Chapter 32: Money Creation

Money Creation32McGraw-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” LO132-*Fractional Reserve SystemBalance sheetAssets = Liabilities + Net WorthBoth sides balanceNecessary transactionsCreate a bankAccept deposits Lend excess reserves LO132-*A Single Commercial BankTransaction #1Vault cash: cash held by the bankAssetsLiabilities and Net WorthCreating a BankBalance Sheet 1: Wahoo BankCash$250,000Stock Shares$250,000LO132-*A Single Commercial BankTransaction #2Acquiring property and equipmentAssetsLiabilities and Net WorthAcquiring Property and EquipmentBalance Sheet 2: Wahoo BankCash$10,000Stock Shares$250,000Property240,000LO132-*A Single Commercial BankTransaction #3Commercial bank functionsAccepting depositsMaking loans AssetsLiabilities and Net WorthAccepting DepositsBalance Sheet 3: Wahoo BankCash$110,000Checkable Deposits$100,000Property240,000Stock Shares250,000LO132-*A Single Commercial BankTransaction #4Depositing reserves in a Federal Reserve bankRequired reservesReserve ratioReserveratio=Commercial bank’sRequired reservesCommercial bank’sCheckable-deposit liabilitiesLO232-*A 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% 38-1400-932-*A 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 FedLO232-*A Single Commercial BankExcess reservesActual reserves - required reservesRequired reservesCheckable deposits x reserve ratioExample:Checkable deposits $100,000Reserve ratio 20%LO232-*A 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$60,000LO232-*Money 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$60,000Loans50,000LO332-*Money 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 LO332-*Money 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 createdLO332-*Profits, Liquidity, and the Fed Funds MarketConflicting goalsEarn profitMake loans to earn interestBuy securities to earn interestMaintain liquidityAlternative?Overnight bank loansFederal funds rateLO332-*The Monetary MultiplierMonetarymultiplier=1required reserve ratio=1RLO532-*