Chapter 15: Money Creation

Fractional Reserve System The Goldsmiths Stored gold and gave a receipt Receipts used as money by public Made loans by issuing receipts Characteristics: Banks create money through lending Banks are subject to “panics”

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Money Creation15McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.Fractional Reserve SystemThe GoldsmithsStored gold and gave a receiptReceipts used as money by publicMade loans by issuing receiptsCharacteristics:Banks create money through lendingBanks are subject to “panics” LO1Fractional Reserve SystemBalance sheetAssets = Liabilities + Net WorthBoth sides balanceNecessary transactionsCreate a bankAccept deposits Lend excess reserves LO1A Single Commercial BankTransaction #1Vault cash: cash held by the bankAssetsLiabilities and Net WorthCreating a BankBalance Sheet 1: Wahoo BankCash$250,000Stock Shares$250,000LO1A Single Commercial BankTransaction #2Acquiring property and equipmentAssetsLiabilities and Net WorthAcquiring Property and EquipmentBalance Sheet 2: Wahoo BankCash$10,000Stock Shares$250,000Property240,000LO1A Single Commercial BankTransaction #3Commercial bank functionsAccepting depositsMaking loans AssetsLiabilities and Net WorthAccepting DepositsBalance Sheet 3: Wahoo BankCash$110,000Checkable Deposits$100,000Property240,000Stock Shares250,000LO1A Single Commercial BankTransaction #4Depositing reserves in a Federal Reserve bankRequired reservesReserve ratioReserveratio=Commercial bank’sRequired reservesCommercial bank’sCheckable-deposit liabilitiesLO2A Single Commercial BankThe Fed can establish and vary the reserve ratio within limits set by CongressRequired reserves help the Fed control lending abilities of commercial banksLO2Type of DepositCurrentRequirementStatutoryLimitsCheckable deposits:$0-$10.7 Million$10.7-$55.2 MillionOver $55.2 MillionNoncheckable nonpersonalsavings and time deposits 0% 310 3% 38-1400-9A Single Commercial BankAssetsLiabilities and Net WorthDepositing Reserves at the FedBalance Sheet 4: Wahoo BankCash$0Checkable Deposits$100,000Property240,000Stock Shares250,000Reserves110,000Transaction #4Assume the bank deposits all cash on reserve at the FedLO2A Single Commercial BankExcess reservesActual reserves - required reservesRequired reservesCheckable deposits x reserve ratioExample:Checkable deposits $100,000Reserve ratio 20%LO2A Single Commercial BankTransaction #5Clearing a check$50,000 check reduces reserves and checkable deposits AssetsLiabilities and Net WorthClearing a CheckBalance Sheet 5: Wahoo BankCheckable Deposits$50,000Property240,000Stock Shares250,000Reserves$60,000LO2Money Creating TransactionsTransaction #6aGranting a loan$50,000 loan deposited to checkingAssetsLiabilities and Net WorthWhen a Loan is NegotiatedBalance Sheet 6a: Wahoo BankCheckable Deposits$100,000Property240,000Stock Shares250,000Reserves$60,000Loans50,000LO3Money Creating TransactionsTransaction #6bUsing the loan$50,000 loan cashed AssetsLiabilities and Net WorthAfter a Check is Drawn on the Loan Balance Sheet 6b: Wahoo BankCheckable Deposits$50,000Property240,000Stock Shares250,000Reserves$10,000Loans50,000A single bank can only lend an amountequal to its preloan excess reserves LO3Money Creating TransactionsTransaction #7Bank buys government securities from a dealerDeposits payment into checking AssetsLiabilities and Net WorthBuying Government SecuritiesBalance Sheet 7: Wahoo BankCheckable Deposits$100,000Property240,000Stock Shares250,000Reserves$60,000Securities50,000 New money is createdLO3Profits, Liquidity, and the Fed Funds MarketConflicting goalsEarn profitMake loans to earn interestBuy securities to earn interestMaintain liquidityAlternative?Overnight bank loansFederal funds rateLO3The Monetary MultiplierMonetarymultiplier=1required reserve ratio=1RLO5