Macro Chapter 13
Money and the Banking System
6 Learning Goals
1) List and describe the functions of money (on
your own)
2) Define the alternative measures of money and
distinguish between M1 and M2 (on your own)
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?
6 Learning Goals
1) List and describe the functions of money (on
your own)
Clicker Extra Credit: 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
Video that illustrates how someone can be
irrational about money:
How is the Money
Supply Measured?
6 Learning Goals
2) Define the alternative measures of money and
distinguish between M1 and M2 (on your own)
The Business of Banking
Clicker Extra Credit: 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
Video:
Example of bank run:
Discuss this question with a neighbor
before answering
Q13.2 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.
25%
25%
25%
25%
60
1
2
3
4
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:
Class Activity:
Illustration of how excess reserves are
used to “create” money
Create this table:
Bank
Deposit
Required Reserves Loans
Here’s how excess reserves are
used to “create” money:
See files “deposit creation.pdf” and
“deposit multiplier.pdf” on BB
Key points:
(1) Commercial banks are required to
keep a portion of their deposits as
reserves at the Federal Reserve Bank or
as cash in the vault
– These are required reserves
– Equal to 10% of deposits (for most banks);
called the required reserve ratio
Key points:
(2) Commercial banks may keep or loan
out additional reserves
– These are excess reserves
– Excess reserves earn interest from the
Federal Reserve Bank, so the commercial
bank must decide where it’s earning the
biggest return- by loaning them out or by
keeping them with the Fed
Key points:
(3) The potential deposit expansion
multiplier is equal to 1 / required reserve
ratio
– Example: 1 / 0.10 = 10
– So $1 could create $10 in new deposits
(4) But the actual deposit expansion
multiplier could be less
– If one or more banks lend less than all of their
excess reserves the multiplier is less
– If one banks doesn’t lend any, the whole
process stops and the multiplier is less
Caution and Clarification!
“The multiplier” will refer to the Keynesian
multiplier in Chapters 11 & 12
The “deposit multiplier” will refer to the
deposit expansion multiplier in Chapters
13 & 14
Any quiz or exam question should put the
multiplier in context and it should be easy
to determine which one to think about
2 Transmitter Questions Next
Q13.3 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 initially no change in the supply of money; your
bank's excess reserves are reduced by $800.
2. There is initially no change in the supply of money; your
bank's excess reserves are reduced by $200.
3. The money supply immediately increases by $1,000, and
the excess reserves of your bank are reduced by $800.
4. The money supply immediately increases by $1,000, and
the excess reserves of your bank are reduced by $200.
25%
25%
25%
25%
60
1
2
3
4
Now discuss that question with your
partner and we’ll redo the question
Q13.4 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 initially no change in the supply of money; your
bank's excess reserves are reduced by $800.
2. There is initially no change in the supply of money; your
bank's excess reserves are reduced by $200.
3. The money supply immediately increases by $1,000, and
the excess reserves of your bank are reduced by $800.
4. The money supply immediately increases by $1,000, and
the excess reserves of your bank are reduced by $200.
25%
25%
25%
25%
60
1
2
3
4
Q13.5 (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
14%
1
14%
2
14%
3
14%
4
14%
5
14%
6
14%
7
Banks do not create money like this:
The Federal Reserve
System
A quick look at the Fed:
13-6a Structure of the Fed
Skim this section, pages 258-261
You will not be asked any detailed
questions about the Fed structure on the
exam
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
Transmitter question next
Q13.6 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.
25%
25%
25%
4. Both decrease.
1
2
3
25%
4
60
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.
First, we need to look like bankers
Create the following three
T accounts
Bank: (make up your own name)
Assets
Required Reserves
Liabilities + Net Worth
Deposits
Excess Reserves
0
Bonds
800
Net Worth
Loans
Total
Total
5,000
Suppose the Fed buys $100 of bonds
Two-step process
Step 1: The bond transaction
Assets
Required Reserves
Liabilities + Net Worth
Deposits
Excess Reserves
Bonds
Net Worth
Loans
Total
Total
Step 2: The actions of the bank
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
Two Transmitter Questions Next
Q13.7 (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
25%
25%
25%
25%
60
1
2
3
4
Q13.8 (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
25%
25%
25%
25%
60
1
2
3
4
How do open market operations
affect the discount rate and
federal funds rate?
The Fed is referred to as the “lender of last
resort”
If a bank needs money to meet its required
reserve ratio, it goes to the federal funds
market first- borrow from other banks at
the federal funds interest rate
If it can’t borrow there, then go to the Fed
and pay the discount rate
When the Fed buys and sells
securities, it shifts supply in the
federal funds market
Buy securities- shift supply right
Sell securities- shift supply left
Graph:
See Fed press release
What is Quantitative Easing
(QE)?
It’s nothing more than the Fed buying
certain kinds of bonds to lower interest
rates
Important section to read:
13-6d The Fed and The Treasury, pages
267-268
6 Learning Goals
1) List and describe the functions of money (on
your own)
2) Define the alternative measures of money and
distinguish between M1 and M2 (on your own)
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