Chapter 13 Multiple Deposit Creation and the Money

Chapter 13 Multiple Deposit Creation and the Money

Chapter 13 Multiple Deposit Creation and the Money Supply Process Meaning and Function of Money Economists Meaning of Money 1. Anything that is generally accepted in payment for goods and services 2. Not the same as wealth or income Functions of Money 1. Medium of exchange 2. Unit of account 3. Store of value Evolution of Payments System 1. Precious metals like gold and silver 2. Paper currency (fiat money) 3. Checks 4. Electronic means of payment 5. Electronic money: Debit cards, Stored-value cards, Smart cards, E-cash 2004 Pearson Addison-Wesley. All rights reserved 15-2

Federal Reserves Monetary Aggregates 15-3 Growth Rates of Feds Monetary Aggregates 2004 Pearson Addison-Wesley. All rights reserved 15-4 Four Players in the Money Supply Process 1. Central bank: the Fed 2. Banks 3. Depositors 4. Borrowers from banks Federal Reserve System 1. Conducts monetary policy 2. Clears checks 3. Regulates banks 2004 Pearson Addison-Wesley. All rights reserved

15-5 The Feds Balance Sheet Federal Reserve System Assets Liabilities Government securities Currency in circulation Discount loans Reserves Monetary Base, MB = C + R 2004 Pearson Addison-Wesley. All rights reserved 15-6 Control of the Monetary Base Open Market Purchase from Bank

The Banking System Assets Liabilities The Fed Assets Liabilities Securities $100 Reserves + $100 Open Market Purchase from Public Public Assets Liabilities Securities + $100 Reserves + $100 Assets Liabilities

Securities $100 Deposits + $100 Banking System Assets Liabilities Securities + $100 Reserves + $100 Reserves + $100 The Fed Checkable Deposits + $100 Result: R $100, MB $100 2004 Pearson Addison-Wesley. All rights reserved 15-7 If Person Cashes Check

Public Assets The Fed Liabilities Assets Liabilities Securities $100 Securities + $100 Currency + $100 Result: R unchanged, MB $100 Effect on MB certain, on R uncertain Currency + $100 Shifts From Deposits into Currency Public Assets The Fed Liabilities

Assets Deposits $100 Currency + $100 Liabilities Currency + $100 Reserves $100 Banking System Assets Liabilities Reserves $100 Deposits $100 Result: R $100, MB unchanged 2004 Pearson Addison-Wesley. All rights reserved 15-8 Discount Loans Banking System Assets Liabilities Reserves

Discount + $100 loan + $100 The Fed Assets Discount loan + $100 Liabilities Reserves + $100 Result: R $100, MB $100 Conclusion: Fed has better ability to control MB than R 2004 Pearson Addison-Wesley. All rights reserved 15-9 Deposit Creation: Single Bank Assets First National Bank

Liabilities Securities Reserves $100 + $100 Assets First National Bank Liabilities Securities Reserves Loans $100 + $100 + $100 Assets First National Bank

Liabilities Securities Loans $100 + $100 Deposits Deposits + $100 + $100 15-10 Deposit Creation: Banking System Bank A Assets Reserves Liabilities + $100

Deposits + $100 Bank A Assets Reserves Loans Liabilities + $10 + $90 Deposits + $100 Bank B Assets Reserves Liabilities + $90

Deposits + $90 Bank B Assets Reserves Loans Liabilities +$9 + $81 Deposits 2004 Pearson Addison-Wesley. All rights reserved + $90 15-11 Deposit Creation

2004 Pearson Addison-Wesley. All rights reserved 15-12 Deposit Creation If Bank A buys securities with $90 check Bank A Assets Liabilities Reserves + $10 Deposits + $100 Securities + $90 Seller deposits $90 at Bank B and process is same Whether bank makes loans or buys securities, get same deposit expansion 2004 Pearson Addison-Wesley. All rights reserved 15-13 Deposit Multiplier

Simple Deposit Multiplier 1 D = R r Deriving the formula R = RR = r D D= 1 D = 1 r r R R 2004 Pearson Addison-Wesley. All rights reserved 15-14 Deposit Creation:

Banking System as a Whole Banking System Assets Liabilities Securities $100 Deposits Reserves + $100 Loans + $1000 + $1000 Critique of Simple Model Deposit creation stops if: 1. Proceeds from loan kept in cash 2. Bank holds excess reserves 2004 Pearson Addison-Wesley. All rights reserved 15-15

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