1. Bank’s Balance Sheet Typical items in US Bank’s balance sheet –Checking Deposits (D) $1000 million –Bonds (US gov’t securities) $190 million –Loans $700 million –Reserves (R) $110 million What are reserves? deposits that banks hold at the Fed plus cash in the bank’s vault

2. Bank’s Balance Sheet US Bank’s Balance sheet Assets Liabilities D $1000 millionBonds $190 million Loans $700 million R $110 million

3. Reserves and excess reserves Excess Reserves and Loans Loaned up = Total Reserves minus Required Reserves When excess reserves = 0, the bank is “loaned up” or “fully loaned” and can’t make any new loans. Banks loan out excess reserves because loans earn interest, but reserves don’t

4. Deposit expansion Suppose that r = 0.10 (bank must hold 10% of its deposits as reserves) In our example, does US Bank hold any excess reserves? Required reserves =.1 ($1000 mil) = $100 mil Excess reserves = $110 mil - $100 mil = $10 mil. YES, US Bank has excess reserves of $10 mil.

5. Deposit expansion What to do with excess reserves? US Bank loans P&G $10 mil. to buy computers - P&G gives loan check to Dell - Dell deposits check in Union Planters Bank

6. Deposit expansion Changes in balance sheets US Bank Assets Liabilities Union Planter’s Bank Assets Liabilities R - $10 mil L + $10 mil R + $10 milD + $ 10 mil

7. Deposit expansion Did deposits rise? Did deposits fall? Deposits rose by $10 mil. but did not fall in any other bank so M1 rose $10 mil.

8. Deposit expansion Not the end of the story........... Does Union Planter’s now have any excess reserves? Required reserves =.1 (+10 mil) = $1 mil Excess reserves = + 10 mil. – 1 mil. = + $9 mil. YES, Union Planter’s has excess reserves of $9 mil.

9. Deposit expansion What to do with excess reserves? Union Planters loans Southeast Hospital $9 mil. for an addition - Southeast Hospital gives loan check to contractor - Contractor deposits check in FirstBank

10. Deposit expansion Changes in balance sheets Union Planters Bank Assets Liabilities FirstBank Assets Liabilities D + $9 mil R + $9 mil R - $9 mil L + $9 mil

11. Deposit expansion Did deposits rise? Did deposits fall? Deposits rose by another $9 mil. but did not fall in any other bank M1 rose $9 mil. $10 mil + $9 mil = $19 mil. increase in M1 so far

12. Deposit expansion Not the end of the story........... Does FirstBank now have any excess reserves? Required reserves =.1 (+ 9 mil) = $.9 mil. Excess reserves = $9 mil. - $.9mil. = $8.1 mil. YES, FirstBank has excess reserves of $8.1 mil.

13. Deposit expansion Process continues --- and so on and so on and so on Deposit expansion multiplier is (1 / r) The maximum change in the money supply = Deposit Expansion Multiplier x initial excess reserves

14. Deposit expansion In our example, what is the maximum change in the money supply? Deposit expansion multiplier = 1/r = 1/.10 = 10 Initial excess reserves = + $10 mil Maximum change in money supply = 10 x (+ $10 mil.) = + $100 mil.