Principles of Economics- Mankiw (5th) 597

Principles of Economics- Mankiw (5th) 597 - CHAPTER 27 T H...

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CHAPTER 27 THE MONETARY SYSTEM 617 On the left-hand side of the T-account are the bank’s assets of $100 (the reserves it holds in its vaults). On the right-hand side of the T-account are the bank’s liabili- ties of $100 (the amount it owes to its depositors). Notice that the assets and liabil- ities of First National Bank exactly balance. Now consider the money supply in this imaginary economy. Before First Na- tional Bank opens, the money supply is the $100 of currency that people are hold- ing. After the bank opens and people deposit their currency, the money supply is the $100 of demand deposits. (There is no longer any currency outstanding, for it is all in the bank vault.) Each deposit in the bank reduces currency and raises de- mand deposits by exactly the same amount, leaving the money supply unchanged. Thus, if banks hold all deposits in reserve, banks do not influence the supply of money. MONEY CREATION WITH FRACTIONAL-RESERVE BANKING
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