Money Creation

Fractional Reserve System
The Goldsmiths
Stored gold and gave a receipt
Receipts used as money by public
Made loans by issuing receipts
Characteristics:
Banks create money through lending
Banks are subject to “panics”
LO1
32-

Fractional Reserve System
Balance sheet
Assets = Liabilities + Net Worth
Both sides balance
Necessary transactions
Create a bank
Accept deposits
Lend excess reserves
LO1
32-

A Single Commercial Bank
Transaction #1
Vault cash: cash held by the bank
LO1
32-

A Single Commercial Bank
Transaction #2
Acquiring property and equipment
LO1
32-

A Single Commercial Bank
Transaction #3
Commercial bank functions
Accepting deposits
Making loans
Accepting Deposits
Balance Sheet 3: Wahoo Bank
Cash
$110,000
Checkable
Deposits
$100,000
Property
240,000
Stock Shares
250,000
LO1
32-

A Single Commercial Bank
Transaction #4
Depositing reserves in a Federal Reserve bank
Required reserves
Reserve ratio
LO2
32-

A Single Commercial Bank
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
LO2
32-

A Single Commercial Bank
Transaction #4
Assume the bank deposits all cash on reserve at the Fed
LO2
32-

A Single Commercial Bank
Excess reserves
Actual reserves - required reserves
Required reserves
Checkable deposits x reserve ratio
Example:
Checkable deposits $100,000
Reserve ratio 20%
LO2
32-

A Single Commercial Bank
Transaction #5
Clearing a check
$50,000 check reduces reserves and checkable deposits
LO2
32-

Money Creating Transactions
Transaction #6a
Granting a loan
$50,000 loan deposited to checking
LO3
32-

Money Creating Transactions
Transaction #6b
Using the loan
$50,000 loan cashed
LO3
32-

Money Creating Transactions
Transaction #7
Bank buys government securities
from a dealer
Deposits payment into checking
New money is created
LO3
32-

Profits, Liquidity, and the Fed Funds Market
Conflicting goals
Earn profit
Make loans to earn interest
Buy securities to earn interest
Maintain liquidity
Alternative?
Overnight bank loans
Federal funds rate
LO3
32-