Balance Sheet of a Commercial Bank Formation of

Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control 14 CHAPTER How Banks and Thrifts Create Money Key Terms Previous Slide End Show 14 - 1 Next Slide Copyright Mc. Graw-Hill/Irwin, 2005

Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 2 Next Slide BALANCE SHEET OF A COMMERCIAL BANK ASSETS = LIABILITIES + NET WORTH The Goldsmiths Fractional Reserve Banking System Money Creation & Reserves Bank Panics & Regulation Copyright Mc. Graw-Hill/Irwin, 2005

FORMATION OF A COMMERCIAL BANK Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 3 TRANSACTION 1 Creating a bank $250, 000 Cash for Capital Stock Next Slide Copyright Mc. Graw-Hill/Irwin, 2005 LIABILITIES AND NET WORTH

FORMATION OF A COMMERCIAL BANK Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Cash LIABILITIES AND NET WORTH $250, 000 Capital Stock $250, 000 Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 4 Next Slide Deposit Added to Vault Cash Copyright Mc. Graw-Hill/Irwin, 2005

FORMATION OF A COMMERCIAL BANK Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Cash Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 5 LIABILITIES AND NET WORTH $250, 000 TRANSACTION 2 Acquiring Property and Equipment $240, 000 Cash Next Slide Copyright Mc. Graw-Hill/Irwin, 2005 Capital Stock $250, 000

FORMATION OF A COMMERCIAL BANK Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Cash Property Multiple Deposit Expansion Process LIABILITIES AND NET WORTH $ 10, 000 240, 000 The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 6 Next Slide Copyright Mc. Graw-Hill/Irwin, 2005 Capital Stock $250, 000

FORMATION OF A COMMERCIAL BANK Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Cash Property Multiple Deposit Expansion Process LIABILITIES AND NET WORTH $ 10, 000 240, 000 TRANSACTION 3 The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 7 Accepting Deposits $100, 000 Cash Next Slide Copyright Mc. Graw-Hill/Irwin, 2005 Capital Stock $250, 000

FORMATION OF A COMMERCIAL BANK Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Cash Property Multiple Deposit Expansion Process LIABILITIES AND NET WORTH $110, 000 240, 000 The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 8 Next Slide Copyright Mc. Graw-Hill/Irwin, 2005 Checkable Deposits Capital Stock $100, 000 250, 000

FORMATION OF A COMMERCIAL BANK Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Cash Property Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 9 LIABILITIES AND NET WORTH $110, 000 Checkable NOTES: 240, 000 Deposits deposits are Capital Stock Bank subject to a reserve requirement. Reserve ratio Next Slide Copyright Mc. Graw-Hill/Irwin, 2005 = Commercial bank’s required reserves Commercial bank’s checkable-deposit liabilities $100, 000 250, 000

FORMATION OF A COMMERCIAL BANK Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Cash Property Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 10 Next Slide LIABILITIES AND NET WORTH $110, 000 240, 000 Checkable Deposits Capital Stock $100, 000 250, 000 Three Important Issues. . . 1 - Excess Reserves = Actual Reserves - Required Reserves (assume 20% reserve requirement) $110, 000 - 20, 000 = $90, 000 2 – Control of Lending Ability 3 - Asset or Liability to Which Bank? Copyright Mc. Graw-Hill/Irwin, 2005

FORMATION OF A COMMERCIAL BANK Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Cash Property Multiple Deposit Expansion Process LIABILITIES AND NET WORTH $110, 000 240, 000 TRANSACTION 4 The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 11 Deposits at the FED $110, 000 Cash Next Slide Copyright Mc. Graw-Hill/Irwin, 2005 Checkable Deposits Capital Stock $100, 000 250, 000

FORMATION OF A COMMERCIAL BANK Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Cash Reserves Property Multiple Deposit Expansion Process LIABILITIES AND NET WORTH $ 0 110, 000 240, 000 The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 12 Next Slide Copyright Mc. Graw-Hill/Irwin, 2005 Checkable Deposits Capital Stock $100, 000 250, 000

FORMATION OF A COMMERCIAL BANK LIABILITIES AND NET WORTH Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Cash $ 0 Checkable Reserves 110, 000 Deposits TRANSACTION Property 240, 0005 Capital Stock Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 13 A check is drawn against the bank $50, 000 Next Slide Copyright Mc. Graw-Hill/Irwin, 2005 $100, 000 250, 000

FORMATION OF A COMMERCIAL BANK Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Cash Reserves Property Multiple Deposit Expansion Process LIABILITIES AND NET WORTH $ 0 60, 000 240, 000 The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 14 Next Slide Copyright Mc. Graw-Hill/Irwin, 2005 Checkable Deposits Capital Stock $ 50, 000 250, 000

FORMATION OF A COMMERCIAL BANK LIABILITIES AND NET WORTH Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Cash $ 0 Checkable Reserves 60, 000 Deposits create money Property Banks 240, 000 Capital Stock Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 15 NOTES: by lending excess reserves and destroy it by loan repayment. Purchasing bonds from the public also creates money. Next Slide Copyright Mc. Graw-Hill/Irwin, 2005 $ 50, 000 250, 000

FORMATION OF A COMMERCIAL BANK LIABILITIES AND NET WORTH Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Reserves Property Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 16 $ 60, 000 240, 000 TRANSACTION 6 Make a loan from excess reserves $50, 000 Next Slide Copyright Mc. Graw-Hill/Irwin, 2005 Checkable Deposits Capital Stock $ 50, 000 250, 000

FORMATION OF A COMMERCIAL BANK Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Reserves Loans Property Multiple Deposit Expansion Process LIABILITIES AND NET WORTH $ 60, 000 50, 000 240, 000 Checkable Deposits Capital Stock The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 17 Next Slide Making the loan created money! Copyright Mc. Graw-Hill/Irwin, 2005 $100, 000 250, 000

FORMATION OF A COMMERCIAL BANK Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Reserves Loans Property Multiple Deposit Expansion Process LIABILITIES AND NET WORTH $ 10, 000 50, 000 240, 000 Checkable Deposits Capital Stock $ 50, 000 250, 000 The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 18 Next Slide After a check for the $50, 000 is drawn against the bank Copyright Mc. Graw-Hill/Irwin, 2005

FORMATION OF A COMMERCIAL BANK LIABILITIES AND NET WORTH Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Reserves $ 10, 000 Checkable Loans 50, 000 Deposits TRANSACTION Property 240, 0007 Capital Stock Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 19 Repaying a loan with cash $50, 000 Next Slide Copyright Mc. Graw-Hill/Irwin, 2005 $ 50, 000 250, 000

FORMATION OF A COMMERCIAL BANK Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Reserves Loans Property Multiple Deposit Expansion Process LIABILITIES AND NET WORTH $ 10, 000 0 240, 000 Checkable Deposits Capital Stock $ 0 250, 000 The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 20 Next Slide $50, 000 in money supply is destroyed! Copyright Mc. Graw-Hill/Irwin, 2005

FORMATION OF A COMMERCIAL BANK LIABILITIES AND NET WORTH Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Reserves $ 60, 000 Checkable Securities 50, 000 Deposits TRANSACTION Property 240, 0008 Capital Stock Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms (Assume previous balance sheet) Buy Government Securities $50, 000 Previous Slide End Show 14 - 21 Next Slide Copyright Mc. Graw-Hill/Irwin, 2005 $100, 000 250, 000

FORMATION OF A COMMERCIAL BANK Balance Sheet of a Commercial Bank ASSETS Formation of a Commercial Bank Reserves Securities Property Multiple Deposit Expansion Process LIABILITIES AND NET WORTH $ 60, 000 50, 000 240, 000 Checkable Deposits Capital Stock $100, 000 250, 000 The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Bankers pursue two conflicting goals: Profits and Liquidity Key Terms Previous Slide End Show 14 - 22 Next Slide Use of Federal Funds Federal Market Funds Rate Copyright Mc. Graw-Hill/Irwin, 2005

MULTIPLE DEPOSIT EXPANSION PROCESS Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 23 Next Slide Bank Acquired reserves Required and deposits reserves Excess reserves Amount bank can lend - New money created $80. 00 64. 00 51. 20 40. 96 32. 77 26. 21 20. 97 16. 78 13. 42 10. 74 8. 59 6. 87 5. 50 4. 40 17. 59 Total amount of money created by the banking system $400. 00 A $100. 00 B 80. 00 C 64. 00 D 51. 20 E 40. 96 F 32. 77 G 26. 21 H 20. 97 I 16. 78 J 13. 42 K 10. 74 L 8. 59 M 6. 87 N 5. 50 Other banks 21. 99 Copyright Mc. Graw-Hill/Irwin, 2005 $20. 00 16. 00 12. 80 10. 24 8. 19 6. 55 5. 24 4. 20 3. 36 2. 68 2. 15 1. 72 1. 37 1. 10 4. 40 $80. 00 64. 00 51. 20 40. 96 32. 77 26. 21 20. 97 16. 78 13. 42 10. 74 8. 59 6. 87 5. 50 4. 40 17. 59

MULTIPLE DEPOSIT EXPANSION PROCESS Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 24 Next Slide Bank Acquired reserves Required and deposits reserves Excess reserves Amount bank can lend - New money created $80. 00 64. 00 51. 20 40. 96 32. 77 26. 21 20. 97 16. 78 13. 42 10. 74 8. 59 6. 87 5. 50 4. 40 17. 59 Total amount of money created by the banking system $400. 00 A $100. 00 B 80. 00 C 64. 00 D 51. 20 E 40. 96 F 32. 77 G 26. 21 H 20. 97 I 16. 78 J 13. 42 K 10. 74 L 8. 59 M 6. 87 N 5. 50 Other banks 21. 99 $20. 00 16. 00 12. 80 10. 24 8. 19 6. 55 5. 24 4. 20 3. 36 2. 68 2. 15 1. 72 1. 37 1. 10 4. 40 $80. 00 64. 00 51. 20 40. 96 32. 77 26. 21 20. 97 16. 78 13. 42 10. 74 8. 59 6. 87 5. 50 4. 40 17. 59 Money destruction works in exactly the same multiple way! Copyright Mc. Graw-Hill/Irwin, 2005

THE MONETARY MULTIPLIER Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process Monetary Multiplier 1 = Required reserve ratio The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 25 Next Slide Maximum checkabledeposit creation = Copyright Mc. Graw-Hill/Irwin, 2005 Excess reserves x Monetary Multiplier

OUTCOME OF MONEY EXPANSION $100 New reserves Balance Sheet of a Commercial Bank $80 Excess reserves Formation of a Commercial Bank Multiple Deposit Expansion Process $20 Required reserves The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 26 $400 Bank system lending Next Slide Money Created Copyright Mc. Graw-Hill/Irwin, 2005 $100 Initial Deposit

OUTCOME OF MONEY EXPANSION $100 New reserves Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 27 $80 Excess reserves Leakages exist. . . $20 Required reserves Currency Drains Excess Reserves $100 $400 Bank system lending Next Slide Money Created Copyright Mc. Graw-Hill/Irwin, 2005 Initial Deposit

Balance Sheet of a Commercial Bank Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Need for Monetary Control Outcome of Money Expansion Need for Monetary Control Key Terms Previous Slide End Show 14 - 28 Next Slide Copyright Mc. Graw-Hill/Irwin, 2005

balance sheet fractional reserve system vault cash required reserves reserve ratio excess reserves actual reserves Federal Funds rate monetary multiplier Copyright Mc. Graw-Hill/Irwin, Inc. 2005 BACK END

Balance Sheet of a Commercial Bank Next. . . Formation of a Commercial Bank Multiple Deposit Expansion Process The Monetary Multiplier Outcome of Money Expansion Monetary Policy Need for Monetary Control Key Terms Previous Slide End Show 14 - 30 Chapter 15 Next Slide Copyright Mc. Graw-Hill/Irwin, 2005