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Money Creation, the Federal Reserve System, and Monetary Policy 1717.1 How Banks Work

17.2 Monetary Policy in the Short Run

17.3 Monetary Policy in the Long Run

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How does the Fed create money?Why don’t you demand all the money you can get your

hands on?What’s the price of holding money?How does the supply of money in the economy affect

your chances of finding a job, your ability to finance a new car, and the interest rate you pay on credit cards?

What’s the impact of changes in the money supply on the economy in the short run and in the long run?

CONSIDER

CONTEMPORARY ECONOMICS © Thomson South-Western

17.1 How Banks Work

Discuss what’s involved in getting a new bank up and running.

Describe how the banking system can expand the money supply by a multiple of excess reserves.

Objectives

CONTEMPORARY ECONOMICS © Thomson South-Western

17.1 How Banks Work

net worthasset liabilitybalance sheet

Key Terms required reserve ratio required reservesexcess reservesmoney multiplier

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Operating a Bank

Getting a charterBank balance sheetReserve accounts

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Getting a Charter

Charter—the right to operateNet worth—assets minus liabilities, also

called owners’ equityAsset—any physical property or financial

claim owned by the bank

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Bank Balance Sheet

Liability—an amount owedBalance sheet—a financial statement

showing assets, liabilities and net worth at a given time; assets must equal liabilities plus net worth, so the statement is in balance

Assets = Liabilities + Net worth

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Reserve Accounts

Required reserve ratio—a Fed regulation that dictates the minimum fraction of deposits each bank must keep in reserve

Required reserves—the dollar amount that must be held in reserve; checkable deposits multiplied by the required reserve ratio

Excess reserves—bank reserves in excess of required reserves

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Money Multiplier

Money multiplier—the multiple by which the money supply can increase as a result of an increase in excess reserves in the banking system

The Fed makes a moveRound oneRound two and beyondReserve requirements and money expansionLimitations on the multiplier