Please answer these questions from the outline, see the attached file and picture from the text book Start with the textbook to get familiar with the content and progression of the lecture. Then, go to videos and supplemental articles, if provided, for further clarification and additional examples. TextbookRead carefully pages 685-686 and 695-698 from the textbook. VideoMoney creationhttp://www.youtube.com/watch?v=pZRvja7Mvrw&list=PLF2A3693D8481F442&index=30More on money creationhttps://www.khanacademy.org/economics-finance-domain/macroeconomics/monetary-system-topic/macro-banking-and-the-expansion-of-the-money-supply/v/overview-of-fractional-reserve-bankinghttps://www.khanacademy.org/economics-finance-domain/macroeconomics/monetary-system-topic/macro-banking-and-the-expansion-of-the-money-supply/v/money-creation-in-a-fractional-reserve-system-ap-macroeconomics-khan-academyMoney multiplierhttps://mru.org/courses/principles-economics-macroeconomics/federal-reserve-money-multiplierOutline for Lecture 20
The Fractional Reserve System
In fractional reserve systems, what percentage of checkable deposits is held in reserves by
commercial banks: all, some, none?
Why are fractional reserve systems vulnerable to bank runs? What can banks do to alleviate the
vulnerability? What can the government do to alleviate the vulnerability?
The Banking System: Multiple Deposit Expansion
We divide the money creation process into several steps.
Step 1: Suppose that the central bank conducts a policy action to provide Person 1 with $100 of
currency. Person 1 uses the funds to make purchases from Firm 1, which deposits its earnings in
Bank 1.
Because checkable deposits are part of money supply, an increase in checkable deposits of $100
raises money supply of $100 at the end of step 1.
Step 2: Suppose that the required reserve ratio (r) is 10 percent; the central bank requires that
commercial banks retain 10 percent of checkable deposits in reserves. Then, Bank 1 keeps $10
(10 percent of $100) in required reserves and lends the remaining $90 ($100 – $10) to Person 2.
Person 2 uses the funds to make purchases from Firm 2, which deposits its earnings in Bank 2.
At the end of step 2, Firm 1 still has $100 of checkable deposits in Bank 1 and Firm 2 has $90 of
checkable deposits in Bank 2, indicating that the total increase in checkable deposits and money
supply is $190 ($100 + $90).
Step 3: Bank 2 keeps $9 (10 percent of $90) in required reserves and lends the remaining $81
($90 – $9) to Person 3. Person 3 uses the funds to make purchases from Firm 3, which deposits
its earnings in Bank 3.
At the end of step 3, Firm 1 still has $100 of checkable deposits in Bank 1, Firm 2 still has $90 of
checkable deposits in Bank 2, and Firm 3 has $81 of checkable deposits in Bank 3, indicating
that the total increase in checkable deposits and money supply is $271 ($100 + $90 + $81).
Further Steps: As commercial banks keep making loans for the full amount of excess reserves
(that is, deposits received minus required reserves) new checkable deposits are created in each
step, leading to further increases in money supply.
However, checkable deposits and money supply rise by smaller amounts ($100, $90, $81, etc.)
because 10 percent of deposits are set aside as required reserves in each step.
The Monetary Multiplier
Total increase in checkable deposits and money supply is determined by money multiplier (m).
In our example, for a reserve ratio (r) of 10 percent or 0.1, money multiplier is 10.
= 1⁄ = 1⁄0.1 = 10
A multiplier of 10 indicates that for every $1 the central bank injects into the economy $10 of
new checkable deposits are created and so money supply rises by $10.
Accordingly, the central bank’s provision to Person 1 of $100 in Step 1 raises checkable deposits
and money supply by a total of $1,000 (10 * $100) at the end of money creation process.
Example
Suppose that the central bank conducts a policy action to provide Person X with $200. Suppose
further that the required reserve ratio (r) is 5 percent or 0.05.
Following the template from above, describe the money creation process, providing three steps
and a generalization (further steps).
In this case, what is money multiplier (m)? What is the total increase in checkable deposits and
money supply at the end of money creation process?
Materials for Lecture 20
Start with the textbook to get familiar with the content and progression of the lecture. Then, go to
videos and supplemental articles, if provided, for further clarification and additional examples.
Textbook
Read carefully pages 685-686 and 695-698 from the textbook.
Video
Money creation
More on money creation
https://www.khanacademy.org/economics-finance-domain/macroeconomics/monetary-systemtopic/macro-banking-and-the-expansion-of-the-money-supply/v/overview-of-fractional-reservebanking
https://www.khanacademy.org/economics-finance-domain/macroeconomics/monetary-systemtopic/macro-banking-and-the-expansion-of-the-money-supply/v/money-creation-in-a-fractionalreserve-system-ap-macroeconomics-khan-academy
Money multiplier
https://mru.org/courses/principles-economics-macroeconomics/federal-reserve-money-multiplier
个
o
Page 695
The Banking System: Multiple-Deposit Expansion
LO35.4
Describe the multiple expansion of loans and money by the entire banking system.
We have seen that a single bank can lend one dollar for each dollar of its excess reserves. The situation is different for all commercial banks
as a group. Indeed, the commercial banking system can lend-that is, can create money-by a multiple of its excess reserves. This multiple
lending occurs even though each bank in the system can lend only “dollar for dollar” with its own excess reserves.
How do these seemingly paradoxical results come about? To answer this question succinctly, we make three simplifying assumptions:
• The reserve ratio for all commercial banks is 20 percent.
Initially, all banks are meeting this 20 percent reserve requirement exactly. No excess reserves exist; or, in the parlance of banking, the
banks are “loaned up” (or “loaned out”).
If any bank can increase its loans as a result of acquiring excess reserves, an amount equal to those excess reserves will be loaned to one
borrower, who will write a check for the entire amount of the loan and give it to someone else, who will deposit the check in another
bank. This third assumption means that the worst thing possible happens to every lending bank-a check for the entire amount of the loan
is drawn and cleared against it in favor of another bank, thereby reducing the first bank’s quantity of excess reserves and its ability to
generate a profit by extending additional loans at interest.
Significant Characteristics of Fractional Reserve Banking
The goldsmith story highlights two significant characteristics of fractional reserve banking. First, banks can create money through lending.
In fact, goldsmiths created money when they made loans that were not fully backed by gold reserves. The quantity of such money goldsmiths
could create depended on the amount of reserves they deemed prudent to have available. The smaller the amount of reserves thought
necessary, the larger the amount of paper money the goldsmiths could create. Today, gold is no longer used as bank reserves. Instead,
currency itself serves as bank reserves so that the creation of checkable-deposit money by banks (via their lending) is limited by the amount
of currency reserves that the banks feel prudent, are required by law, to keep.
A second reality is that banks operating on the basis of fractional reserves are vulnerable to “panics” or “runs.” A goldsmith who issued
paper money equal to twice the value of his gold reserves would be unable to convert all that paper money into gold in the event that all the
holders of that money appeared at his door at the same time demanding their gold. In fact, many European and U.S. banks were once ruined
by this unfortunate circumstance. However, a bank panic is highly unlikely if the banker’s reserve and lending policies are prudent. Indeed,
one reason why banking systems are highly regulated industries is to prevent runs on banks.
This is also why the United States has the system of deposit insurance that we mentioned in the last chapter. By guaranteeing deposits,
deposit insurance helps to prevent the sort of bank runs that used to happen so often before deposit insurance was available. In those
situations, rumors would spread that a bank was about to go bankrupt and that it only had a small amount of reserves left in its vaults. Bank
runs are called “bank runs” because depositors would literally run to the bank trying to be one of the lucky few to withdraw their money
while the bank had any reserves left. The rumors were usually totally unfounded. But, unfortunately, a bank could still go bankrupt even if it
began the day with its normal amount of reserves. With so many customers withdrawing money simultaneously, it would run out of reserves
and be forced to default on its obligations to its remaining depositors. By guaranteeing depositors that they will always get their money back,
deposit insurance removes the incentive to try to withdraw one’s deposit before anyone else can. It thus forestalls most bank runs.
UURShen
M MHE Reader
Assets
Liabilities and net worth
Reserves
$+100 (a)
Checkable deposits
$+100 (21)
-80 (a3)
+80 (az)
Loans
+80 (az)
-80 (a3)
Recall from transaction 3 that this $100 deposit of currency does not alter the money supply. While $100 of checkable-deposit money
comes into being, it is offset by the $100 of currency no longer in the hands of the public (the junkyard owner). But bank A has acquired
excess reserves of $80. Of the newly acquired $100 in currency, 20 percent, or $20, must be earmarked for the required reserves on the new
$ 100 checkable deposit, and the remaining $80 goes to excess reserves. Remembering that a single commercial bank can lend only an
amount equal to its excess reserves, we conclude that bank A can lend a maximum of $80. When bank A makes a loan for this amount, its
loans increase by $80 and the borrower gets an $80 checkable deposit. We add these figures–entries (a2)—to bank A’s balance sheet.
Now we make our third assumption: The borrower uses the full amount of the loan ($80) to write a check ($80) to someone else, and that
Derson deposits the amount in bank B, a different bank. As we saw in transaction 6, bank A loses both reserves and deposits equal to the
oan amount, as indicated in entries (az). The net result of these transactions is that bank A’s reserves now stand at +$20 (= $ 100 – $80),
oans at +$80, and checkable deposits at +$100 (= $100 + $80 – $80). When the dust has settled, bank A is just meeting the 20 percent
reserve ratio.
Recalling our previous discussion, we know that bank B acquires both the reserves and the deposits that bank A has lost. Bank B’s Page 696
wat
bangodecin antro..
15 urawi anu vicarvu agamot i II tavoi vi anvu1 Vann, UTUT Oy Tvuung WU HIDt valin quantity UI VALUSS TUSUTVs and its amy to
generate a profit by extending additional loans at interest.
The Banking System’s Lending Potential
Suppose a junkyard owner finds a $ 100 bill while dismantling a car. He deposits the $100 in bank A, which adds the $100 to its reserves. We
will record only changes in the balance sheets of the various commercial banks. The deposit changes bank A’s balance sheet as shown by
entries (a):
MULTIPLE-DEPOSIT EXPANSION PROCESS
Balance Sheet: Commercial Bank A
Assets
Liabilities and net worth
Reserves
$+100 (21)
Checkable deposits
$+100 (a)
-80 (az)
+80 (az)
Loans
+80 (az)
-80 (az)
Recall from transaction 3 that this $100 deposit of currency does not alter the money supply. While $100 of checkable-deposit money
comes into being, it is offset by the $100 of currency no longer in the hands of the public (the junkyard owner). But bank A has acquired
Purchase answer to see full
attachment
Why Choose Us
- 100% non-plagiarized Papers
- 24/7 /365 Service Available
- Affordable Prices
- Any Paper, Urgency, and Subject
- Will complete your papers in 6 hours
- On-time Delivery
- Money-back and Privacy guarantees
- Unlimited Amendments upon request
- Satisfaction guarantee
How it Works
- Click on the “Place Order” tab at the top menu or “Order Now” icon at the bottom and a new page will appear with an order form to be filled.
- Fill in your paper’s requirements in the "PAPER DETAILS" section.
- Fill in your paper’s academic level, deadline, and the required number of pages from the drop-down menus.
- Click “CREATE ACCOUNT & SIGN IN” to enter your registration details and get an account with us for record-keeping and then, click on “PROCEED TO CHECKOUT” at the bottom of the page.
- From there, the payment sections will show, follow the guided payment process and your order will be available for our writing team to work on it.