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

Bank’s Balance Sheet

US Bank’s Balance sheet Assets Liabilities

D $1000 millionBonds $190 million

Loans $700 million

R $110 million

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

Deposit expansionSuppose 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.

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

Deposit expansionChanges in balance sheets

US Bank

Assets Liabilities

Union Planter’s Bank

Assets Liabilities

R - $10 milL + $10 mil

R + $10 mil D + $ 10 mil

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.

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.

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

Deposit expansionChanges in balance sheets

Union Planters Bank

Assets Liabilities

FirstBank

Assets Liabilities

D + $9 milR + $9 mil

R - $9 milL + $9 mil

Deposit expansionDid 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

Deposit expansionNot 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.

Deposit expansionProcess 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

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.