ap chapter14 how banks create money
TRANSCRIPT
How Banks and Thrifts Create
Money
14C H A P T E R
How Banks CreateHow Banks Create MoneyMoney[[MSMS]]M1=Currency+DD of PublicM1=Currency+DD of Public
Banks Banks [thru loans][thru loans] C Create reate MMoreore DDDD
Give me a loan so Give me a loan so there will be more there will be more DD in the system.DD in the system.
“Wow, you mean we can create money out of thin air.?”
Once upon a time there was a gold-smithygold-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.”“good as gold.” Our Smithy was not stupidnot stupid. He said to himself. “I have 2000 ounces of gold“I have 2000 ounces of goldstored in my vault, but in the last year I was never called upon to pay outmore than 100 ounces100 ounces in a single day. What harm could it do if I lent out say,half the goldhalf 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. Icould earn 30 additional ounces ofearn 30 additional ounces of goldgold each week. I think I’ll do it.”““The smithy has invented the Fractional Reserve Banking System.”The smithy has invented the Fractional Reserve Banking System.”Advantages of LendingAdvantages 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 economy
The Very Early Days Of BankingThe Very Early Days Of Banking
The fractional banking system began when someone issuedclaims for gold that alreadybelonged to someone else.
GreatestGreatestinventioninventionsincesincesliced breadsliced bread
BALANCE SHEET OF ACOMMERCIAL BANK
ASSETS = LIABILITIES + NET WORTH
The Goldsmiths
Fractional Reserve Banking
System
FORMATION OF ACOMMERCIAL BANK
ASSETS LIABILITIES(OWN) (OWE)
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 1
Creating a bank$250,000 Cash
forCapital Stock
Cash $250,000 Capital Stock $250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Deposit Added to Vault Cash
Property 250,000 Capital Stock $250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
History of Deposit InsuranceHistory of Deposit Insurance
In 1934, federaldeposit insurance made its debut at$2,500$2,500 to protect the average family’s savings and end thebank runsbank runs that hadshut down businessesand contributed to the Great DepressionGreat Depression.Through the yearsthe coverage rosein $5,000 increments$5,000 incrementsuntil the 70suntil the 70s when itjumped to $40,000.In 19801980, it was raisedto $100,000$100,000.
Property 250,000 Capital Stock $250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 2
AcceptingDeposits
$100,000 Cash
Cash $100,000Property 250,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Cash $110,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTHNOTES:Bank deposits aresubject to a reserverequirement.
Reserveratio
Cash $100,000Property 250,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
• Actual Reserves $ 100,000• Required Reserves - $ 20,000• Excess Reserves $ 80,000
Cash $100,000Property 250,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Important Issue...
1 - Excess Reserves = Actual Reserves - Required Reserves
(assume 20% reserve requirement) $100,000 - 20,000 = $80,000
Cash $100,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 3
Depositsat the FED
$100,000 Cash
Cash $ 0Reserves 100,000Property 250,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Cash $ 0Reserves 110,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 4
A check is drawn against
the bank$50,000
Cash $ 0Reserves 50,000Property 250,000
Checkable Deposits $ 50,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
And What Happens If A Turtle Doesn’t And What Happens If A Turtle Doesn’t Keep Up with His Mortgage PaymentsKeep Up with His Mortgage Payments
Cash $ 0Reserves 50,000Property 240,000
Checkable Deposits $ 50,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
NOTES:Banks create moneyby lending excessreserves and destroyit by loan repayment.Purchasing bondsfrom the public alsocreates money.
Reserves $ 50,000Property 250,000
Checkable Deposits $ 50,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 5
Make a loan from excess
reserves$40,000
Reserves $ 50,000Loans 40,000Property 250,000
Checkable Deposits $90,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Making the loancreated money!
Reserves $ 10,000Loans 40,000Property 250,000
Checkable Deposits $ 50,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
After a check for the $40,000is drawn against the bank
Reserves $ 50,000Securities 50,000Property 250,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTHTRANSACTION 6
(Assume previous balance sheet)
Buy GovernmentSecurities$50,000
Reserves $ 50,000Securities 50,000Property 250,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
MULTIPLE DEPOSIT EXPANSION PROCESS
BankAcquired reserves
and depositsRequiredreserves
Excessreserves
Amount bankcan lend - Newmoney created
ABCDEFGHIJKLMNOther 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
$400.00Total amount of money created by the banking system
RRRR Excess ReservesExcess Reserves
Total(Actual) ReservesTotal(Actual) Reserves
Dennis Rodman deposits $1 with A 10% RRDennis Rodman deposits $1 with A 10% RR
.1010 cents cents 90 cents90 cents
One DollarOne Dollar
One bank’s loan becomesOne bank’s loan becomesanother bank’s DD.another bank’s DD.
Rodman’sRodman’s
MULTIPLE DEPOSIT EXPANSION PROCESS
BankAcquired reserves
and depositsRequiredreserves
Excessreserves
Amount bankcan lend - Newmoney created
ABCDEFGHIJKLMNOther 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
$400.00Total amount of money created by the banking system
Moneydestruction worksin exactly the same
multiple way!
Maximumcheckable-
depositcreation
= Excessreserves x Monetary
Multiplier
MonetaryMultiplier Required reserve ratio
1
=
THE MONETARY MULTIPLIER
$20Requiredreserves
$100New reserves
$100Initial
Deposit
$400Bank system lending
Money Created
$80Excess
reserves
OUTCOME OF MONEY EXPANSION
$20Requiredreserves
$100New reserves
$100Initial
Deposit
$400Bank system lending
Money Created
$80Excess
reserves
OUTCOME OF MONEY EXPANSION
Leakages exist...
Currency Drains Excess Reserves
Coming Soon...
Monetary Policy
Chapter 15
THE END