Macro Chapter 13
Money and the Banking System
6 Learning Goals
1) List and describe the functions of money
2) Define the alternative measures of money and
distinguish between M1 and M2
3) Explain fractional reserve banking
4) Investigate how banks create money by
extending loans
5) List the tools used by the Fed to control the
money supply
6) Analyze how those tools change the money
supply
What is Money?
3 functions of money
1) Medium of exchange
2) Store of value
3) Unit of account
Optional video about money titled
“History Channel US Mints- paper
and coin production”
Look for the following:
When and why the federal government
started printing money
Where the US Mint locations are
Where the Bureau of Engraving and
Printing has locations
How much currency is printed and where it
is
How is the Money
Supply Measured?
2 Measures of Money
M1 = most liquid assets, i.e. cash or the
easiest to turn in to cash
M2 = less liquid, but still able to turn in to
cash
demand deposits = checking accounts;
can get your money “on demand”
Credit cards are NOT money!
The Business of Banking
Optional video about banks titled
“History Channel Banks-Banking
history”
Look for the following:
When and where was the first bank
formed in the US?
How did Bank of America get started?
When were credit cards first created and
how did they change to the way they are
today?
Explanation of fractional reserve
banking
Watch Video: FTC80_03-fractional
reserve banking
Example of bank run:
Watch Video: It’s a Wonderful Life-bank
run
Q13.1 If you have a checking account at a
local bank, your bank account there is
1. an asset to the bank and an asset to you.
2. a liability of the bank and a liability of
yours.
3. a liability of the bank and an asset to you.
4. an asset to the bank and a liability of
yours.
Typical assets and liabilities of
banks:
Assets:
– Vault cash
– Reserves at the Fed
– Loans to customers
– Bonds (i.e. securities)
Liabilities:
– Checking deposits
– Savings deposits
– Borrowings
How Banks Create
Money by Extending
Loans
Explanation of money creation process:
Watch video “FTC80_03-money creation
process”
Here’s how excess reserves are
used to “create” money:
See files “deposit creation.pdf” and
“deposit multiplier.pdf”
Key points:
(1) Banks are required to keep a portion of
their deposits as reserves at the Federal
Reserve Bank
– These are required reserves
– Roughly equal to 10% of deposits
(2) Banks may keep or loan out additional
reserves
– These are excess reserves
– Excess reserves earn interest from the
Federal Reserve, so the bank must decide
where it’s earning the biggest return- by
loaning them out or by keeping them with the
Fed
Q13.2 Suppose you withdraw $1,000 from your
checking account. If the reserve requirement is 20
percent, how does this transaction affect the supply of
money and the excess reserves of your bank?
1. There is no change in the supply of money; your bank's
excess reserves are reduced by $800.
2. There is no change in the supply of money; your bank's
excess reserves are reduced by $200.
3. The money supply increases by $1,000, and the excess
reserves of your bank are reduced by $800.
4. The money supply increases by $1,000, and the excess
reserves of your bank are reduced by $200.
Q13.3 (MA) Suppose you deposit $1,000 into your
checking account. If the reserve requirement is 10 percent,
what impact does this transaction have?
1.
2.
3.
4.
5.
6.
7.
The money supply increases
The money supply remains the same
The bank’s required reserves increase by $100
The bank’s required reserves decrease by $100
The bank’s required reserves increase by $900
The bank can make new loans of $900
The bank can make new loans of $1,000
The Federal Reserve
System
A quick look at the Fed:
Watch video Catch Me If You Can- check
routing
Four tools of the Fed to control the
money supply:
1) Reserve requirements
2) Open Market Operations
3) Extend loans
4) Interest paid on excess and required
reserves
Expansionary Monetary Policy:
Buy securities (i.e. bonds, Treasury or
other)
Extend more loans
Reduce the interest rate paid on reserves
Restrictive Monetary Policy:
Sell securities (i.e. bonds, Treasury or
other)
Extend fewer loans
Increase the interest rate paid on reserves
Q13.4 If the Fed lends to member banks, what
happens to reserves and the money supply?
1. Reserves increase and the money supply
decreases.
2. Both increase.
3. Reserves decrease and the money supply
increases.
4. Both decrease.
Open market operations is the key
tool the Fed uses
Open market operations is the buying and
selling of bonds, usually US Treasury
securities
Class Activity:
Let’s see how this works
Copy this activity into your notes. I think it
will be helpful to study later.
Watch video: Macro Chapter 13 contentFed buys bonds
Bank: (make up your own name)
Assets
Required Reserves
Liabilities + Net Worth
Deposits
Excess Reserves
Bonds
Net Worth
Loans
Total
Total
Results:
New excess reserves at your bank = $100
Impact on money supply = $100 / 0.10 =
$1,000
Q13.5 (MA) When the Fed sells Treasury Bonds
on the open market, it will tend to
1.
2.
3.
4.
increase the money supply
decrease the money supply
increase interest rates
decrease interest rates
Q13.6 (MA) When the Fed buys Treasury Bonds
on the open market, it will tend to
1.
2.
3.
4.
increase the money supply
decrease the money supply
increase interest rates
decrease interest rates
Question Answers
13.1 = 3
13.2 = 1
13.3 = 2, 3, 6
13.4 = 2
13.5 = 2, 3
13.6 = 1, 4