Banks and the Creation of Money

Banks and the Creation of Money

Bank Balance Sheets

Key Concepts Notes for an AP Macro Class

       I.            How do banks “create” money? Banks “create” money by lending deposits.

    II.            Where do the loans come from? Loans come from deposits who take cash and place it into accounts of the bank.

 III.            How are the amounts of potential loans calculated? They are calculated by

Bank Liabilities (the right side of the T-Account Sheet):

#1= Demand deposits (DD) or checkable deposits (CD)

-cash deposits from the public

- are a liability because they belong to the depositors and can be withdraw by depositors

#2- owner’s equity stocks held by the public ownership of bank shares

Key concept for AP concerning liabilities:

-         If DD comes in from someone’s cash holdings, then that DD is already of the money supply

-         If the DD comes in from the purchase bonds (by the FED), then this creates new cash, and therefore creates new money supply  

Bank Assets (the left side of the T Account Sheet):

#1= Required reserves (RR)- percentages of demand deposits that must be held the vault, so that some depositors have access to their money (5%,10%,20%)

#2=Excess Reserves (ER) is the source of new loans

#3=Property

#4=Securities (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 become available as ER.

#5=Loans

The Monetary Multiplier (also known as): Tax and spending multiplier

The formula is simple: 1 divided by the reserve requirement (ratio)= 1/RRR

Excess reserves are multiplied by the multiplier