Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides...
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Transcript of Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIver Slides...
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-1
Chapter 10
How banks create money
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-2
Learning objectives• Describe the simplified balance sheets of
a single bank and the banking system• Explain the money-creating abilities of a single bank
that is part of a multibank system• Explain the money-creating abilities of the
banking system as a whole through multiple-deposit expansion, and compare this with the money-creating abilities of the single bank
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-3
Learning objectives (cont.)• Define the monetary (or credit) multiplier• Discuss some of the limitations on the banking
system’s ability to create deposits and expand the money supply
• Describe how the banks’ lending activities may contribute to financial instability and to increased fluctuations in the level of economic activity
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-4
Balance sheet• A statement of assets and claims that summarises
the financial position of a firm at a point in time• Each side balances:
– Assets are items of economic and financial value
– Assets = Liabilities + Net worth
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-5
Formation of a bank• Transaction (1): The birth of a bank
– New owners sell $250 000 worth of shares in the bank
Assets $
Liabilities & Net worth $
Cash 250 000 Capital stock 250 000
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-6
Formation of a bank (cont.)• Transaction (2): Becoming a going concern
– Acquisition of property and equipment
Assets $
Liabilities & Net worth $
Cash 10 000 Property 240 000
Capital stock 250 000
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-7
Formation of a bank (cont.)• Transaction (3): Accepting deposits
– Citizens and businesses deposit $100 000
– Change in composition not total supply of money
Assets $
Liabilities & Net worth $
Cash 110 000 Property 240 000
Deposits 100 000 Capital stock 250 000
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-8
Formation of a bank (cont.)• Required reserve ratio
– The ratio of reserves to deposits to meet official liquidity requirements
• Transaction (4): Setting aside required reserves– Assume reserve ratio is 20%
– Bank must keep $20 000 (required reserves)
Reserve ratio = banks required reservebanks deposit liabilities
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-9
Formation of a bank (cont.)– Bank decides to keep $110 000 (actual reserves),
which is $90 000 more than required (excess reserves)
– Bank’s required reserves are 20% of $100 000
Assets $
Liabilities & Net worth $
Cash 0 Reserves 110 000 Property 240 000
Deposits 100 000 Capital stock 250 000
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-10
Formation of a bank (cont.)• Transaction (5): Drawing a cheque
– A citizen who has substantial deposits in the bank draws a cheque for $50 000 to buy goods
– The seller of the goods deposits the cheque in another bank
– The banking system as a whole has not lost or gained
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-11
Formation of a bank (cont.)
Assets $
Liabilities & Net worth $
Reserves 60 000 Property 240 000
Deposits 50 000 Capital stock 250 000
Transaction (5): Drawing a cheque (cont.)
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-12
Creating money
• Transaction (6): Granting a loan– A company borrows $50 000 from the bank
– Money is created
– Balance sheet after loan is negotiated:
Assets $
Liabilities & Net worth $
Reserves 60 000 Loans 50 000 Property 240 000
Deposits 100 000 Capital stock 250 000
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-13
Creating money (cont.)Balance sheet after cheque drawn on loan has been cancelled:
Now, bank has no excess reserves
Assets $
Liabilities & Net worth $
Reserves 10 000 Loans 50 000 Property 240 000
Deposits 50 000 Capital stock 250 000
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-14
Creating money (cont.)• Transaction (7): Buying government bonds
– Bank buys $50 000 of government bonds instead of lending $50 000
– Money is created
Assets $
Liabilities & Net worth $
Reserves 60 000 Bonds 50 000 Property 240 000
Deposits 100 000 Capital stock 250 000
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-15
The banking system• Multiple banks: multiple-deposit expansion• Money is created by a multiple of the banking
system’s excess reserves
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-16
Multiple-deposit expansion
• Assume initially: 20% reserve requirement • Bank A
– Accepts a deposit for $100 Does not alter money supply Excess reserves of $80
– A loan of $80 is negotiated
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-17
Multiple-deposit expansion (cont.)• Balance sheet: Bank A
Assets $
Liabilities & Net worth $
Reserves +100 –80 Loans +80
Current deposits +100 +80 –80
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-18
Multiple-deposit expansion (cont.)• Loan cheque of $80 is drawn on Bank A
and deposited in Bank B• Bank B
– Gains $80 in reserves and deposits
– Excess reserves of $64
– Loans $64
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-19
Multiple-deposit expansion (cont.)• Bank B
• Loan cheque of $64 is drawn on Bank B and deposited in Bank C, and so on …
Assets $
Liabilities & Net worth $
Reserves –80 –64 Loans +80
Current deposits +80 +64 –64
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-20
Multiple deposit expansion process
BankAcquired reserves
and depositsRequiredreserves
Excessreserves
$80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.57
ABCDEFGHIJKLMNOther banks
$100.00 80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 21.97
$20.00 16.00 12.80 10.24 8.19 6.55 5.24 4.20 3.36 2.68 2.15 1.72 1.37 1.10 4.40
$80.00 64.00 51.20 40.96 32.77 26.22 20.98 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.57
$400.00$400.00Total amount of money created by the banking system
New moneycreated
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-21
Multiple-deposit expansion (cont.)• Total banking system has created $400• How?
– Via the monetary multiplier
– Where m is the monetary multiplier
1
R
1
reserve ratiomonetary multiplier =
m =
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-22
Multiple-deposit contraction
• The multiple credit expansion process is reversible and leads to a multiple reduction in the level of deposits — and hence the supply of money — if reserves are withdrawn
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-23
Current Australian system• The reserve ratio is based on the level
of prime assets that are to be held by banks against their liabilities
• Indicated in the prime asset ratio (PAR)• Currently, the PAR is not set at a specific level• Arrived by a process of negotiation between
APRA and each bank
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-24
Possible leakages• Currency drains
– Loan may be paid in cash and remain in circulation
• Transfer of deposits to non-bank financial institutions• Excess reserves
– Individual banks may choose to have larger reserves than required (say 25% instead of 20%)
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-25
Willingness to borrow• For the full multiplier effect to take place:
– Borrowers must be willing and able to utilise the loans
– Borrowing is likely to be low during a recession
Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Jackson and McIverSlides prepared by Muni Perumal
10-26
Banks and financial instability• Banks may contribute to business fluctuations• Can exacerbate recession, by holding back
on credit expansion• May amplify inflationary pressures, by increasing
lending and credit creation, during recovery and business cycle peaks