]
MS = Currency + DD of Public
Banks [thru loans] Create More DD

2. How Banks and Thrifts Create Money

3. Dennis Rodman deposits $1 with A 10% RR Total(Actual) Reserves
.10
90 cents RR
Excess Reserves
Total(Actual) Reserves
One Dollar
PMC = M x ER, so 10 x .90 = $9
TMS = PMC[$9] + DD[$1] = $10
[MS = currency + DD of public]

4. Rodman’s Bank Borrows $1 From The Fed [10% RR] Total(Actual) Reserves
One Dollar RR
Excess Reserves
Total(Actual) Reserves
One Dollar
PMC = M x ER, so 10 x $1 = $10
TMS [$10] = PMC[$10]
[MS = currency + DD of public]

5. BALANCE SHEET OF A COMMERCIAL BANK
ASSETS [cash] = LIABILITIES[DD]
[The cash is property of the bank] [“liable”, DDs are owed to depositors]
Cash $100, DD $100,000
The Goldsmiths
Fractional Reserve Banking System
Money Creation & Reserves
Bank Panics and Regulation

6. $1,000 DD by Brian [MS=Currency+DD of Public]
Katy
$1,000.00
800.00
Dell
800.00
640.00
640.00
512.00
Sam’s
512.00
409.60
Canon
409.60
327.70
Target
5,000.00
4,000.00
MS grows by
a multiple of 5
Katy

7. $1,000 DD by Tammy [MS=Currency + DD of Public]
$1,000.00
900.00
810.00
900.00
729.00
729.00
810.00
729.00
656.10
656.10
590.49
656.10
$9,000
$10,000
MS grows
by a factor
of “10”
Tammy

8. MS is MS MS RR=20% $10,000 RR = 20% $10,000 $8,000 $6,400 $24,400
MS = DD + Currency of the Public
[A DD of $10,000 will incr MS by another $40,000($50,000 MS]
RR=20% MS
$10,000
$8,000
$6,400
$24,400
MS is
$10,000
4. 2nd Bank lends Sports Shop $6,400.
1. Joe Biker deposits $10,000 in his bank.
RR = 20% MS
$10,000
$8,000
$18,000
2. Suzie Rah Rah borrows $8,000
5. Eventually the MS will be $50,000
Joe
3. Suzie pays $8,000 for a new car.
GoNow Auto deposits the $ in 2nd Bank.
$10,000+$40,000=$50,000

9. How Banks Create Money [Vocabulary]1.
Fractional Reserve Banking System –
a fraction of DD are kept in
reserve(say, 10%) at either the banks vault or at the Fed. 2.
Vault cash
cash held
by a
bank
(banks rarely keep more than 2%
of their in cash) 3.
Required Reserve(RR)
specified percentage of
DD that banks
must keep as
RR. 4.
Excess reserves
total reserves(TR)
RR. ER is what can be loaned out.
Also some ER is used to meet sudden withdrawal demands. 5.
Actual(Total) reserves
RR + ER. 6.
Deposit Multiplier
one/RR or 1/.10 or $1/10 cents or 10
Multipliers 1/RR[$1/5 cents = 20]
1/5% = /25% = 4
1/10% = /33.3%= 3
1/12.5% = /40 = 2.5
1/20% = /50% = 2 7.
Balance
Sheet
statement of
assets & liabilities[assets=liabilities]. 8.
Discount Rate
when
banks borrow from the Fed.
[symbolic -
emergencies]
“wholesale price of money” 9.
Federal Funds Rate
banks borrow from other banks
for overnight loans.
10.
Prime Rate
when a bank’s
prime customers
[good credit] get loans.
“retail price of money”
11.
Buying Bonds
“buying”
bonds means
“bigger
” supply of money
and
“lower interest rates”.
[So,
more “C”, “Ig”, and “Xn” ]
12.
Selling Bonds
“selling”
bonds mea ns
“smaller”
supply of money and
“higher interest rates”.
less “C”, “Ig”, and “Xn”]

10. Most Famous “Panic Run” in Movie History

11. History of Deposit Insurance
In , federal
deposit insurance
made its debut at
$2,500 to protect
the average family’s
savings and end the
bank runs that had
shut down businesses
and contributed to the
Great Depression.
Through the years
the coverage rose
in $5,000 increments
until the 70s when it
jumped to $40,000.
In 1980, it was raised
to $100,000.

12. The Very Early Days Of Banking
“Wow, you mean we can create money out of thin air.?”
There were
more claims
to gold than
there were
ounces of
gold.
The fractional banking system
began when someone issued
claims for gold that already
belonged to someone else.
Once upon a time there was a gold-smithy who offered to store people’s
gold in his vault. He issued paper receipts for the gold, and it was not long
before the townsfolk used the paper to purchase eggs and beer. The smithy’s
paper receipts became as “good as gold.”
Our Smithy was not stupid. He said to himself. “I have 2000 ounces of gold
stored in my vault, but in the last year I was never called upon to pay out
more than 100 ounces in a single day. What harm could it do if I lent out say,
half the gold I now have? I’ll still have more than enough to pay off any
depositors that come in for a withdrawal. No one will know the difference. I
could earn 30 additional ounces of gold each week. I think I’ll do it.”
“The smithy has invented the Fractional Reserve Banking System.”
Advantages of Lending [One disadvantage was the possibility of “bank runs”]
1. Depositors haven’t lost money [Goldsmiths paid them instead of other way]
2. With the interest you earned you could give some to depositors.
3. The loans benefited the community thru loans

13. Birth of a COMMERCIAL BANK
In Lovelady, Texas
LIABILITIES AND NET WORTH
ASSETS
TRANSACTION 1
Creating a bank
$250,000 Cash
for
Capital Stock

14. FORMATION OF A COMMERCIAL BANK
In Lovelady, Texas
LIABILITIES AND NET WORTH
ASSETS
Cash $250,000
Capital Stock $250,000
Deposit Added to Vault Cash

15. Birth OF A COMMERCIAL BANK
In Lovelady, Texas
LIABILITIES ANDNET WORTH
ASSETS
Cash $250,000
Capital Stock $250,000
TRANSACTION 2
Acquiring Property and
Equipment
$240,000 Cash

16. Birth OF A COMMERCIAL BANK
In Lovelady, Texas
LIABILITIES AND NET WORTH
ASSETS
Cash $ 10,000
Property ,000
Capital Stock $250,000
Lovelady Bank

17. Birth OF A COMMERCIAL BANK
In Lovelady, Texas
LIABILITIES AND NET WORTH
ASSETS
Cash $ 10,000
Property ,000
Capital Stock $250,000
$250,000
$250,000
TRANSACTION 3
Accepting
Deposits
$100,000 Cash

18. Birth OF A COMMERCIAL BANK
In Lovelady, Texas
LIABILITIES AND NET WORTH
ASSETS
Was $10,000
Cash $110,000
Property ,000
DD $100,000
Capital Stock ,000

19. Birth OF A COMMERCIAL BANK
In Lovelady, Texas
ASSETS
LIABILITIES AND NET WORTH
Was $10,000
Cash $110,000
Property ,000
DD $100,000
Capital Stock ,000
$350,000
$350,000

20. FORMATION OF A COMMERCIAL BANK
In Lovelady, Texas
LIABILITIES AND
NET WORTH
ASSETS
Cash $110,000
Property ,000
DD $100,000
Capital Stock ,000
$350,000
$350,000
TRANSACTION 4
A $50,000 check is written against the bank

21. Birth OF A COMMERCIAL BANK
In Lovelady, Texas
LIABILITIES AND
NET WORTH
ASSETS
Was $110,000
Cash $ 60,000
Property ,000
DD $ 50,000
Capital Stock ,000
$300,000
$300,000

22. Birth OF A COMMERCIAL BANK
In Lovelady, Texas
NOTES:
Banks create money
by lending ER and
destroy money by
loan repayment.
Purchasing bonds
from the public also
creates money.

23. Birth OF A COMMERCIAL BANK
In Lovelady, Texas
LIABILITIES AND
NET WORTH
ASSETS
Cash $ 60,000
Property ,000
DD $ 50,000
Capital Stock ,000
TRANSACTION 5
Make a loan from excess reserves
of $50,000

24. FORMATION OF A COMMERCIAL BANK
In Lovelady, Texas
ASSETS
LIABILITIES AND NET WORTH
Cash $ 60,000
Loans ,000
Property ,000
DD $100,000
Capital Stock ,000
Making the loan
created money!

25. Birth OF A COMMERCIAL BANK
In Lovelady, Texas
LIABILITIES AND NET WORTH
ASSETS
Cash $ 60,000
Loans
Property ,000
DD $ 50,000
Capital Stock ,000
After a check for the $50,000
is written against the bank

26. (a) Joe Bozo pays Best Buy a $50,000 check
Dallas
Big “D”
Lovelady Bank
Hateman Bank
(a) Joe Bozo pays Best Buy
a $50,000 check

27. Birth OF A COMMERCIAL BANK
In Lovelady, Texas
LIABILITIES AND NET WORTH
ASSETS
Reserves $ 10,000
Loans ,000
Property ,000
DD $ 50,000
Capital Stock ,000
TRANSACTION 6
Repaying a loan with cash
$50,000

28. Birth OF A COMMERCIAL BANK
In Lovelady, Texas
LIABILITIES AND NET WORTH
ASSETS
Reserves $ 10,000
Loans
Property ,000
DD $ 0
Capital Stock ,000
$50,000 in money supply
is destroyed!

29. MULTIPLE DEPOSIT EXPANSION PROCESS
RR= 20%
Bank
Acquired reserves
and deposits
Required
reserves
Excess
Amount bank
can lend - New
money created A B C D E F G H I J K L M N
Other banks
$100.00
80.00
64.00
51.20
40.96
32.77
26.22
20.98
16.78
13.42
10.74
8.59
6.87
5.50
21.97
$20.00
16.00
12.80
10.24
8.19
6.55
5.24
4.20
3.36
2.68
2.15
1.72
1.37
1.10
4.40
$80.00
17.57
Paris Hilton
1st 10
$357 of
the
$400
Susie RahRah
Ronald McDonald
Potential Money Creation in the banking system
$400.00
Manuel Labor
TMS = $500.00

30. THE DEPOSIT MULTIPLIERRR 1 =
The deposit multiplier is the reciprocal
of the reserve requirement.
Potential money
Creation in the
Banking System
[PMC]
Maximum
checkable-
deposit
expansion = ER x MD

31. Ashley Olsen Deposits $1,000 in her bank
RR = 20%
$1,000
New reserves
$800
Excess
reserves
$200 RR
Ashley Olsen
deposits $1,000
$4,000
PMC thru bank lending
$1,000
Initial
Deposit
Money Created
TMS = $5,000

32. Fed Buys A $1,000 Bond From Ashley’s Bank
New reserves
$1,000
Excess
Reserves
20% RR
$5,000
PMC thru Bank Lending
TMS is $5000

33. OUTCOME OF MONEY EXPANSION
$100
New reserves
$20
Required
reserves
Leakages exist...
Currency Drains
Excess Reserves
$80
Excess
reserves
$400
Bank system lending
$100
Initial
Deposit
Money Created

34. NS 31-35 AP Econ [MS = Currrency+DD of Public]
RR+ER=TR; TR-RR=ER; TR-ER=RR; MXER=PMC; PMC(Public)+DD=TMS; PMC(Fed)=TMS
Excess Reserves prior to new currency deposit (DD) = $0
Britney Spears deposits in the banking system = $40 billion
Legal Reserve Requirement [RR] = 20%
31. The $40 billion deposit of Currency into DD
will result in MS staying at ($8/$40/$160) billion.
32. The $40 billion deposit of currency into
checking accounts will create ER of ($20/$32/$40) billion.
33. The Potential Money Creation of the banking system
through loans is ($40/$160/$$200) bil. The Potential TMS
[all DD of the public] could be as much as ($40/$160/$200)
34. The RR applies to checkable deposits at (banks/S&Ls/
credit unions/ all depository institutions).
35. If the Duck National Bank has ER of $6,000 & DD of $100,000
what is the size of the bank’s TR if the RR is 25%?
($25,000/$75,000/$31,000) [RR($____)+ER($___)+TR($____)
25,000
6,000
31,000

35. NS 36-45 AP Econ [MS = Currrency+DD of Public]
36. A stranger deposits $1,000 in a bank that has a RR of 10%. The
maximum possible change in the dollar value of the local bank’s loans would
be $______. PMC[M X ER] in the banking system is $_____. Potential TMS
could become as high as $_______.
37. Suppose a commercial bank has DD of $100,000 and the RR is 10%.
If the bank’s RR & ER are equal, then its TR are ($10,000/$20,000/$30,000).
38. Total Reserves (minus/plus) RR = ER.
39. Suppose the Thunderduck Bank has DD of $500,000 & the RR is 10%.
If the institution has ER of $4,000 then its TR are ($46,000/$54,000/$4,000).
40. If ER in a bank are $4,000, DD are $40,000, & the RR is 10%, then
TR are ($4,000/$8,000).
41. The main purpose of the RR is to (have funds for emergency withdrawals/
influence the lending ability of commercial banks).
42. If I write you a check for $1 & we both have our checking accts at the
Poorman Bank, the bank’s balance sheet will (increase/decrease/be unchanged).
43. Banks (create/destroy) money when they make loans and repaying bank
loans (create/destroy) money.
44. When a bank loan is repaid the MS is (increased/decreased).
45. The Fed Funds rate is a loan by one bank (to another bank/from the Fed).
RR+ER=TR; TR-RR=ER; TR-ER=RR; MXER=PMC; PMC(Public)+DD=TMS; PMC(Fed)=TMS
900
9,000
10,000

36. NS 46-47 AP Econ [MS = Currrency+DD of Public]
RR+ER=TR; TR-RR=ER; TR-ER=RR; MXER=PMC; PMC(Public)+DD=TMS; PMC(Fed)=TMS
46. If the RR was lowered [say, from 50% to 10%], the size of the
monetary multiplier [MM] would (increase/decrease).
Leakages(limitations) of the Money Creating Process
1. Cash leakages [taking part of loan in cash]
2. ER (banks don’t loan it or we don’t borrow]
47. If borrowers take a portion of their loans as cash, the maximum amount by
which the banking system increases the MS by lending will (increase/decrease).

37. The End