CHAPTER 14: HOW BANKS AND THRIFTS CREATE MONEY?

BALANCE SHEET OF A COMMERCIAL BANK

BALANCE SHEET – is a statement of assets and claims on assets that summarizes the financial position of the bank at a certain time.

Assets = liabilities + net worth

PROLOGUE: THE GOLDSMITHS

Functional reserve banking system – only a fraction of the total money supply is held in reserve as currency. It has two significant characteristics:

• Money creation and reserves
• Bank panics and regulation

A SINGLE COMMERCIAL BANK

• Formation of a Commercial Bank

·         Transaction 1: Creating a Bank

Vault cash or till money – cash held by the bank

Account – item listed in a balance sheet

·         Transaction 2: Acquiring Property and Equipment

·         Transaction 3: Accepting Deposits

·         Transaction 4: Depositing Reserves in a Federal Reserve Bank

·         Transaction 5: Clearing a Check Drawn against the Bank

• Money- Creating Transactions of a Commercial Bank

The next three transactions are crucial because they explain (1) how a commercial bank can literally create money by making loans, (2) how money is destroyed when loans are repaid, and (3) how banks create money by purchasing government bonds from the public.

·         Transaction 6: Granting a Loan

·         Transaction 7: Repaying a Loan

·         Transaction 8: Buying Government Securities

THE BANKING SYSTEM: MULTIPLE-DEPOSIT ExPANSION

3 simplifying assumptions

• The reserve ratio for all commercial banks is 20%
• Initially all banks are meeting this 20% reserve requirement exactly
• If any bank can increase its loans as a result of acquiring excess reserves, an amount equal to those excess reserves will be lent to the borrower, who will write a check for the entire amount of the loan and give it to someone else, who will deposit the check in another bank.

• The Banking System’s Lending Potential

• Monetary Multiplier

The multiple of its excess reserves by which the banking system can expand checkable deposits and thus the money supply by making new loans equal to 1 divided by the reserve requirement

• Some Modifications

·         Other Leakages

-Currency drains

-Excess reserves