Lecture Macroeconomics - Chapter 13: How banks create money

After studying this chapter you will be able to understand: How a single chartered bank can create (or destroy) money through loans to the public, about the multiple-deposit expansion of the entire chartered banking system, what the monetary multiplier is and how to calculate it.

How Banks Create Money Chapter 13 SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 In this chapter you will learn How a single chartered bank can create (or destroy) money through loans to the public About the multiple-deposit expansion of the entire chartered banking system What the monetary multiplier is and how to calculate it © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 Chapter 13 Topics The Balance Sheet of a Chartered Bank Prologue: The Goldsmiths A Single Chartered Bank The Banking System: Multiple-Deposit Expansion © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 The Balance Sheet of a Chartered Bank ASSETS = LIABILITIES + NET WORTH ASSETS LIABILITIES AND NET WORTH BALANCE SHEETS WILL BE USED TO DESCRIBE THE CREATION OF MONEY © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter Chapter 13 Topics The Balance Sheet of a Chartered Bank Prologue: The Goldsmiths A Single Chartered Bank The Banking System: Multiple-Deposit Expansion © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 Prologue: The Goldsmiths Goldsmiths accepted gold deposits and issued paper receipts Paper receipts were used as a medium of exchange 100% reserve system eventually led to fractional reserve system © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 Prologue: The Goldsmiths Fractional Reserve System Money creation & reserves Bank panics & regulation © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 Chapter 13 Topics The Balance Sheet of a Chartered Bank Prologue: The Goldsmiths A Single Chartered Bank The Banking System: Multiple-Deposit Expansion © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 Formation of a Chartered Bank ASSETS Vancouver Bank LIABILITIES AND NET WORTH TRANSACTION Birth of a bank $250,000 Cash for Capital Stock © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 Formation of a Chartered Bank ASSETS Cash Vancouver Bank $250,000 © 2002 McGraw-Hill Ryerson Ltd LIABILITIES AND NET WORTH Capital Stock $250,000 Macroeconomics, Chapter 13 10 Table 13-1 Multiple Deposit Expansion Process Amount bank Bank Acquired reserves and deposits Desired reserves A $100.00 $ 20.00 Excess reserves can lend New money created $80.00 $80.00 Money Money is is created created once once the the loan loan is is made made © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 47 Table 13-1 Multiple Deposit Expansion Process Amount bank Bank Acquired reserves and deposits Desired reserves A $100.00 $ 20.00 Excess reserves can lend New money created $80.00 $80.00 Loan Loan recipient recipient now now spends spends the the money money He/she He/she buys buys something; something; seller seller deposits deposits proceeds proceeds in in his/her his/her bank bank © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 48 Table 13-1 Multiple Deposit Expansion Process Amount bank Bank Acquired reserves and deposits Desired reserves A B $100.00 80.00 $ 20.00 Excess reserves can lend New money created $80.00 $80.00 New New deposit deposit means means excess excess reserves reserves in in seller’s seller’s bank; bank; process process repeats repeats © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 49 Table 13-1 Multiple Deposit Expansion Process Amount bank Bank Acquired reserves and deposits Desired reserves A B $100.00 80.00 $ 20.00 16.00 © 2002 McGraw-Hill Ryerson Ltd Excess reserves can lend New money created $80.00 64.00 Macroeconomics, Chapter 13 $80.00 64.00 50 Table 13-1 Multiple Deposit Expansion Process Amount bank Bank Acquired reserves and deposits Desired reserves A B C $100.00 80.00 64.00 $ 20.00 16.00 12.80 © 2002 McGraw-Hill Ryerson Ltd Excess reserves can lend New money created $80.00 64.00 51.20 Macroeconomics, Chapter 13 $80.00 64.00 51.20 51 Table 13-1 Multiple Deposit Expansion Process Amount bank Bank Acquired reserves and deposits Desired reserves Excess reserves can lend New money created $80.00 $100.00 $ 20.00 $80.00 A 64.00 80.00 16.00 64.00 B 51.20 64.00 12.80 51.20 C 40.96 51.20 10.24 40.96 D 32.77 40.96 8.19 32.77 E 26.22 32.77 6.55 26.22 F 20.98 26.22 5.24 20.98 G 16.78 20.98 4.20 16.78 H 13.42 16.78 3.36 13.42 I 10.74 13.42 2.68 10.74 J 8.59 10.74 2.15 8.59 K 6.87 8.59 1.72 6.87 L 5.50 6.87 1.37 5.50 M 4.40 5.50 1.10 4.40 N 17.57 21.97 4.40 17.57 Other Total amount of money created by the bank system = $400.00 banks © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 52 Table 13-1 Multiple Deposit Expansion Process Amount bank Bank Acquired reserves and deposits Desired reserves Excess reserves can lend New money created $80.00 $100.00 $ 20.00 $80.00 A 64.00 80.00 16.00 64.00 B 51.20 64.00 12.80 51.20 C 40.96 51.20 10.24 40.96 D 32.77 40.96 8.19 32.77 E 26.22 32.77 6.55 26.22 F 20.98 26.22 5.24 20.98 G 16.78 20.98 4.20 16.78 H 13.42 16.78 3.36 13.42 I 10.74 13.42 2.68 10.74 J 8.59 10.74 2.15 8.59 K 6.87 8.59 1.72 6.87 L 5.50 6.87 1.37 5.50 M 4.40 5.50 1.10 4.40 N 17.57 21.97 4.40 17.57 Other Total amount of money created by the bank system = $400.00 banks Monetary Monetary destruction destruction works works the the same same way way in in reverse reverse © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 53 The Monetary Multiplier Monetary multiplier = © 2002 McGraw-Hill Ryerson Ltd R = = 20 Macroeconomics, Chapter 13 54 The Monetary Multiplier Monetary multiplier Maximum demand-deposit expansion = = © 2002 McGraw-Hill Ryerson Ltd R = = 20 Excess reserves x Monetary multiplier Macroeconomics, Chapter 13 55 The Monetary Multiplier Monetary multiplier Maximum demand-deposit expansion = R = = 20 x = = 80 x = © 2002 McGraw-Hill Ryerson Ltd Excess reserves Monetary multiplier 400 Macroeconomics, Chapter 13 56 Outcome of Money Expansion - Fig 13-1 $100 New reserves $80 Excess reserves $400 Bank system lending $ 20 Desired reserves $100 initial deposit Money created © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 57 Some Modifications Other Leakages Currency Drains Excess Reserves © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 58 Need for Monetary Control an unregulated banking system can destabilize the economy there is a role for a central bank © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 59 Chapter 13 Topics The Balance Sheet of a Chartered Bank Prologue: The Goldsmiths A Single Chartered Bank The Banking System: Multiple-Deposit Expansion © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 60 Next The Bank of Canada and Monetary Policy Chapter 14 © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 61 ... Stock $100,000 250,000 New New money money of of $50,000 $50,000 has has been been created created created created © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 27 New Loan Before... to its excess reserves The bank creates money when it creates new loans Money is destroyed when loans are repaid © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 23 Creating a New Loan... McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 13 Prologue: The Goldsmiths Fractional Reserve System Money creation & reserves Bank panics & regulation © 2002 McGraw-Hill Ryerson Ltd Macroeconomics,