DOC PREVIEW
UGA ECON 2105 - Module 25 part 2
Type Lecture Note
Pages 5

This preview shows page 1-2 out of 5 pages.

Save
View full document
View full document
Premium Document
Do you want full access? Go Premium and unlock all 5 pages.
Access to all documents
Download any document
Ad free experience
View full document
Premium Document
Do you want full access? Go Premium and unlock all 5 pages.
Access to all documents
Download any document
Ad free experience
Premium Document
Do you want full access? Go Premium and unlock all 5 pages.
Access to all documents
Download any document
Ad free experience

Unformatted text preview:

ECON 2105 1nd Edition Lecture 19 Outline of Last Lecture I. Role of Banks II. How Banks Create Money III. Bank Runs IV. Bank Regulations Outline of Current Lecture I. Banks Creating Money Current LectureModule 25 continued I. Banks Creating Money -These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.- Silas keeps a shoebox full of cash under his bed. Deciding to enter the twenty-first century, he deposits this cash at the bank. What’s the effect of his $1,000 deposit on money supply?- - Banks make their profit from loans, so eventually they will make new loans with 90% of Silas’s money at the maximum (The rest they must hold in reserve).- Recall: M1= C + D+ Traveler’s checks- So, ΔM1= Δ C + Δ D+ Δ Traveler’s checks- What happens to C and D after the $1,000 deposit Silas made?o Currency in circulation decreases by $1,000 o And bank deposits increases by $1,000 o As a result, no change in money supply, M1. - The first bank lends $900 to Maya, who pays the money to Anne, whodeposits it at her bank—and the cycle starts all over. -- How much can the banking sector create money from their deposits atthe maximum?- We will assume a hypothetical (but not necessarily a realistic) situation:- Assumption 1: Any time a bank receives a deposit from the public, thatbank will lend out the maximum possible amount of that deposit by only keeping the minimum requirements in their reserves ( zero excess reserve)- Assumption 2: Any time a person gets a loan from a bank, that money will somehow return to the banking sector (no leakages - Any time a bank receives certain $ in deposits, the bank can lend out (1-rr)*the initial deposits at the maximumo Say that rr=10%.o If a bank receives $100 in deposits, they can lend out $90 of that deposit at the maximum.o If a bank receives $800 in deposits, they can lend out $720 of that deposit at the maximum.o If a bank receives $50 million in deposits, they can lend out $45 million of that deposit at the maximum.- Start the process: (assume rr=10%)o Put $1,000 in a bank account (D rises by $1,000)o The bank will keep $100 in reserves and lend out (1-rr)*$1,000=$900 to the public as bank loan.o The $900 bank loan will come back to the banking sector (Assumption 2) as new deposit so D rises by $900. o The bank will keep $90 in reserves and lend out (1-rr)*$900=$810 to the public as bank loan (Assumption 2)- Increase in bank deposits from $1,000 initial deposits=o $1,000 + [$1,000 × (1 − rr)] + [$1,000 × (1 − rr)2] + [$1,000 ×(1 − rr)3] + . . .o This can be simplified to $1,000*1/rro Where 1/rr is the money multiplier. - IF nobody holds cash but return the money to the banking system AND- All banks hold only the required reserve and lends out the rest (zero excess reserve), - THEN, the total (maximum possible) increase in deposits with $1,000 initial reserves will be:- $1,000 /rr- Where rr is the required reserve ratio.- At the maximum, ^M1=excess reserves/rr - ^D= Initial deposits/rr - With $1000 initial deosits and rr=10% o Initial excess reserves=$900o Money multiplier= 10o At the maximum, o ΔD=10*$1,000=$10,000o ΔM1=10*$900=$9,000-- Given this T-account and assuming the bank holds no excess reserves, what is the required reserve ratio?o 10% correct!!!o 40% o 80% o 1%- Suppose the required reserve ratio initially is 10% of bank deposits and is increased by the Fed to 20% of bank deposits. Holding everything else constant, this will:o reduce the size of the money multiplier.o cause the banking system to contract the level of bank deposits in the banking system.o change the value of the money multiplier from 10 to 5.o Answers (a), (b), and (c) are all correct.- The monetary base is the sum of currency in circulation and bank reserves.-- In reality, the determination of the money supply is more complicated than our simple model suggests:- It depends not only on the ratio of reserves to bank deposits but also on the fraction of the money supply that individuals choose to hold in the form of currency.o If Silas can increase the money supply by pulling cash out from under his bed and injecting into the banking system, the reverse can happen anytime people carry cash.- The money multiplier is the ratio of the money supply to the monetarybase. - In normal times, the U.S. money multiplier for M1 is between 1.5 and 3.0.o Why isn’t it 1/0.1 = 10?- People hold significant amounts of cash, which reduces bank


View Full Document
Download Module 25 part 2
Our administrator received your request to download this document. We will send you the file to your email shortly.
Loading Unlocking...
Login

Join to view Module 25 part 2 and access 3M+ class-specific study document.

or
We will never post anything without your permission.
Don't have an account?
Sign Up

Join to view Module 25 part 2 2 2 and access 3M+ class-specific study document.

or

By creating an account you agree to our Privacy Policy and Terms Of Use

Already a member?