Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All...

24
Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

TAGS:

Transcript of Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All...

Page 1: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

MoneyCreation

Chapter 32

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Page 2: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives

• “Fractional Reserve” system• Actual reserves vs. required

reserves• How banks create money through

granting loans• Multiple expansion of loans and

money by the banking system• The monetary multiplier

32-2

Page 3: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Fractional Reserve Banking

• 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”

32-3

Page 4: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Fractional Reserve System

• Balance sheet–Assets = Liabilities + Net Worth–Both sides balance

• Necessary transactions–Create a bank–Accept deposits –Lend excess reserves

32-4

Page 5: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Assets Liabilities and Net Worth

Creating a Bank

• Transaction #1• Vault cash: cash held by the

bankCreating a Bank

Balance Sheet 1: Wahoo Bank

Cash $250,000 Stock Shares $250,000

32-5

Page 6: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Assets Liabilities and Net Worth

Creating a Bank

• Transaction #2• Acquiring property and equipment

Acquiring Property and EquipmentBalance Sheet 2: Wahoo Bank

Cash $10,000 Stock Shares $250,000Property 240,000

32-6

Page 7: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Assets Liabilities and Net Worth

Creating a Bank

• Transaction #3• Commercial bank functions

–Accepting deposits–Making loans

Accepting DepositsBalance Sheet 3: Wahoo Bank

Cash $110,000 Checkable Deposits $100,000Property 240,000Stock Shares 250,000

32-7

Page 8: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Creating a Bank

• Transaction #4• Depositing reserves in a Federal

Reserve bank–Required reserves–Reserve ratio

Reserveratio =

Commercial bank’sRequired reserves

Commercial bank’sCheckable-deposit liabilities

32-8

Page 9: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Reserve Requirements

Type of DepositCurrent

RequirementStatutory

Limits

Checkable deposits:

$0-$9.8 Million$9.3-$43.9 MillionOver $43.9 Million

Noncheckable nonpersonalsavings and time deposits

0% 310

3% 38-14

0 0-9

• Fed can establish and vary reserve ratio within limits set by Congress

• Required reserves help Fed control lending abilities of commercial banks

32-9

Page 10: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Assets Liabilities and Net Worth

Creating a Bank

Depositing Reserves at the FedBalance Sheet 4: Wahoo Bank

Cash $0 Checkable Deposits $100,000

Property 240,000 Stock Shares 250,000

Reserves 110,000

• Transaction #4• Assume the bank deposits all

cash on reserve at the Fed

32-10

Page 11: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Reserve Requirements

• Excess reserves–Actual reserves - required reserves

• Required reserves–Checkable deposits x reserve ratio

• Example:–Checkable deposits $100,000–Reserve ratio 20%

32-11

Page 12: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Assets Liabilities and Net Worth

Creating a Bank

• Transaction #5• Clearing a check

–$50,000 check reduces reserves and checkable deposits

Clearing a CheckBalance Sheet 5: Wahoo Bank

Checkable Deposits $50,000

Property 240,000 Stock Shares 250,000

Reserves $60,000

32-12

Page 13: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Assets Liabilities and Net Worth

Money Creating Transactions

• Transaction #6a

• Granting a loan–$50,000 loan deposited to checking

When a Loan is NegotiatedBalance Sheet 6a: Wahoo Bank

Checkable Deposits $100,000

Property 240,000 Stock Shares 250,000

Reserves $60,000

Loans 50,000

32-13

Page 14: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Assets Liabilities and Net Worth

Money Creating Transactions

• Transaction #6b• Using the loan

–$50,000 loan cashed

After a Check is Drawn on the Loan Balance Sheet 6b: Wahoo Bank

Checkable Deposits $50,000

Property 240,000 Stock Shares 250,000

Reserves $10,000

Loans 50,000

A single bank can only lend an amountequal to their preloan excess reserves

32-14

Page 15: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Assets Liabilities and Net Worth

Money Creating Transactions

• Transaction #7• Bank buys government securities

from dealer–Deposits payment into checking

Buying Government SecuritiesBalance Sheet 7: Wahoo Bank

Checkable Deposits $100,000

Property 240,000 Stock Shares 250,000

Reserves $60,000

Securities 50,000

New money is created 32-15

Page 16: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Commercial Banks

• Conflicting goals• Earn profit

–Make loans to earn interest–Buy securities to earn interest

• Maintain liquidity• Alternative?

–Overnight bank loans–Federal funds rate

32-16

Page 17: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

The Banking System

• Multiple-deposit expansion• Assumptions:

–20% required reserves–All banks “loaned up”–Banks lend all of excess reserves

• A $100 bill is found and deposited• Multiple deposits can be created

32-17

Page 18: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Bank

(1)AcquiredReserves

and Deposits

(2)RequiredReserves

(3)Excess

Reserves(1)-(2)

(4)Amount Bank CanLend; New Money

Created = (3)

Bank A $100 $20 $80 $80

Bank B $80 $16 $64 $64

Bank C $64 $12.80 $51.20 $51.20

Bank D $51.20 $10.24 $40.96 $40.96

The process will continue…

The Banking System

32-18

Page 19: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Bank ABank BBank CBank DBank EBank FBank GBank HBank IBank JBank KBank LBank MBank NOther Banks

Bank

(1)AcquiredReserves

and Deposits

(2)RequiredReserves(Reserve

Ratio = .2)

(3)Excess

Reserves(1)-(2)

(4)Amount Bank CanLend; New Money

Created = (3)

$100.0080.0064.0051.2040.9632.7726.2120.9716.7813.4210.748.596.875.50

21.99

$20.0016.0012.8010.248.196.555.244.203.362.682.151.721.371.104.40

$80.0064.0051.2040.9632.7726.2120.9716.7813.4210.748.596.875.504.40

17.59

$80.0064.0051.2040.9632.7726.2120.9716.7813.4210.748.596.875.504.40

17.59$400.00

The Banking System

32-19

Page 20: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

The Monetary Multiplier

Monetarymultiplier =

1

required reserve ratio

New Reserves$100

$20RequiredReserves

$80Excess

Reserves

$100Initial

Deposit

$400Bank System Lending

Money Created

GraphicExample

=1

R

32-20

Page 21: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

The Monetary Multiplier

• Maximum amount of new money created by single dollar of excess reserves

• Higher R, lower m

• Reversibility–Making loans creates money

–Loan repayment destroys money

32-21

Page 22: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Bank Panics of 1930-1933

• Before deposit insurance• Bank failure led to mass withdrawals • Forced loan reduction• 25-33% decline in money supply• 1933 national bank holiday to

evaluate all banks• Contributed to the Great Depression• Regulation protects the system today

32-22

Page 23: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Key Terms

• fractional reserve banking system• balance sheet• vault cash• required reserves• reserve ratio• excess reserves• actual reserves• Federal funds rate• monetary multiplier

32-23

Page 24: Money Creation Chapter 32 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Next Chapter Preview…

Interest Ratesand MonetaryPolicy

32-24


McGraw-Hill/Irwin ©2005 The McGraw-Hill Companies, All rights reserved ©2005 The McGraw-Hill Companies, All rights reserved McGraw-Hill/Irwin.

McGraw-Hill/Irwin ©2005 The McGraw-Hill Companies, All rights reserved ©2005 The McGraw-Hill Companies, All rights reserved McGraw-Hill/Irwin.

© McGraw-Hill Companies, Inc., McGraw-Hill/Irwin.

© McGraw-Hill Companies, Inc., McGraw-Hill/Irwin.

Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., ...

Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., ...

McGraw-Hill/Irwin ©2005 The McGraw-Hill Companies, All rights reserved McGraw-Hill/Irwin.

McGraw-Hill/Irwin ©2005 The McGraw-Hill Companies, All rights reserved McGraw-Hill/Irwin.

1 2-1 McGraw-Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc.,

1 2-1 McGraw-Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin.

McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill ...

McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill ...

McGraw-Hill/Irwin McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

12-1 McGraw-Hill/Irwin

12-1 McGraw-Hill/Irwin

10-1 McGraw-Hill/Irwin

10-1 McGraw-Hill/Irwin

McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill ...

McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill ...

#14-1 McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights.

#14-1 McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights.

McGraw-Hill/Irwin Copyright © 2004, The McGraw-Hill Companies ...

McGraw-Hill/Irwin Copyright © 2004, The McGraw-Hill Companies ...

© 2002 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin.

© 2002 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin.

Irwin/McGraw Hill The McGraw-Hill Companies, Inc., 2000 · Slides by Matthew Will Chapter 2 Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 2000. Irwin/McGraw Hill ... " Tools

Irwin/McGraw Hill The McGraw-Hill Companies, Inc., 2000 · Slides by Matthew Will Chapter 2 Irwin/McGraw Hill ©The McGraw-Hill Companies, Inc., 2000. Irwin/McGraw Hill ... " Tools

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies,

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies,

© McGraw-Hill Companies, Inc., McGraw-Hill/Irwin McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

© McGraw-Hill Companies, Inc., McGraw-Hill/Irwin McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

4 1 Irwin/McGraw Hill

4 1 Irwin/McGraw Hill

McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, All Rights Reserved Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, All Rights Reserved Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, All Rights Reserved McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, All Rights Reserved.

McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, All Rights Reserved McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, All Rights Reserved.