Chapter15Summary - Chapter 15 Summary Tucker Macroeconomics...

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Chapter 15 Summary Tucker , Macroeconomics for Today , 5th Edn. 1. The Fed controls the money supply by affecting the behavior of for-profit, deposit holding institutions like commercial banks. These institutions accept deposits because they have the opportunity to use the money in those deposits for a variety of investments, most of which we will call "loans." These loans earn interest which covers all of these expenses associated with accepting deposits and processing checks and loans, with something left over (profits) for the owners (stockholders) of the commercial bank. 2. When you deposit money in a commercial bank (e. g., $1000) this deposit is viewed by that bank both as a liability and as an asset. It is a liability because your checking account represents money that the bank has to pay back to you, or to whoever you dictate by writing checks against that deposit. It is an asset because the bank has use of that money until take it out of the bank by writing checks to others or cashing checks for currency. The asset side of your deposit is called "reserves." These reserves are divided, by law, into two components called "required" and "excess" reserves. Required reserves cannot be loaned out or otherwise invested by the bank. The reserves must be held as "vault cash" at the bank or otherwise deposited in the commercial bank's account at the Fed district bank for the geographic area that the commercial bank is in. The Fed sets the "legal reserve requirement" for all deposit holding institutions. It is set as a percentage of deposits which the bank must hold as required reserves. For example, if the legal reserve requirement is 10%, then in my example above the $1000 deposit leads to $1000 in total reserves, which are divided into required reserves of $100 and excess reserves of $900. 3. Banks make money only by loaning out (or otherwise investing) their excess reserves. So, excess reserves are "loaned out" and then spent by those who took out the loans. When the funds are spent, in most cases this leads to new deposits in other banks. These new deposits create additional reserves, which are once again divided into their respective "required" and "excess" components. The excess reserves are once again loaned out, spent, re-deposited, and so the
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Chapter15Summary - Chapter 15 Summary Tucker Macroeconomics...

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