Give me a loan so there Give me a loan so there will be more DD in the will be more DD in the system. system. How Banks Create How Banks Create Money Money [ [ MS MS ] ] MS MS = Currency + DD of Public = Currency + DD of Public Banks Banks [thru loans] [thru loans] Create More Create More DD DD
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Give me a loan so there will be more DD in the system. How Banks Create Money [ MS ] MS = Currency + DD of Public Banks [thru loans] Create More DD.
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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.
How Banks Create How Banks Create MoneyMoney[[MSMS]]MSMS = Currency + DD of Public = Currency + DD of Public
Banks Banks [thru loans][thru loans] Create MoreCreate More DDDD
How Banks and Thrifts Create MoneyHow Banks and Thrifts Create Money
RRRR Excess ReservesExcess Reserves
Total(Actual) ReservesTotal(Actual) Reserves
PMC = M x ER, so 10 x .90 = $9PMC = M x ER, so 10 x .90 = $9TMS = PMC[$9] + DD[$1] = $10TMS = PMC[$9] + DD[$1] = $10[[MSMS = = currencycurrency + DD+ DD of of publicpublic]]
Dennis Rodman deposits $1 with A 10% RRDennis Rodman deposits $1 with A 10% RR
.1010 90 cents90 cents
One DollarOne Dollar
Excess ReservesExcess Reserves
Total(Actual) ReservesTotal(Actual) Reserves
PMC = M x ER, so 10 x $1 = $10PMC = M x ER, so 10 x $1 = $10TMS [$10] = PMC[$10] TMS [$10] = PMC[$10] [[MSMS = = currencycurrency + + DDDD of public of public]]
Rodman’s Bank Borrows $1 From The Fed [10% RR]Rodman’s Bank Borrows $1 From The Fed [10% RR]
RRRR
One DollarOne Dollar
One DollarOne Dollar00
Rodman’s BankRodman’s Bank
BALANCE SHEET OF A COMMERCIAL BANKBALANCE SHEET OF A COMMERCIAL BANK
ASSETS [cash]ASSETS [cash] = LIABILITIES[DD]LIABILITIES[DD][The cash is property of the bank] [“liable”, DDs are owed to depositors]
DD by L indsay PMC in bank sys. Total Money Supply
$1,000 + $9,000 = $10,000
36 in.
Now a “Dell Dude”
Digital camcorder
Canon
Sam’s
Best Buy
Dell
Pool Table
Target
19 inch LCD
Monitor
$1,000 DD by TammyTammy [MS=Currency + DD of Public]
MS growsby a factor
of “10”
729.00
656.10
900.00
810.00
729.00
656.10
590.49
Tammy
$9,000
$1,000.00
900.00
810.00
729.00
656.10
$10,000
1. Joe BikerJoe Biker deposits $10,000 in his bank.
2. Suzie Rah RahSuzie Rah Rah borrows $8,000
RR = 20%
3. SuzieSuzie pays $8,000 for a new car.GoNow Auto deposits the $ in 2nd Bank.
4. 2nd Bank lends Sports Shop $6,400.
5. Eventually the MS will be $$5050,,000000
Joe
$$1010,,000000+$+$4040,,000000=$=$5050,,000000
MSMS$10,000 $8,000$18,000
MSMS$10,000 $8,000 $6,400$24,400
MSMS = = DDDD + + CurrencyCurrency of the of the PublicPublic[A DD of $10,000 will incr MS by another $40,000($50,000 MS]
RR=20%
MSMS is$10,000
How Banks Create Money [Vocabulary]How Banks Create Money [Vocabulary] 1. Fractional Reserve Banking SystemFractional Reserve Banking System – a fraction of DD are kept in reserve(say, 10%) at either the banks vault or at the Fed.
2. Vault cashVault cash – cash held by a bank (banks rarely keep more than 2%2% of their in cash)
3. Required Reserve(RR)Required Reserve(RR) –specified percentage of DD that banks must keep as RR.
4. Excess reservesExcess reserves – total reserves(TR) – RR. ER is what can be loaned out. Also some ER is used to meet sudden withdrawal demands.
7. BalanceBalance SheetSheet–statement of assets & liabilities[assets=liabilitiesassets=liabilities].
8. Discount RateDiscount Rate – when banks borrow from the Fedbanks borrow from the Fed. [symbolic-emergencies] “wholesale price of money”
9. Federal Funds RateFederal Funds Rate – banks borrow from other banksbanks borrow from other banks for overnight loans.
10. Prime RatePrime Rate – when a bank’s prime customersprime customers [good credit] get loans. “retail price of money”
11. Buying BondsBuying Bonds – ““buying”buying” bonds means ““biggerbigger”” supply of money and “lower interest rates”. [So, more “C”, “Ig”, and “Xn” ]
12. Selling BondsSelling Bonds – ““selling”selling” bonds means ““smaller”smaller” supply of money and “higher interest rates”. [So, less “C”, “Ig”, and “Xn”]
Most Famous Most Famous “Panic Run”“Panic Run” in Movie in Movie History History
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.
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 community thru loans
The fractional banking system began when someone issuedclaims for gold that alreadybelonged to someone else.
The Very Early Days Of BankingThe Very Early Days Of Banking
There were more claims to gold thanthere wereounces ofgold.
“Wow, you mean we can create money out of thin air.?”
Birth of a COMMERCIAL BANKBirth of a COMMERCIAL BANKIn Lovelady, TexasIn Lovelady, Texas
ASSETS LIABILITIES AND NET WORTH
TRANSACTION 1
Creating a bank$250,000$250,000 Cash
forCapital Stock
Cash $250,000$250,000 Capital Stock $250,000$250,000
FORMATION OF A COMMERCIAL BANKFORMATION OF A COMMERCIAL BANKIn Lovelady, TexasIn Lovelady, Texas
ASSETS LIABILITIES AND NET WORTH
DepositDeposit Added to Vault Cash
Cash $250,000$250,000 Capital Stock $250,000$250,000
Birth OF A COMMERCIAL BANKBirth OF A COMMERCIAL BANKIn Lovelady, TexasIn Lovelady, Texas
31. The $40 billion deposit$40 billion deposit of Currency into DDDD will result in MSMS staying at ($8/$40/$160) billion. 32. The $40 billion deposit$40 billion deposit of currency into checking accounts will create ERER of ($20/$32/$40) billion.
33. The Potential Money CreationPotential Money Creation of the banking system through loans is ($40/$160/$$200) bil. The Potential TMSPotential TMS [all DDDD of the public] could be as much as ($40/$160/$200)34. The RR applies to checkable deposits at (banks/S&Ls/ credit unions/ all depository institutions). 35. If the Duck National Bank has ER of $6,000ER of $6,000 & DD of $100,000DD of $100,000 what is the size of the bank’s TRTR if the RR is 25%RR is 25%? ($25,000/$75,000/$31,000) [RR($____)+ER($___)+TR($____)
Excess ReservesExcess Reserves prior to new currency deposit ( prior to new currency deposit (DDDD) = ) = $0$0Britney Spears Britney Spears depositsdeposits in the banking system = in the banking system = $40$40 billionbillionLegal Reserve RequirementLegal Reserve Requirement [RR] = 20%[RR] = 20%
25,00025,000 6,0006,000 31,00031,000
NS 36-45 AP Econ NS 36-45 AP Econ [[MSMS = = CurrrencyCurrrency++DDDD of of PublicPublic]]
36. A stranger deposits $1,000deposits $1,000 in a bank that has a RR of 10%.RR of 10%. The maximum possible change in the dollar value of the local bank’s loans would be $______. PMCPMC[M M XX ER ER] in the banking system is $_____. Potential TMSPotential TMS could become as high as $_______.37. Suppose a commercial bank has DD of $100,000DD of $100,000 and the RR is 10%RR is 10%. If the bank’s RR & ER are equalRR & ER are equal, then its TRTR are ($10,000/$20,000/$30,000).38. Total Reserves (minus/plus) RR = ERER.39. Suppose the Thunderduck Bank has DD of $500,000DD of $500,000 & the RR is 10%RR is 10%. If the institution has ER of $4,000ER of $4,000 then its TRTR are ($46,000/$54,000/$4,000).40. If ERER in a bank are $4,000are $4,000, DD are $40,000DD are $40,000, & the RR is 10%RR is 10%, then TRTR are ($4,000/$8,000). 41. The main purpose of the RRmain purpose of the RR is to (have funds for emergency withdrawals/ influence the lending ability of commercial banks). 42. If I write you a check for $1check for $1 & we both have our checking accts at the Poorman Bank, the bank’s balance sheet will (increase/decrease/be unchanged).43. Banks (create/destroy) money when they make loansmake loans and repaying bankrepaying bank loansloans (create/destroy) money.44. When a bank loan is repaidbank loan is repaid the MSMS is (increased/decreased).45. The Fed Funds rateFed Funds rate is a loan by one bank (to another bank/from the Fed).
47. If borrowers take a portion of their loans as cashloans as cash, the maximum amount by which the banking system increases the MSMS by lending will (increase/decrease).
NS 46-47 AP Econ NS 46-47 AP Econ [[MSMS = = CurrrencyCurrrency++DDDD of of PublicPublic]]
LeakagesLeakages(limitations)(limitations) of the Money Creating Process of the Money Creating Process 1. Cash leakages [taking part of loan in cash] 1. Cash leakages [taking part of loan in cash] 2. ER (banks don’t loan it or we don’t borrow]2. ER (banks don’t loan it or we don’t borrow]
46. If the RR was loweredRR was lowered [say, from 50% to 10%], the size of the monetary multipliermonetary multiplier [MMMM] would (increase/decrease).