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14 - 1Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
How Banks and Thrifts Create Money
14C H A P T E R
14 - 2Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
BALANCE SHEET OF ACOMMERCIAL BANK
ASSETS = LIABILITIES + NET WORTH
The Goldsmiths
Fractional Reserve Banking
System
Money Creation & Reserves
Bank Panics & Regulation
14 - 3Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 1
Creating a bank$250,000 Cash
forCapital Stock
14 - 4Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Cash $250,000 Capital Stock $250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Deposit Added to Vault Cash
14 - 5Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Cash $250,000 Capital Stock $250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 2
Acquiring Property andEquipment
$240,000 Cash
14 - 6Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Cash $ 10,000Property 240,000
Capital Stock $250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
14 - 7Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Cash $ 10,000Property 240,000
Capital Stock $250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 3
AcceptingDeposits
$100,000 Cash
14 - 8Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Cash $110,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
14 - 9Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Cash $110,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
NOTES:Bank deposits aresubject to a reserverequirement.
Reserveratio
Commercial bank’srequired reserves
Commercial bank’scheckable-depositliabilities
=
14 - 10Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Cash $110,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Three Important Issues...
1 - Excess Reserves = Actual Reserves - Required Reserves
(assume 20% reserve requirement) $110,000 - 20,000 = $90,0002 – Control of Lending Ability3 - Asset or Liability to Which Bank?
14 - 11Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Cash $110,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 4
Depositsat the FED
$110,000 Cash
14 - 12Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Cash $ 0Reserves 110,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
14 - 13Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Cash $ 0Reserves 110,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 5
A check is drawn against
the bank$50,000
14 - 14Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Cash $ 0Reserves 60,000Property 240,000
Checkable Deposits $ 50,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
14 - 15Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Cash $ 0Reserves 60,000Property 240,000
Checkable Deposits $ 50,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
NOTES:Banks create moneyby lending excessreserves and destroyit by loan repayment.Purchasing bondsfrom the public alsocreates money.
14 - 16Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Reserves $ 60,000Property 240,000
Checkable Deposits $ 50,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 6
Make a loan from excess
reserves$50,000
14 - 17Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Reserves $ 60,000Loans 50,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Making the loancreated money!
14 - 18Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Reserves $ 10,000Loans 50,000Property 240,000
Checkable Deposits $ 50,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
After a check for the $50,000is drawn against the bank
14 - 19Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Reserves $ 10,000Loans 50,000Property 240,000
Checkable Deposits $ 50,000Capital Stock 250,000
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 7
Repaying a loan with cash
$50,000
FORMATION OF ACOMMERCIAL BANK
14 - 20Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Reserves $ 10,000Loans 0Property 240,000
Checkable Deposits $ 0Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
$50,000 in money supplyis destroyed!
14 - 21Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Reserves $ 60,000Securities 50,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
TRANSACTION 8
(Assume previous balance sheet)
Buy GovernmentSecurities$50,000
14 - 22Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Reserves $ 60,000Securities 50,000Property 240,000
Checkable Deposits $100,000Capital Stock 250,000
FORMATION OF ACOMMERCIAL BANK
ASSETSLIABILITIES AND
NET WORTH
Bankers pursue two conflicting goals:Profits and Liquidity
Use of Federal Funds MarketFederal Funds Rate
14 - 23Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
MULTIPLE DEPOSIT EXPANSION PROCESS
BankAcquired reserves
and depositsRequiredreserves
Excessreserves
Amount bankcan lend - Newmoney created
ABCDEFGHIJKLMNOther banks
$100.00 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 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
$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
$400.00Total amount of money created by the banking system
14 - 24Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
MULTIPLE DEPOSIT EXPANSION PROCESS
BankAcquired reserves
and depositsRequiredreserves
Excessreserves
Amount bankcan lend - Newmoney created
ABCDEFGHIJKLMNOther banks
$100.00 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 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
$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
$400.00Total amount of money created by the banking system
Moneydestruction worksin exactly the same
multiple way!
14 - 25Copyright McGraw-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
PreviousSlide
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Maximumcheckable-
depositcreation
= Excessreserves x Monetary
Multiplier
MonetaryMultiplier Required reserve ratio
1
=
THE MONETARY MULTIPLIER
14 - 26Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
$20Requiredreserves
$100New reserves
$100Initial
Deposit
$400Bank system lending
Money Created
$80Excess
reserves
OUTCOME OF MONEY EXPANSION
14 - 27Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
$20Requiredreserves
$100New reserves
$100Initial
Deposit
$400Bank system lending
Money Created
$80Excess
reserves
OUTCOME OF MONEY EXPANSION
Leakages exist...
Currency Drains Excess Reserves
14 - 28Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Need for Monetary Control
ENDBACK
balance sheet fractional reserve system vault cash required reserves reserve ratio excess reserves actual reservesFederal Funds ratemonetary multiplier
Copyright McGraw-Hill/Irwin, Inc. 2005
14 - 30Copyright McGraw-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
PreviousSlide
NextSlide
EndEndShowShow
Next...
Monetary Policy
Chapter 15
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