Chapter 10 - part 2

Chapter 10 - part 2 - Chapter 10: Money, Prices and the...

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Commercial Banks and the Creation of Money Example : continued Chapter 10: Money, Prices and the Federal Reserve When reserves are always 1,000,000 guilders, a 10% reserve-deposit ratio means that 10,000,000 in deposits can be accumulated in successive rounds of loans and deposits. Thus at the end, the money supply in the economy is made up of the deposits available in the banks: 10,000,000 guilders. Total loans at that time must be 9,000,000 guilders to balance banks’ assets and liabilities.
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A banking system where the desired reserves are less than the amount of deposits is called a fractional reserve banking system . In such a system, banks only hold a proportion of their total deposits as currency in their reserves. The existence of a fractional-reserve banking system has multiplied the money supply by a factor of 10 in this example . Depending on the reserve-deposit ratio the total amount of banks’ deposits can determined. Since: We can also obtain that: Commercial Banks and the Creation of Money ratio deposit - to - reserve reserves Bank deposits Bank = Chapter 10: Money, Prices and the Federal Reserve ratio deposit - to - reserve deposits Bank reserves Bank =
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Commercial Banks and the Creation of Money The money supply is exactly equal to banks’ deposits when the population does not hold and cash. When the public does hold a certain amount of cash on hand, the money supply is the sum of the cash in circulation and the total amount of deposits at banks . Example : out of the 1 million guilders in currency in the economy, the public holds 500,000 on hand and deposits the rest in checking bank accounts. With a 10% reserve to deposits ratio, banks will have a total of 5 million guilders in deposits after several rounds of loaning and redepositing. Thus the money supply in the economy is the sum of the 500,000 guilders in cash in the hands of the public and the 5 million in total bank deposits = 5.5 million guilders. Chapter 10: Money, Prices and the Federal Reserve
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Commercial Banks and the Creation of Money Exercises : 1. What is money supply if banks decide to hold a larger proportion of deposits in reserves? Instead of 10%, they want to hold 25%, while the public still holds 500,000 guilders as cash on hand. 1. What is the money supply if the public decides to increase the amount of cash on hand? The public holds 600,000 guilders while banks keep 10% of deposits in their reserves. Chapter 10: Money, Prices and the Federal Reserve
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The Federal Reserve System The Federal Reserve System or the Fed is the central bank of the United States. It is composed of 12 regional Federal Reserve Banks. Two main responsibilities:
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Chapter 10 - part 2 - Chapter 10: Money, Prices and the...

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