# chap9 - Outline of todays talk Banking system and money...

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11/13/2010 1 Outline of today’s talk Banking system and money creation. What roles Federal Reserve Bank has on Money Supply Changes? How much is the change in the Money Supply after a deposit of \$1,000? Currency in circulation decreases by \$1,000 And bank deposits increases by \$1,000 As a result, no change in money supply, M1 . Bank makes some new loan! Effect on the Money Supply of a Deposit at First Street Bank Effect After Bank Makes New Loans: Currency in circulation increases by \$900 No change in deposits As a result, money supply increases by \$900. .

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11/13/2010 2 How Banks Create Money Currency in circulation (C) Bank Deposits (D) Money Supply M1=C +D First stage: David keeps his \$1,000 under his pillow. \$1,000 \$0 \$1,000 Second stage: David deposits his \$1,000 cash in Bank of America which lends out \$900 to Yuti. (Yuti buys a laptop from Max for \$900) \$900 (Yuti holds this) \$1,000 (David’s deposit) \$1,900 Third stage : Max deposits \$900 to Chase Bank which lends out \$810 to Kimberly. (Kimberly buys a shoe for \$810 from Prada at Buckhead.) \$810 (Kimberly has it) \$1,900 (David’s \$1000 deposit+ Max’s \$900 deposit) \$2,710 Assume that initially there is zero money in the banking system and in the hands of the people but only David has \$1,000 cash. Also assume rr=10%. Reserves, Bank Deposits, and the Money Multiplier IF nobody holds cash but if they return the money to the banking system AND All banks hold only the required reserve and lends out the rest, THEN, the total (maximum possible) increase in money supply with \$1,000 initial deposit ( excess reserves ) will be: \$1,000 /rr Where rr is the required reserve ratio. Excess reserve s are bank reserve s over and above its require d Money multiplier=1/rr The Federal Reserve The Federal Reserve System was created in 1913. Regulate the banking industry “Lender of Last Resort” Regulate the money supply Provide banking services for the federal government Check Clearing
11/13/2010 3 The Federal Reserve board is headquartered in Washington DC. The Board Consists of 7 “Governors” appointed by the President and confirmed by the

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chap9 - Outline of todays talk Banking system and money...

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