Unit - 4 Banking System
from the worksheet "Here are the Components and Definitions" and notes
Note- Money supply is affected by the money market graph and AD/AS graph.
Money Supply
- Affects AD when increased: -> r down, Ig up, AD up (Vertical)
- Decreases - Goes Left: MS down, r up, Ig down, AD down
Financial Sector
- Fin. Assets - Stocks and bonds provide expected future benefits
- Benefits owner from issuer of asset meeting certain obligations
- Fin. Liabilities - Incurred by issuer of fin. asset to stand behind issued asset
- Interest Rate - $ paid to use fin. asset
- Stocks - Fin. asset that represent ownership in a company
- Bonds - Promise to pay $ and interest in the future
Banks
- Fin. Intermediary - use liquid assets to fund investments of borrowers -> Fractional Reserve Banking
- Liquid assets include currency in bank vaults and bank reserves
- Banks create money by lending out deposits that are used multiple times
- When a customer deposits cash or withdraws cash from their demand deposit account, it has NO EFFECT ON THE MONEY SUPPLY
- It only changes...
- The composition of money
- Excess Reserves
- Required Reserves
- Changes in Money Supply for....
- Single Bank
- Loan money from ER
- Banking System
- ER x Money multiplier (1/RR) -> Total Money Supply
- When the FED buys or sells bonds, ER is created
-Basic accounting (cont.)
- Assets (Amounts owned) - Items claimed legally by bank; use of funds by fin. intermediary
- Included in assets
- Required Reserves - % of DD in vault
- Excess Reserves - Remaining % of DD used for loans
- Property - Statement of a bank's property values
- Securities or Bonds - Previously purchased bonds held by the banks as investments
- Loans - Previously loaned funds now owed back to the bank
- Liabilities (Amounts owed) - Legal claims against a bank; sources of funds.
- Included in liabilities
- Demand Deposits - Cash deposits from the public to the bank
- Part of MS if from person's cash holdings
- Becomes new $ if from a bond -> MS up
- Owner's equity or stock shares - Values of the bank stocks as held by the public
- DD = RR + ER
- Reserve Requirement - Fed needs banks to always have $ to meet demand
- Amount = Reserve Ratio - % of DD locked to bank
- Included in assets
- Required Reserves - % of DD in vault
- Excess Reserves - Remaining % of DD used for loans
- Property - Statement of a bank's property values
- Securities or Bonds - Previously purchased bonds held by the banks as investments
- Loans - Previously loaned funds now owed back to the bank
- Included in liabilities
- Demand Deposits - Cash deposits from the public to the bank
- Part of MS if from person's cash holdings
- Becomes new $ if from a bond -> MS up
- Owner's equity or stock shares - Values of the bank stocks as held by the public
- Amount = Reserve Ratio - % of DD locked to bank
Scenario 1
A private citizen takes cash that they possess and put it into a bank account
- The cash placed into the bank is already part of the money supply
- The deposit is counted as a bank liability
- A % must be placed into required reserve
- The remainder is placed into excess reserve
- The bank will want to lend all of the ER, if possible
- The amount in ER is multiplied by the monetary multiplier
- This will be assumed to become new loans in the banking system
- This will be counted as the change in money supply
Scenario 2
- The Fed buys bonds back from the public
- The public now has new cash
- This new cash is new loans
- Assume that the public puts the cash into demand deposits
- A set percentage is placed into required reserve
- The remainder becomes excess reserve
- Excess reserve is multiplied by the money multiplier (1/RR)
- This amount becomes new loans and is new money supply
- The total change in money supply is the amount of demand deposits plus the new loan amounts
Scenario 3
- The Fed buys bonds back from the member banks
- The banks now have new ER
- No money is needed to be placed in RR, since this is not owed to the public
- All of these ER are multiplied by the monetary multiplier
- This amount becomes new loans
- This amount is the change in the money supply
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