Docstoc

Liabilities Assets

Document Sample
Liabilities Assets Powered By Docstoc
					Banks create money!!
               Remember that bank
               deposits are money.
                Banks create bank
             deposits when they make
                      loans.
Creating a Bank
To create a bank, you will need to go through
   the following 8 steps:
1. Obtain a charter to operate a commercial
   bank.
2. Raise some financial capital.
3. Buy some equipment and computer
   programs.
4. Accept deposits
5. Establish a reserve account at a Federal
   Reserve Bank
6. Clear checks
7. But government securities
8. Make loans
Virtual College Bank’s Balance Sheet #1

         Assets              Liabilities
    Cash    $200,000 Owners' Equity $200,000



     A bank charter has been obtained, and Virtual
   College Bank has been able to raise $200,000
   from private individuals.
Virtual College Bank’s Balance Sheet #2

           Assets                  Liabilities
   Cash               $0
   Equipment    $200,000 Owners' Equity       $200,000


    Virtual College Bank uses its financial
   resources to purchase servers, database,
   software, etc.
Virtual College Bank’s Balance Sheet #3

         Assets               Liabilities
  Cash       $120,000 Checkable deposits $120,000
  Equipment    $200,000 Owners' Equity      $200,000


    Virtual College Bank accepts $120,000 in new
   deposits.
   Virtual College Bank’s Balance Sheet #4
                Assets                             Liabilities
Cash                             $0
Reserves at the Dallas FED   $120,000   Checkable deposits $120,000
Equipment                    $200,000   Owners' Equity     $200,000


         We assume the required reserve ratio is 25
       percent. Thus, Virtual College Bank initially has
       required reserves of $30,000 ($120,000 × .25)
       excess reserves of $90,000
•Virtual College depositor Jay writes a check for
$20,000 to buy some computers from Hal’s PCs.
•Hal’s PCs has a checking account with first
American Bank.
•Virtual College and First American Banks are
both located in the Dallas Federal Reserve district.
•The Dallas FED facilitates the check clearing
process.
Federal Reserve Bank of Dallas
                Assets                                 Liabilities
                                        First American Reserves      +$20,000
                                        Virtual College Reserves     -$20,000
            (a) Change in Dallas Fed’s balance sheet

First American Bank
                Assets                                 Liabilities
Reserves at the Dallas FED   +$20,000 Checkable deposits         +$20,000

           (b) Change in First American Bank’s balance sheet


Virtual College Bank
                Assets                                 Liabilities
Reserves at the Dallas FED   -$20,000   Checkable deposits       -$20,000
         (C) Change in Virtual College Bank’s balance sheet
•Virtual college Banks wishes to purchase
$60,000 in government securities.
•First American Bank wishes to sell $60,000 in
government securities.
•Virtual College pays for the securities with a
check.
Federal Reserve Bank of Dallas
               Assets                                    Liabilities
                                            First American Reserves    +$60,000
                                            Virtual College Reserves   -$60,000
           (a) Change in Dallas Fed’s balance sheet

First American Bank
               Assets                                  Liabilities
Reserves at the Dallas FED    +$60,000

Government securities         -$60,000

          (b) Change in First American Bank’s balance sheet
  Virtual College Bank
                 Assets                                  Liabilities
 Reserves at the Dallas FED      -$60,000

 Government securities           +$60,000

         (C) Change in Virtual College Bank’s balance sheet
  Banks may make in
 loans amounts up to,
   but not exceeding,
their holding of excess
        reserves.
   Virtual College Bank’s Balance Sheet #5

                  Assets                            Liabilities
Reserves at the Dallas FED     $40,000 Checkable deposits $100,000
Gov. securities              $60,000    Owners' Equity        $200,000
Equipment                    $200,000
Total assets                 $300,000   Total liabilities     $300,000

 With a .25 required reserve ratio and $100,000 in checkable
  deposits, this bank has required reserves of $25,000.
 Excess Reserves = Total Reserves – Required Reserves.

   Thus for this bank:

   Excess Reserves = $40,000 - $25,000 = $15,000
 Now Virtual College
 Bank makes $15,000
  in loans. The bank
credits the accounts of
   loan recipients by
 $15,000. Keep in the
mind that the loans are
an asset for the bank.
  Virtual College Bank’s Balance Sheet #6
                  Assets                            Liabilities
Reserves at the Dallas FED     $40,000 Checkable deposits $115,000
Gov. securities               $60,000   Owners' Equity        $200,000
Loans                        $15,000
Equipment                    $200,000
Total assets                 $315,000   Total liabilities     $315,000

     After the loans are made and the new deposits
      (money) are created, required reserves are $28,750
      ($115,000 × .25).
     The bank now has excess reserves = $11, 250. Why
      not make more loans?
Virtual College Bank can
anticipate that borrowers
 will quickly spend their
loans by drawing checks
on accounts at the bank.
    The bank must be
    prepared for these
       withdrawals.
Virtual College Bank’s Balance Sheet #7
                  Assets                            Liabilities
Reserves at the Dallas FED     $25,000 Checkable deposits $100,000
Gov. securities               $60,000   Owners' Equity        $200,000
Loans                        $15,000
Equipment                    $200,000
Total assets                 $300,000   Total liabilities     $300,000

  Once borrowers have spent their loans, and checks have
   cleared, checkable deposits have decreased by $15,000
   to $100,000.
  Virtual College Bank “made good” on the checks by
   drawing on its reserve account at the FED.
  Excess reserves are now equal to zero.
  Virtual College Bank still has loans outstanding of
   $15,000
Multiple Creation of Bank Deposits

    The following illustration of the mechanics
  of multiple deposit creation is based on the
  following assumptions:
  •Initially, all banks are “loaned up”—that is,
  have zero excess reserves.
  •The required reserve ratio is 25 percent (or
  .25).
  •Proceeds of all checks written are re-
  deposited in the banking system
Steps in the process
1. Tony Soprano deposits $100,000 in cash
   into a checking account at Virtual College
   Bank. The transaction creates a $75,000
   excess reserve for Virtual College Bank.
2. Virtual College Bank makes a $75,000 loan
   to Amy.
3. Amy writes a check for $75,000 to
   purchase a copy-shop franchise from Barb.
4. Barb deposits a $75,000 check into her
   account at First American Bank. This
   transaction creates a $56,250 excess
   reserve for First American.
5. First American makes a $56,250 loan to Bob.
6. Bob writes a check for $56,250 to Carl to pay off a
   business loan.
7. Carl deposits the check for $56,250 into his account at
   Fleet PC. This transaction creates a $42,187 excess
   reserve for Fleet PC.
8. Fleet PC makes a loan for $42,187 to Emelda.
9. Emelda writes a check for $42,187 to Acme Inc. for
   restaurant equipment.
10.Acme Inc. deposits the check for $42, 187 into its
  account at First e-bank. This transaction creates a
  $31,640 excess reserve for First e-bank.
11.And so on and so on . . .
                                                 The running tally
 Round            The sequence                Reserves Loans Deposits

                          Deposit
                         $100,000
1. Virtual     Reserve         Loan
   College                                    $25,000 $75,000   $100,000
               $25,000        $75,000


                              Deposit
                              $75,000
 2. First      Reserve           Loan         $43,750 $131,250 $175,000
    American   $18,750          $56,250

                                Deposit
                                $56,250

 3. Fleet PC       Reserve           Loan
                                              $57,813   $173,437 $231,250
                   $14,063          $42,187
                                             The running tally
 Round             The sequence           Reserves Loans Deposits

                             Deposit
                             $42,187
4. First e-bank
                  Reserve       Loan      $68,360   $205,077 $273,437
                  $10,547      $31,640
                                                               
                            and                                
                            so on . . .                        
                                          $100,000 $300,000 $400,000
The process summarized
  Notice that at each stage of the process the loan is 75
 percent (0.75) of the previous loan and the deposit is 75
 percent (0.75) of the previous deposit. Let L denote this
 proportion. Thus the sequence is described by:

           1  L  L  L  ...
                  2     3      4


 The total change in deposits when the process
 is complete is given by:

            1
                 Initial change in reserves
           1 L
Do the math

$100,000  75,000  56,250  42,187  ...
 $100,000  (1  0.75  0.5625  0.42187  ...)
 $100,000  (1  0.75  0.752  0.753  ...)
                  1
 $100,000 
             (1  0.75)
               1
 $100,000         $100,000  4  $400,000
             0.25
         The Deposit Multiplier
 The deposit multiplier is the number by which an increase
in bank reserves is multiplied to find the resulting increase
in bank deposits. That is:

  Change in deposits = Deposit multiplier × Change in reserves

  The deposit multiplier is linked to the required
 reserve ratio by the following equation

                                           1
       Deposit Multiplier =
                                 Required reserve ratio
Open Market Operations
 Now we will illustrate
     how FED open
   market operations
   impact the reserve
       positions of
  commercial banks—
 and hence their ability
   to make loans and
     create money.
   When the FED buys
  securities on the open
 market, it pays for them
 with newly created bank
reserves. We will illustrate
       how it works.
FED Buys Securities
 Suppose the FED buys $100 million is
   securities from Manhattan Commercial
   Bank. What happens then?
 1. The Manhattan commercial bank has $100
    million less in securities, and the FED has
    $100 million more in securities.
 2. To pay for the securities, the FED increases
    Manhattan Commercial Bank’s reserve
    account at the New York FED by $100
    million.
      The FED Buys Securities From a Commercial Bank

Federal Reserve Bank of New York
                Assets                                 Liabilities
Securities               +$100 million   Reserves of Manhattan
                                         Commercial Bank       +$100 million

   The FED buys securities                . . .and pays for the securities
   from a commercial bank . . .           by increasing the reserves of
                                          the commercial bank .

Manhattan Commercial Bank
                Assets                              Liabilities
Securities               -$100 million

Reserves                 +$100 million
The Multiplier Effect of an Open
Market Operation
 •An open market purchase creates excess reserves.
 •Banks lend excess reserves.
 •Bank deposits increase.
 •The quantity of money increases.
 •New money is used to make payments.
 •Some of the new money is held as currency.
 •Some of the new money remains in deposits at the bank.
 •Banks’ required reserves increase
 •Excess reserves decrease but remain positive.
A Round in the Multiplier Process Following an Open
Market Operation
                       Banks lend
           Excess      excess
           reserves    reserves           Banks
                                          deposits
                                          increase


Open                                           Quantity of
market                                         money
purchase                                       increases


           Excess       Money that      New money
           reserves     remains in      used to make
                        deposits        payments
           Required
           reserves
           increase
                       Currency
                       drain
Note:
Required
reserve ratio
is 10 percent
              The Money Multiplier
     This version of the multiplier takes into account cash
   drains:
Change in the quantity of money  Money multiplier  Change in monetary base

    The monetary base consists of bank reserves and
   currency in circulation. Thus we have:
    Change in the quantity of money  2.5  $100,000  $250,000

    The total amount of new money created by as a
  result of an open market operation is described by
                                   1
      Quantity of money created        Open market purchase
                                  1- L

                                               Money multiplier
                What is L?
              L  (1  C )  (1  R)
  Where C is the proportion of new money that is held
as currency and R is the required reserve ratio.

In our example, C = 0.33 and R = .10. Thus:

        L  (1  0.33)  (1  0.1)  0.6
   Notice that, the value of L is inversely related
 to the values of C and R
Do the math

                                         1
Quantity of money created  $100,000
                                      (1- 0.6)
              1
 $100,000 
             0.4
 $10,000  2.5
 $250,000

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:7
posted:11/5/2012
language:Unknown
pages:34