Money Creation- Fractional Reserve System o In a fractional reserve banking system, banks keep a fraction of deposits on reserve and use the rest to make loanso The Federal Reserve Board establishes reserve requirements, regulations on the minimum amount of reserves that banks must holdo Banks may hold more than the minimum o The reserve ratio Fraction of deposits that banks hold as reserves Total reserves as a percentage of total deposits o The Goldsmiths Stored gold and gave a receipt  Receipts used as money by public  Made loans by issuing receipts o Characteristics: Banks create money through lending  Banks are subject to “panics”- A Single Commercial Bank o Balance Sheet  Assets= liabilities + net worth  Both sides balanceo Necessary transactions  Create a bank  Accept deposits Lend excess reserves o Transaction 1: Creating a bank  Vault Cash: Cash held by the bank o Transaction 2: Acquiring Property and Equipment  Acquiring property and equipment o Transaction 3: Accepting Deposits  Commercial bank functions- Accepting depositso Transaction 4: Depositing Reserves in a Federal Reserve Bank  The Fed is the bank’s bank  A bank can make deposits at the Fed These are called reserves - All banks are required to keep some reserves at the fed- Assets of the bank  Banks are required to keep a portion of their reserves at the FED. The percentage is the Reserve Ratio Require Reserves:- Checkable deposits * reserve Ratio Excess Reserves - Actual reserves- Require reserves The fed can establish and vary the reserve ratio within limits set by Congress Required reserves help the Fed control lending abilities of commercial banks Assume the bank deposits all cash on reserve at the Fedo Transaction 5: Clearing a Check Drawn Against the Bank  Clearing a Check - $50,000 check reduces reserves and checkable deposits-o Transaction 6: Granting a Loan  Loans are assets of the banks  Banks can only loan out the amount of their excess reserves  Can borrow reserves from other banks to meet their required reserves  Granting a loan- $50,000 loan deposited to checking- Using the Loan - $50,000 loan withdrawn by check -- Banking System o Cash- An asset of the bank o Checkable Deposits: a liability of the bank o Banks need to make money so they loan out a portion of the cash brought in as checkable deposits - Banking System Reviewedo Bank balance Sheet Assets = Liabilities + Net Worth  Both Sides balanceo Assets: Cash, Property, Reserves, Loanso Liabilities Checkable Depositso Net Worth: Stock Shares - Profits, Liquidity, and the Federal Funds Marketo Conflicting goalso Earn profit Make loans to earn interest Buy securities to earn interest o Maintain Liquidity- for depositors who wish to withdraw money from the bank o Alternative? Overnight bank loans Federal funds rate - Interest rate that banks loan each other (borrow from each other at)- The Banking System o Multiple-deposit expansion- as the loan money is deposited into other accounts, banks will use that money to create more moneyo Assumptions:  20% required reserves All banks have no excess reserves o A $100 bill is found and depositedo Multiple deposits can be created- The Money Multiplier o Money Multiplier: the amount of money the banking system generates with each dollar of reserves 1/(required reserve ration)=1/Ro The higher the reserve ratio, the lower the money multiplier o Suppose The reserve ratio was 20% Money Multiplier= 1/.20=5o The money multiplier x deposit= $500 $400 is the amount of new money created ($500-$100)o The money multiplier tells us the maximum increase in the money supply The minimum is zero $0 If banks don’t loan out money, there is no increase o Maximum amount of new money created by a single dollar of excess reserves o The higher Reserve ratio, the lower money multiplier o Reversibility Making loans creates money Loan repayment destroys