UNIT 4 Day 3

Banks

• Fin. Intermediary - use liquid assets to fund investments of borrowers -- Fractional Reserve Banking

• Liquid assets include currency in bank vaults and bank reserves

• Banks create money by lending out deposits that are used multiple times

• When a customer deposits cash or withdraws cash from their demand deposit account, it has NO EFFECT ON THE MONEY SUPPLY

                                           It only changes...

• The composition of money

• Excess Reserves

• Required Reserves

Changes in Money Supply for 

• Single Bank

                      -Loan money from ER

• Banking System

                     -ER x Money multiplier (1/RR) -> Total Money Supply

• When the FED buys or sells bonds, ER is created

Basic Accounting Review

• T-Account (Balance Sheet) - Lists assets and liabilities

• Assets (Amounts owned) - Items claimed legally by bank; use of funds by fin. intermediary

• Included in assets

Required Reserves - % of DD in vaultExcess Reserves - Remaining % of DD used for loansProperty - Statement of a bank's property valuesSecurities or Bonds - Previously purchased bonds held by the banks as investmentsLoans - Previously loaned funds now owed back to the bankLiabilities (Amounts owed) - Legal claims against a bank; sources of funds.
Included in liabilities

• Demand Deposits (Cash deposits from the public to the bank)

• Part of MS if from person's cash holdings

• Becomes new $ if from a bond -> MS up

• Owner's equity or stock shares (Values of the bank stocks as held by the public)

• DD = RR + ER

Federal Reserve Banks

• Functions

• Uses paper

• Set reserve requirement and holds bank reserves

• Lends $ to banks and charges interest

• Check-clear service for banks

• Personal bank for government

• Supervises member banks

• Controls money supply in the  economy

• Reserve Requirement - Fed needs banks to always have $ to meet demand

• Amount = Reserve Ratio - % of DD locked to bank

Scenario 1
A private citizen takes cash that they possess and put it into a bank account

• The cash placed into the bank is already part of the money supply

• The deposit is counted as a bank liability

• A % must be placed into required reserve

• The remainder is placed into excess reserve

• The bank will want to lend all of the ER, if possible

• The amount in ER is multiplied by the monetary multiplier

• This will be assumed to become new loans in the banking system

• This will be counted as the change in money supply

Scenario 2

• The Fed buys bonds back from the public

• The public now has new cash

• This new cash is new loans

• Assume that the public puts the cash into demand deposits

• A set percentage is placed into required reserve

• The remainder becomes excess reserve

• Excess reserve is multiplied by the money multiplier (1/RR)

• This amount becomes new loans and is new money supply

• The total change in money supply is the amount of demand deposits plus the new loan amounts

Scenario 3

• The Fed buys bonds back from the member banks

• The banks now have new ER

• No money is needed to be placed in RR, since this is not owed to the public

• All of these ER are multiplied by the monetary multiplier

• This amount becomes new loans

• This amount is the change in the money supply