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Principles of Economics- Mankiw (5th) 596

Principles of Economics- Mankiw (5th) 596 - safe place to...

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616 PART TEN MONEY AND PRICES IN THE LONG RUN Recall that the amount of money you hold includes both currency (the bills in your wallet and coins in your pocket) and demand deposits (the balance in your checking account). Because demand deposits are held in banks, the behavior of banks can influence the quantity of demand deposits in the economy and, there- fore, the money supply. This section examines how banks affect the money supply and how they complicate the Fed’s job of controlling the money supply. THE SIMPLE CASE OF 100-PERCENT-RESERVE BANKING To see how banks influence the money supply, it is useful to imagine first a world without any banks at all. In this simple world, currency is the only form of money. To be concrete, let’s suppose that the total quantity of currency is $100. The supply of money is, therefore, $100. Now suppose that someone opens a bank, appropriately called First National Bank. First National Bank is only a depository institution—that is, it accepts de-
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Unformatted text preview: safe place to keep their money. Whenever a person deposits some money, the bank keeps the money in its vault until the depositor comes to withdraw it or writes a check against his or her balance. Deposits that banks have received but have not loaned out are called reserves. In this imaginary economy, all deposits are held as reserves, so this system is called 100-percent-reserve banking. We can express the financial position of First National Bank with a T-account, which is a simplified accounting statement that shows changes in a bank’s assets and liabilities. Here is the T-account for First National Bank if the economy’s entire $100 of money is deposited in the bank: FIRST NATIONAL BANK A SSETS L IABILITIES Reserves $100.00 Deposits $100.00 ”I’ve heard a lot about money, and now I’d like to try some.” reserves deposits that banks have received but have not loaned out...
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