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Outline
In this chapter, we study the channel in
circular flow diagram
Consumers
Money creation
I
Bank
Investor
Unit of account
Standard unit quoting prices
Store of value
Store wealth
15
Figure 2
Two definitions of the money supply, December 2007
16
Credit cards
Not included in money supply
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26
27
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Reserve requirements
Minimum amount of reserves
Proportional to volume of deposits
Table 1
Balance sheet of Bank-a-mythica,
December 31, 2007
Assets
Assets
Reserves
Loans outstanding
Total
Addendum: Bank
Reserves
Actual reserves
Required reserves
Excess reserves
$5,000,00
0
$500,000
$5,500,0
00
31
Excess reserves
Reserves held in excess of legal
minimum
Earn no interest
32
Table 2
Changes in Bank-a-mythicas balance sheet,
January 2, 2008
Assets
Reserves
Addendum: Changes in
Reserves
Actual reserves
Required reserves
Excess reserves
+
$100,00
0
+
$100,000
+$
20,000
+$
80,000
33
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Table 3
Changes in Bank-a-mythicas balance sheet,
January 36, 2008
Assets
Loans outstanding
Reserves
Addendum: Changes in
Reserves
Actual reserves
Required reserves
Excess reserves
No change
-$80,000
No
change
$80,000
35
Table 4
Changes in Bank-a-mythicas balance sheet,
January 26, 2008
Assets
Reserves
Loans outstanding
Addendum: Changes in
Reserves
Actual reserves
Required reserves
Excess reserves
Checking
deposits
+
$100,00
0
+
$20,000
+
$20,000
No
change
36
Table 5
Changes in First National Banks balance sheet
Assets
Reserves
Loans outstanding
Addendum: Changes in
Reserves
Actual reserves
Required reserves
Excess reserves
Checking
deposits
+
$80,000
+
$16,000
+
$16,000
No
change
37
Table 6
Changes in Second National Banks balance sheet
Assets
Reserves
Loans outstanding
Addendum: Changes in
Reserves
Actual reserves
Required reserves
Excess reserves
Checking
deposits
+
$64,000
+
$12,800
+
$12,800
No
change
38
1
1 R R R ...
1 R
2
39
Figure 3
The chain of multiple deposit creation
40
Money multiplier
ratio of newly created bank deposits to new
reserves
Change in money supply=(1/m) Change in reserves
41
Money Multiplier
Money multiplier
=deposit / reserve
= 1 / legal reserve requirement (m)
Table 7
Changes in the balance sheet of Bank-a-mythica
(a)
Assets
Reserves
Addendum: Changes in
Reserves
Actual reserves
Required reserves
Excess reserves
Assets
Reserves
Loans outstanding
Addendum: Changes in
Reserves
Actual reserves
Required reserves
$100,000
-$20,000
(b)
$80,000
+
$80,000
-$80,000
+
$80,000
$100,00
0
44
Table 8
Changes in the balance sheet of First National Bank
(a)
Assets
Reserves
Addendum: Changes in
Reserves
Actual reserves
Required reserves
Excess reserves
-$80,000
-$16,000
$64,000
(b)
Assets
Reserves
Loans outstanding
Addendum: Changes in
Reserves
Actual reserves
Required reserves
$80,000
No change
45
2.Every bank
Must hold reserves - legal minimum
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Aggravate recession
Milton Friedman believed this is the cause
of Great Depression
Need government intervention
50
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Summary