Banking & Finance: Sect. 4.2
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Explain how the Federal Reserve measures
the money supply.
Describe how changes in the money supply
affect interest rates.
Explain how banks create money.
Inflation
Total amount of
money available at a
given time in an
economy
 aka money stock
 Watched and
measured by Federal
Reserve

M1
Currency (coins and
bills) +
Funds deposited in
checking accounts
M2
M3
Savings account
deposits < $100,000
Savings account
deposits > $100,000
Money market
account deposits <
$100,000
Money market
deposits > $100,000
Certificates of
deposit (CDs)
Institutional Money
Market Mutual
Funds
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The Federal Reserve
uses which three
measures to calculate
the money supply?
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Primary way banks make money is by
charging _________ to customers for
__________.
Demand affects interest rates
More people wanting loans, higher interest
rates will be
Dramatic drop in loans during the Great
Recession. Why?

Writing Prompt:
 What is the money supply and describe (in
narrative form) how it is measured.
 Use your own words with subjects and predicates.
FRACTIONAL RESERVE SYSTEM
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Requires banks and other
depository institutions to
keep a fraction of their
deposits in reserves
As banks make loans with
remaining funds, (excess
reserves) money is created
Most money is just
numbers in a computer
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Reserves (required
reserves) are deposits kept
back and not available to
make loans
May be in vault or at
Federal Reserve district
bank (Where’s ours?)
Banks must keep ___% of
deposits in reserves
$1500 (Nia’s deposit) - $150 (10% required reserves) =
$1350 (excess reserves)
What is the fractional
reserve system?
 What are reserves?
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Money Multiplier Effect
Our money is
increased by
the depositand-loan
process of
banks.
Creation of Money
Money Multiplier Effect:
A new deposit increases the money
supply by more than the original deposit
$100 deposit
Excess
reserves:
amount
available by
the bank to
loan
$80
$20
Initial
deposit
$80 deposit
$64
$16
$64 deposit
$51.20
$12.80
$51.20 deposit
$40.76
And so on . . .
$10.24
Amount to be
held by the
bank as 20%
reserve
requirement
Small increase in deposits can lead to a much
larger increase in the money supply
 Fed. Reserve increases bank deposits by
purchasing securities
 Counts on multiplier effect to increase money
supply by a larger amount
 With a 20% reserve requirement:
$500 (increase in dep) /.20 (% of reserve
requirement) = $2500 (potential increase in
money supply)
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If deposits leave banks, there will be less
money to make loans.
 So, money supply will decrease.
 When Fed. Reserve sells securities and
receives money from customers, bank
deposits fall.
 With a 10% reserve requirement:
$500 (decrease in deposits) / .10 (% of reserve
requirement) = $5000 (potential decrease in
money supply)
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When economy slows
down (recession), Fed
tries to stimulate
economy by increasing
money supply
 With a threat of
inflation (rising prices),
Fed decreases the
money supply
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How is money created?
If a bank’s deposits
increase initially by
$2500 and the reserve
requirement is 10%,
what is the potential
increase in the money
supply?
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Describe, in narrative form, how money is
created. Be sure to use and define at least 2
vocabulary terms in your narrative.
Submit in drawer.
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Complete the online post test for Chapter 4
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