View
237
Download
0
Category
Tags:
Preview:
Citation preview
Banks create money!!
Remember that bank deposits are money. Banks create bank
deposits when they make loans.
Creating a BankTo create a bank, you will need to go through
the following 8 steps:
1. Obtain a charter to operate a commercial bank.
2. Raise some financial capital.
3. Buy some equipment and computer programs.
4. Accept deposits
5. Establish a reserve account at a Federal Reserve Bank
6. Clear checks
7. But government securities
8. Make loans
Assets Liabilities
Cash $200,000 Owners' Equity $200,000
Virtual College Bank’s Balance Sheet #1
A bank charter has been obtained, and Virtual College Bank has been able to raise $200,000 from private individuals.
Assets Liabilities
Cash $0
Equipment $200,000 Owners' Equity $200,000
Virtual College Bank’s Balance Sheet #2
Virtual College Bank uses its financial resources to purchase servers, database, software, etc.
Assets Liabilities
Cash $120,000 Checkable deposits $120,000
Equipment $200,000 Owners' Equity $200,000
Virtual College Bank’s Balance Sheet #3
Virtual College Bank accepts $120,000 in new deposits.
Assets Liabilities
Cash $0
Reserves at the Dallas FED $120,000 Checkable deposits $120,000
Equipment $200,000 Owners' Equity $200,000
We assume the required reserve ratio is 25 percent. Thus, Virtual College Bank initially has required reserves of $30,000 ($120,000 × .25) excess reserves of $90,000
Virtual College Bank’s Balance Sheet #4
•Virtual College depositor Jay writes a check for $20,000 to buy some computers from Hal’s PCs.
•Hal’s PCs has a checking account with first American Bank.
•Virtual College and First American Banks are both located in the Dallas Federal Reserve district.
•The Dallas FED facilitates the check clearing process.
Assets Liabilities
Reserves at the Dallas FED +$20,000 Checkable deposits +$20,000
Assets Liabilities
First American Reserves +$20,000
Virtual College Reserves -$20,000
Assets Liabilities
Reserves at the Dallas FED -$20,000 Checkable deposits -$20,000
(C) Change in Virtual College Bank’s balance sheet
Virtual College Bank
First American Bank
(b) Change in First American Bank’s balance sheet
(a) Change in Dallas Fed’s balance sheet
Federal Reserve Bank of Dallas
•Virtual college Banks wishes to purchase $60,000 in government securities.
•First American Bank wishes to sell $60,000 in government securities.
•Virtual College pays for the securities with a check.
Assets Liabilities
First American Reserves +$60,000
Virtual College Reserves -$60,000
(C) Change in Virtual College Bank’s balance sheet
Virtual College Bank
First American Bank
(b) Change in First American Bank’s balance sheet
(a) Change in Dallas Fed’s balance sheet
Federal Reserve Bank of Dallas
Assets Liabilities
Reserves at the Dallas FED +$60,000
Government securities -$60,000
Assets Liabilities
Reserves at the Dallas FED -$60,000
Government securities +$60,000
Assets Liabilities
Reserves at the Dallas FED $40,000 Checkable deposits $100,000
Gov. securities $60,000 Owners' Equity $200,000
Equipment $200,000
Total assets $300,000 Total liabilities $300,000
Virtual College Bank’s Balance Sheet #5
With a .25 required reserve ratio and $100,000 in checkable deposits, this bank has required reserves of $25,000.
Excess Reserves = Total Reserves – Required Reserves.
Thus for this bank:
Excess Reserves = $40,000 - $25,000 = $15,000
Now Virtual College Bank makes $15,000
in loans. The bank credits the accounts of
loan recipients by $15,000. Keep in the mind that the loans are an asset for the
bank.
Assets Liabilities
Reserves at the Dallas FED $40,000 Checkable deposits $115,000
Gov. securities $60,000 Owners' Equity $200,000
Loans $15,000
Equipment $200,000
Total assets $315,000 Total liabilities $315,000
Virtual College Bank’s Balance Sheet #6
After the loans are made and the new deposits (money) are created, required reserves are $28,750 ($115,000 × .25).
The bank now has excess reserves = $11, 250. Why not make more loans?
Virtual College Bank can anticipate that borrowers will quickly spend their
loans by drawing checks on accounts at the bank.
The bank must be prepared for these
withdrawals.
Assets Liabilities
Reserves at the Dallas FED $25,000 Checkable deposits $100,000
Gov. securities $60,000 Owners' Equity $200,000
Loans $15,000
Equipment $200,000
Total assets $300,000 Total liabilities $300,000
Virtual College Bank’s Balance Sheet #7
Once borrowers have spent their loans, and checks have cleared, checkable deposits have decreased by $15,000 to $100,000.
Virtual College Bank “made good” on the checks by drawing on its reserve account at the FED.
Excess reserves are now equal to zero.
Virtual College Bank still has loans outstanding of $15,000
Multiple Creation of Bank Deposits
The following illustration of the mechanics of multiple deposit creation is based on the following assumptions:
•Initially, all banks are “loaned up”—that is, have zero excess reserves.
•The required reserve ratio is 25 percent (or .25).
•Proceeds of all checks written are re-deposited in the banking system
Steps in the process1. Tony Soprano deposits $100,000 in cash
into a checking account at Virtual College Bank. The transaction creates a $75,000 excess reserve for Virtual College Bank.
2. Virtual College Bank makes a $75,000 loan to Amy.
3. Amy writes a check for $75,000 to purchase a copy-shop franchise from Barb.
4. Barb deposits a $75,000 check into her account at First American Bank. This transaction creates a $56,250 excess reserve for First American.
5. First American makes a $56,250 loan to Bob.
6. Bob writes a check for $56,250 to Carl to pay off a business loan.
7. Carl deposits the check for $56,250 into his account at Fleet PC. This transaction creates a $42,187 excess reserve for Fleet PC.
8. Fleet PC makes a loan for $42,187 to Emelda.
9. Emelda writes a check for $42,187 to Acme Inc. for restaurant equipment.
10.Acme Inc. deposits the check for $42, 187 into its account at First e-bank. This transaction creates a $31,640 excess reserve for First e-bank.
11.And so on and so on . . .
Round The sequenceThe running tally
Deposit$100,000
Loan$75,000
Reserve$25,000
Deposit$75,000
Loan$56,250
Reserve$18,750
Deposit$56,250
Loan$42,187
Reserve$14,063
1. Virtual College
2. First American
3. Fleet PC
Reserves Loans Deposits
$25,000
$43,750
$57,813
$75,000
$131,250
$173,437
$100,000
$175,000
$231,250
Round The sequenceThe running tally
Reserve$10,547
Deposit$42,187
Loan$31,640
4. First e-bank
Reserves Loans Deposits
$68,360 $273,437
$400,000
$205,077
andso on . . .
$100,000
$300,000
The process summarized
...1 432 LLL
Notice that at each stage of the process the loan is 75 percent (0.75) of the previous loan and the deposit is 75 percent (0.75) of the previous deposit. Let L denote this proportion. Thus the sequence is described by:
The total change in deposits when the process is complete is given by:
L1
1Initial change in reserves
Do the math
000,400$4000,100$25.0
1000,100$
)75.01(
1000,100$
...)75.075.075.01(000,100$
...)42187.05625.075.01(000,100$
...187,42250,56000,75000,100$
32
The Deposit Multiplier The deposit multiplier is the number by which an increase in bank reserves is multiplied to find the resulting increase in bank deposits. That is:
Change in deposits = Deposit multiplier × Change in reserves
The deposit multiplier is linked to the required reserve ratio by the following equation
Deposit Multiplier =1
Required reserve ratio
Open Market Operations
Now we will illustrate how FED open
market operations impact the reserve
positions of commercial banks—
and hence their ability to make loans and
create money.
When the FED buys securities on the open
market, it pays for them with newly created bank
reserves. We will illustrate how it works.
FED Buys Securities
Suppose the FED buys $100 million is securities from Manhattan Commercial Bank. What happens then?
1. The Manhattan commercial bank has $100 million less in securities, and the FED has $100 million more in securities.
2. To pay for the securities, the FED increases Manhattan Commercial Bank’s reserve account at the New York FED by $100 million.
Assets Liabilities
Securities +$100 million Reserves of Manhattan
Commercial Bank +$100 million
Manhattan Commercial Bank
Federal Reserve Bank of New York
Assets Liabilities
Securities -$100 million
Reserves +$100 million
The FED buys securitiesfrom a commercial bank . . .
. . .and pays for the securities by increasing the reserves of the commercial bank .
The FED Buys Securities From a Commercial Bank
The Multiplier Effect of an Open
Market Operation •An open market purchase creates excess reserves.
•Banks lend excess reserves.
•Bank deposits increase.
•The quantity of money increases.
•New money is used to make payments.
•Some of the new money is held as currency.
•Some of the new money remains in deposits at the bank.
•Banks’ required reserves increase
•Excess reserves decrease but remain positive.
Banks lend excess reserves
Excess reserves Banks
deposits increase
Quantity of money increases
New money used to make payments
Open market purchase
Money that remains in deposits
Currency drain
Excess reserves
Required reserves increase
A Round in the Multiplier Process Following an Open Market Operation
The Money Multiplier
basemonetary in Change multiplierMoney money ofquantity in the Change
000,250$000,100$ 5.2money ofquantity in the Change
This version of the multiplier takes into account cash drains:
The total amount of new money created by as a result of an open market operation is described by
purchasemarket Open L-1
1 createdmoney ofQuantity
The monetary base consists of bank reserves and currency in circulation. Thus we have:
Money multiplier
What is L?
)1()1( RCL
Where C is the proportion of new money that is held as currency and R is the required reserve ratio.
In our example, C = 0.33 and R = .10. Thus:
6.0)1.01()33.01( L
Notice that, the value of L is inversely related to the values of C and R
Recommended