2. 14 - 1 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show How Banks and Thrifts Create Money 14 C H A P T E R

3. 14 - 2 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show BALANCE SHEET OF A COMMERCIAL BANK ASSETS = LIABILITIES + NET WORTH The Goldsmiths Fractional Reserve Banking System Money Creation & Reserves Bank Panics & Regulation

4. 14 - 3 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH TRANSACTION 1 Creating a bank $250,000 Cash for Capital Stock

5. 14 - 4 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Cash $250,000Capital Stock $250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH Deposit Added to Vault Cash

6. 14 - 5 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Cash $250,000Capital Stock $250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH TRANSACTION 2 Acquiring Property and Equipment $240,000 Cash

7. 14 - 6 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Cash $ 10,000 Property 240,000 Capital Stock $250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH

8. 14 - 7 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Cash $ 10,000 Property 240,000 Capital Stock $250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH TRANSACTION 3 Accepting Deposits $100,000 Cash

9. 14 - 8 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Cash $110,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH

10. 14 - 9 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Cash $110,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH NOTES: Bank deposits are subject to a reserve requirement. Reserve ratio Commercial bank’s required reserves Commercial bank’s checkable-deposit liabilities =

11. 14 - 10 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Cash $110,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH Three Important Issues... 1 - Excess Reserves = Actual Reserves - Required Reserves (assume 20% reserve requirement) $110,000 - 20,000 = $90,000 2 – Control of Lending Ability 3 - Asset or Liability to Which Bank?

12. 14 - 11 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Cash $110,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH TRANSACTION 4 Deposits at the FED $110,000 Cash

13. 14 - 12 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Cash $ 0 Reserves 110,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH

14. 14 - 13 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Cash $ 0 Reserves 110,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH TRANSACTION 5 A check is drawn against the bank $50,000

15. 14 - 14 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Cash $ 0 Reserves 60,000 Property 240,000 Checkable Deposits $ 50,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH

16. 14 - 15 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Cash $ 0 Reserves 60,000 Property 240,000 Checkable Deposits $ 50,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH NOTES: Banks create money by lending excess reserves and destroy it by loan repayment. Purchasing bonds from the public also creates money.

17. 14 - 16 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Reserves $ 60,000 Property 240,000 Checkable Deposits $ 50,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH TRANSACTION 6 Make a loan from excess reserves $50,000

18. 14 - 17 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Reserves $ 60,000 Loans 50,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH Making the loan created money!

19. 14 - 18 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Reserves $ 10,000 Loans 50,000 Property 240,000 Checkable Deposits $ 50,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH After a check for the $50,000 is drawn against the bank

20. 14 - 19 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Reserves $ 10,000 Loans 50,000 Property 240,000 Checkable Deposits $ 50,000 Capital Stock 250,000 ASSETS LIABILITIES AND NET WORTH TRANSACTION 7 Repaying a loan with cash $50,000 FORMATION OF A COMMERCIAL BANK

21. 14 - 20 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Reserves $ 10,000 Loans 0 Property 240,000 Checkable Deposits $ 0 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH $50,000 in money supply is destroyed!

22. 14 - 21 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Reserves $ 60,000 Securities 50,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH TRANSACTION 8 (Assume previous balance sheet) Buy Government Securities $50,000

23. 14 - 22 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Reserves $ 60,000 Securities 50,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 FORMATION OF A COMMERCIAL BANK ASSETS LIABILITIES AND NET WORTH Bankers pursue two conflicting goals: Profits and Liquidity Use of Federal Funds Market Federal Funds Rate

24. 14 - 23 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show MULTIPLE DEPOSIT EXPANSION PROCESS Bank Acquired reserves and deposits Required reserves Excess reserves 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 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 21.99 $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 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.59 $80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.59 $400.00 Total amount of money created by the banking system

25. 14 - 24 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show MULTIPLE DEPOSIT EXPANSION PROCESS Bank Acquired reserves and deposits Required reserves Excess reserves 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 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 21.99 $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 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.59 $80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.59 $400.00 Total amount of money created by the banking system Money destruction works in exactly the same multiple way!

26. 14 - 25 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Maximum checkable- deposit creation = Excess reserves x Monetary Multiplier Monetary Multiplier Required reserve ratio 1 = THE MONETARY MULTIPLIER

27. 14 - 26 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show $20 Required reserves $100 New reserves $100 Initial Deposit $400 Bank system lending Money Created $80 Excess reserves OUTCOME OF MONEY EXPANSION

28. 14 - 27 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show $20 Required reserves $100 New reserves $100 Initial Deposit $400 Bank system lending Money Created $80 Excess reserves OUTCOME OF MONEY EXPANSION Leakages exist... Currency Drains Excess Reserves

29. 14 - 28 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Need for Monetary Control

30. ENDBACK balance sheet fractional reserve system vault cash required reserves reserve ratio excess reserves actual reserves Federal Funds rate monetary multiplier Copyright McGraw-Hill/Irwin, Inc. 2005

31. 14 - 30 Copyright McGraw-Hill/Irwin, 2005 Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide Next Slide End Show Next... Monetary Policy Chapter 15