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lecture 18 & 19 ~ chapter 10.docx

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Hannah Holmes

How do banks create money? Fractional-reserve banking  Fractional-reserve banking: a banking system in which a bank holds only a fraction of deposits as reserves  creates money that otherwise would not exist  banks can make loans to other people from your money (charge interest rate)  but don’t give all money in loans incase of withdrawals  reserve ratio: the fraction of total deposits that a bank holds as reserves  reserves are the cash they keep in the vault, in the drawers and in the bank machines Demonstration This classroom is a closed economy. I have $50000 in currency and there is no banking system.  What is the current money supply? M = C + D = $50000 + 0 = $ 50000  Now, I deposit my $50,000 into a bank. The reserve ratio is 50% M = C + D = $3125 + $50000 + $25000 + $12500 + $6250 (putting in bank, bank giving loan, person buying something, seller get money and puts in bank, etc) = $ 96 875 (50000/.5) *without money, would use barters *money allows us to take advantage of specialization and trade Money creation using T-accounts  Balance sheets of a banks  Assets = liabilities  Reserve ratio = 20%  Suppose someone deposits $100. What happens immediately? What happens after all adjustments have taken place? - initially full amount - then only need 20% Money Multiplier  money multiplier: the amount the baking system generates with each dollar of reserves Example Suppose the reserve ratio is 5%. If $100 is deposited into the banking system, what happens to total deposits? Money multiplier = 1/.05 = 20 x 100 = 2000 Deposits increases by $2000 ?M=C+D  what happens to the money supply? Depends on where it came from *** understand Bank of Canada  established in 1935  bank of Canada is Canada’s central bank o bank of England o bank of
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