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Unformatted text preview: that is, banks must have reserves equal to 10% of their deposits. If our hypothetical bank were the only bank in the system, it would calculate that the additional $1,000 in reserves would allow it to create new deposits of $10,000 to fund new loans and investments ($1,000 of additional reserves = .10 x $10,000 of new deposits). MULTIPLE BANK SYSTEM
In reality, the bank will be much more conservative in extending loans because it is not operating alone. There are approximately 35,000 depository institutions operating in the U.S. A bank recognizes that a large part of any new deposits it creates will be spent and re–deposited in other banks. As a result, the bank will have to transfer reserves to those other banks. To protect itself from losing too many of its reserves, a bank originating loans will limit the new deposits it creates. A bank is therefore likely to make a loan for no more than the full amount of its excess reserves –reserves in excess of what it is required to hold. In our hypothetical example, the bank initially has excess reserves of $1,000. Suppose it makes a loan to a car dealer of $1,000 to buy automotive parts. The bank opens a new account for the dealer and credits it with $1,000 of new deposits. The dealer will write a check on his new account to pay the parts supplier, who in turn will deposit the check in his account at another bank. The second bank will credit the supplier's account with the amount of the check and return the check to the first bank for settlement. The first bank will settle this 2-18 Licensing School for Appraisal, CPA, Contractors, Insurance, Real Estate, Notary, Nurse, Food Handlers, Tax and Securities 2. THE MONEY MARKET
check by transferring $1,000 of reserves to the second one and thus will no longer have any excess reserves. Thus, its ability to create new deposits is over. At this point, however, the second bank has $1,000 of additional deposits and an equal amount of new reserves. This second bank, which must hold required reserves of .10 x $1,000 = $100 against the increase in its dep...
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This note was uploaded on 12/30/2010 for the course SOC 101 taught by Professor Zhung during the Spring '10 term at Punjab Engineering College.
- Spring '10