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Multiple Deposit Expansion and the Federal Reserve

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Title: Multiple Deposit Expansion and the Federal Reserve


1
  • Multiple Deposit Expansion and the Federal Reserve

2
The Federal Reserve System
  • The Federal Reserve was established in 1913 to
    regulate the banking system
  • There is a Board of Governors (the head) of 7
    members, appointed by the president for 14 year,
    staggered terms
  • The Chairman has a 4 year term and can be
    reappointed multiple times
  • The Federal Open Market Committee (the brain)
    includes the 7 governors, and 5 of the regional
    Federal Reserve Bank presidents (New York region
    always included) and they set monetary policy if
    they need to
  • Federal Advisory Council includes 12 important
    commercial bankers from each FED district who
    advise the Board

3
Federal Reserve System
  • There are 12 district Federal Reserve Banks (the
    body) and 25 regional banks
  • Work with the central bank or FED
  • Each region is quasi-public owned by member
    banks, but controlled by Federal Reserve Board
    and profits go to Treasury
  • They accept reserve deposits and make loans to
    banks and other financial institutions
  • 3 Functions
  • Monetary policy actions that influence money
    supple to control inflation or recession
  • Supervisory role regulate commercial banks
  • Financial services bankers bankhold bank
    deposits in vaults and lend money to banks

4
(No Transcript)
5
Functions of the FED
  • It issues paper currency
  • Sets reserve requirements and holds reserves of
    banks
  • It lends money to banks and charges them interest
  • They are a check clearing service for banks
  • It acts as personal bank for the government
  • Supervises member banks
  • Controls the money supply in the economy

6
How Banks Create Money
  • How do banks create money?
  • By lending out deposits that are used multiple
    times
  • Where do the loans come from?
  • From depositors who take cash and place it in
    their banks
  • How are the amounts of potential loans
    calculated?
  • Using their bank balance sheet, or T-accounts
    that consist of assets and liabilities for banks

7
Bank Liabilities
  • Right side of the T-Account Sheet
  • 1Demand Deposits (DD) or checkable deposits
  • Cash deposits from the public
  • They are liabilities because they belong to
    depositors
  • 2Owners Equity (stock shares)
  • There are values of stocks held by the public
    ownership of bank shares
  • Key concept for AP concerning Liabilities
  • If demand deposit come from someones cash
    holdings, then the DD is already part of money
    supply
  • If the demand deposit comes in from the purchase
    of bonds (by the FED) then this creates new cash
    and therefore creates new Money Supply (M-1)

8
Bank Assets
  • Left side of the T-Account Sheet
  • 1Required Reserves (RR)
  • These are the percentages of demand deposits that
    must be held in the vault so that some depositors
    have access to their money. This amount can
    vary, but AP usually uses 5, 10, or 20 for
    easy calculations
  • 2Excess Reserves (ER)
  • These are the source of new loans. These amount
    are applied to the Monetary Multiplier/Reserve
    Multiplier (DDRR plus ER)
  • 3Bank Property Holdings (buildings and
    fixtures)
  • 4Securities (Federal Bonds)
  • These are bonds purchased by the bank, or new
    bonds sold to the bank by the Federal Reserve.
    These bonds can be purchased from the bank,
    turned into cash that immediately becomes
    available as excess reserves
  • 5Customer Loans
  • This can be amounts held by banks from previous
    transactions, owed to the bank by prior customers

9
Creating Money (using excess reserves)
  • Banks want to create profit. They generate
    profit by lending the excess reserves and
    collecting interest. Since each loan will go out
    into customers and business accounts, more
    loans are created in decreasing amounts (because
    of reserve requirement). A rough estimate of the
    number of loan amounts created by any first loan
    is the money multiplier.
  • The Money Multiplier, a.k.a. Checkable Deposits
    Multiplier, Reserve Multiplier, Loan Multiplier
  • The formula 1 divided by the reserve
    requirement (ratio)
  • RR101/.1Monetary Multiplier of 10
  • Excess Reserves are multiplied by the Multiplier
    to create new loans for the entire banking system
    and this creates new Money Supply

10
Summary
  • Bank Balance Sheet
  • Assets and Liabilities in a T Account
  • Liabilities
  • DD and Owners Equity (Stock Shares)
  • Assets
  • RR, ER, Bank Property, Securities, Loans
  • Assets must equal Liabilities
  • DDRRER
  • Money is Created through Monetary Multiplier
  • ER x 1/RR (Multiplier)New Loans throughout the
    banking system
  • The Money Supply is affected
  • Cash from citizens becomes a DD, but does NOT
    change the Money Supply the ER from this cash
    becomes an immediate loan amount
  • ER x Multiplier becomes New Loans and DOES change
    the Money Supply
  • The Fed Buying bonds creates new loans and
    changes the Money Supply
  • If the Fed buys bonds on the open market, this
    also becomes a new DD amount if the Fed buys
    bonds from accounts already held by a particular
    bank, then the amount only becomes new Excess
    Reserves
  • Finally, bond prices move opposite to the
    changes in interest rates
  • Higher interest rates will push bond prices
    downward (less money supply)
  • Lower interest rates will push bond prices upward
    more money supply)

11
The Three Types of Multiple Deposit Expansion
Question
  • Oops!!!! Type 4 Calculate the change in demand
    deposits

12
The Three Types of Multiple Deposit Expansion
Question
  • Type 1 Calculate the initial change in excess
    reserves
  • a.k.a. the amount a single bank can loan from the
    initial deposit
  • Type 2 Calculate the change in loans in the
    banking system
  • Type 3 Calculate the change in the money supply
  • Sometimes type 2 and type 3 will have the same
    result (i.e. no Fed involvement)

13
Example 1
  • Given a required reserve ratio of 20, assume the
    Federal Reserve purchases 100 million worth of
    US Treasury Securities on the open market from a
    primary security dealer. Determine the amount
    that a single bank can lend from this Federal
    Reserve purchase of bonds.
  • The amount of new demand deposits required
    reserve The initial change in excess reserves
  • 100 million (20 100 million)
  • 100 million 20 million 80 million in ER

14
Example 2
  • Given a required reserve ratio of 20, assume the
    Federal Reserve purchases 100 million worth of
    US Treasury Securities on the open market from a
    primary security dealer. Determine the maximum
    change in loans in the banking system from this
    Federal Reserve purchase of bonds.
  • The initial change in excess reserves The money
    multiplier max change in loans
  • 80 million (1/20)
  • 80 million (5) 400 million max in new loans

15
Example 3
  • Given a required reserve ratio of 20, assume the
    Federal Reserve purchases 100 million worth of
    US Treasury Securities on the open market from a
    primary security dealer. Determine the maximum
    change in the money supply from this Federal
    Reserve purchase of bonds.
  • The maximum change in loans amount of Federal
    Reserve action
  • 400 million 100 million 500 million max
    change in the money supply

16
Example 4
  • Given a required reserve ratio of 20, assume the
    Federal Reserve purchases 100 million worth of
    US Treasury Securities on the open market from a
    primary security dealer. Determine the maximum
    change in demand deposits from this Federal
    Reserve purchase of bonds.
  • The maximum change in loans amount of initial
    deposit
  • 400 million 100 million 500 million max
    change in demand deposits

17
Review
  • Required Reserve Amount of deposit X required
    reserve ratio
  • Excess Reserves Total Reserves Required
    Reserves
  • Maximum amount a single bank can loan the
    change in excess reserves caused by a deposit
  • The money multiplier 1/required reserve ratio
  • Total Change in Loans amount single bank can
    lend X money multiplier
  • Total Change in the money supply Total Change
    in Loans amount of Fed action
  • Total Change in demand deposits Total Change in
    Loans any cash deposited
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