ch18 - BankReservesandthe MoneySupply Introduction

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    Bank Reserves and the  Money Supply
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    Introduction Examine the relationship between bank  reserves and the money supply Money supply (M1) is composed mostly of  demand deposits in commercial banks and  other financial institutions Bank reserves play a crucial role in creating  demand deposits By regulating bank reserves, Federal reserve  gets leverage to control amount of demand  deposits and thereby nation’s money supply
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    Check Clearing and Collection Many checks and electronic transfers  are “cleared” by local banks exchanging  them through local clearinghouse  associations.   Clearinghouses net out the value of  checks and transfers drawn on or  received by each depository institution  in the association.
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    The Fed’s Role in Check Clearing The Fed clears a check  by subtracting the amount of the check from the reserve  account balance of the bank on which the check was written  and  by adding the amount to the reserve account balance of the  bank that presents the check to the Fed for clearing. Reserve balances are transferred from one bank to  another when checks are cleared between them.   They do not disappear from the banking system. Float Inter-District Settlement Fund
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    Example: Barbara is on vacation in  Atlanta.  While shopping at Saks Fifth  Avenue, she buys a coat for $500 She writes a check for the purchase amount  on her bank in Minneapolis, Norwest Bank. Saks receives the check in its processing  area. It deposits the check at its bank, Wachovia  Bank, that evening - along with many others. The bank first encodes the dollar amount in  magnetic ink on the bottom right-hand side of  the check, then batches this check with many  others it has received that were written on  banks outside the Atlanta area.
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  It transports the checks to the Atlanta Federal  Reserve Bank. The Atlanta Fed sorts this check and other unsorted  checks it has received, according to the check’s  destination (the drawee bank-Norwest Bank). The Atlanta Fed settles accounts, crediting Wachovia  Bank’s reserve account according to a prearranged  “availability schedule”. After settlement, checks drawn on banks in the 9 th   District are grouped and sent to the Minneapolis Fed. The Minneapolis Fed returns Barbara’s check to  Norwest and debits Norwest’s reserve account  (called presentment). Norwest then debits Barbara’s checking account.
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ch18 - BankReservesandthe MoneySupply Introduction

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