- By lending out deposits that are used multiple times
Where do the loans come from?
- From depositors who take cash and place it in their banks
How are amounts of potential loans calculated?
- using their bank balance sheet, or T-accounts that consist of assets and liabilities for banks
Bank Assets (left side of T-account sheet)
1. Required Reserves (RR)
- These are the percentages of DD that must be held in the vault so that some depositors have access to their money.
2. Excess Reserves (ER)
- Sources of new loans. These amounts are applied to the Monetary Multiplier/Reserve Multiplier (DD = RR + ER)
3. Bank Property Holdings (buildings and fixtures)
4. Securities (Federal Bonds)
- Bonds purchased by the bank, or new bonds sold to the bank by the Federal Reserve. These bonds can be purchased from the bank, turned into cash that immediately become available as ER.
5. Customer Loans
- Amount held by banks from previous transactions, owed to the bank by prior customers
Bank Liabilities (right side of the T-account sheet)
1. Demand deposits (DD) or checkable deposits
- Cash deposits from the public
- They are liabilities because they belong to depositors
2. Owner's Equity (stock shares)
- There are values of stock held by public ownership of bank shares
Key concepts for AP concerning Liabilities:
- If demand deposits come from someone's cash holdings, then the DD is already part of money supply
- If DD comes in from purchase of bonds (by the FED), this creates new cash and therefore creates M1 (new money supply)
Money Creation (using excess reserves)
-Banks want to create profit, they generate it by lending the excess reserves and collecting interest. Since each loan will go out into customer's and business accounts, more loans are created in decreasing amounts (because of reserve requirement). Rough estimate of # of loan amounts created by any first loan is the money multiplier.
The Monetary Multiplier (AKA)
- Checkable Deposits Multiplier
- Reserve Multiplier
- Loan Multiplier
- Multiplier = 1/RR
- Excess reserves are multiplied by the monetary multiplier to create new loans for the entire banking system and this creates new money supply
I really like the notes that you put on here! especially the picture. It help me a lots!
ReplyDeleteYour notes are very organized! I find it very helpful that you included the T-chart of assets and liabilities so I can clarify what goes where and such. One thing I would like to ask is about the monetary multiplier. I am aware that it is 1/RR, but I need more assistance on when to use the multiplier in certain problems. So it would be great if you were to add examples and steps on how to do it that includes the monetary multiplier or any equation actually! it would help me and your other peers! Thank you! :D
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