Creating Money

© 2012 McGraw-Hill Ryerson Limited 8- 1

LO4

Assets • What a company owns or what is owed to it

Liabilities • What a company owes

Net Worth • Total assets minus total liabilities • Also called equity

Balance Sheet of Saymor Bank Ltd. as of December 31, 2011

Assets Liabilities and Equity

Reserves $ 10 000 Demand deposits $100 000

Loans to customers 60 000Shareholders’ equity 20 000

Securities 30 000Fixed assets    20 000

$120 000 $120 000

Creating Money

© 2012 McGraw-Hill Ryerson Limited 8- 2

LO4

Net worth of Saymor Bank is $20,000 (million):

Creating Money

© 2012 McGraw-Hill Ryerson Limited 8- 3

LO4

Target Reserve Ratio • the portion of deposits that a bank wants to hold

in cash

Target reserves = target reserve ratio demand deposits

Creating Money

© 2012 McGraw-Hill Ryerson Limited 8- 4

LO4

Reserve ratio = 10,000/100,000 = 10%

Balance Sheet of Saymor Bank Ltd. as of December 31, 2011

Assets Liabilities and Equity

Reserves $ 10 000 Demand deposits $100 000

Loans to customers 60 000Shareholders’ equity 20 000

Securities 30 000Fixed assets    20 000

$120 000 $120 000

Creating Money

© 2012 McGraw-Hill Ryerson Limited 8- 5

LO4

Excess Reserves • reserves in excess of what the bank wants to hold

as its target reserves

Excess reserves = Actual reserves target reserves

Balance Sheet of Saymor Bank Ltd. as of December 31, 2011

Assets Liabilities and Equity

Reserves $ 10 000 Demand deposits $100 000

Loans to customers 60 000Shareholders’ equity 20 000

Securities 30 000Fixed assets    20 000

$120 000 $120 000

Creating Money

© 2012 McGraw-Hill Ryerson Limited 8- 6

LO4

New deposit of $1,000: Target reserves = 10% x 101,000 = $10,100 Excess reserves = 11,000 – 10,100 = $900

11 000101 000

Creating Money

© 2012 McGraw-Hill Ryerson Limited 8- 7

LO4

• Banks use excess reserves to make loans • Loans are eventually deposited, creating new

money • Process continues until no more excess reserves

Money Multiplier

© 2012 McGraw-Hill Ryerson Limited 8- 8

LO4

• the increase in total deposits that would occur in the whole banking system as a result of a new deposit in a single bank

depositsMoney Multiplier = reserves

Money Multiplier = 1 / Target Reserve Ratio

Self-Test 7

© 2012 McGraw-Hill Ryerson Limited

LO4

8-9

Assume that the nation’s banking system is over-reserved by $20 M. What is the value of the money multiplier and what is the maximum possible expansion in the money supply if the target reserve ratio is:

a) 10%

b) 2%

c) 5%

Money Multiplier

© 2012 McGraw-Hill Ryerson Limited 8- 10

LO4

• Also works in reverse if under-reserved • Banks can call in loans, decreasing deposits • The size of the multiplier can be reduced by:

1. An increase in the banks’ target reserves 2. An increase in the amount of cash people hold3. An insufficient number of creditworthy loan

applicants 4. A reduced demand for loans during a recession