¶ … Banks Create Money
M1 is the basic measure of our money supply and includes coins and currency in people's hands plus the funds available in checking accounts (Beale). Banks may either increase or decrease the checking deposit component of the money supply by making loans. The amount of money that banks can lend is directly affected by the reserve requirement set by the Federal Reserve that defines what fraction of their customer's deposits must be set aside as required reserves (Obringer). The reserve requirement is currently 3% to 10% of a bank's total deposits. Banks may lend out whatever is left over after they have met the reserve requirement.
The process where banks make loans equal to the amount of their excess reserves and create new checkbook money is known as multiple deposit creation (Beale). The money multiplier is the number of deposit (loan) dollars that the banking system can create from $1 of excess reserves (Larsson, 2005). The formula for the money multiplier is:
Required Reserve Ratio = Money Multiplier.
If the Federal Reserve requirement is 10%, the money multiplier is 10, meaning that banks can lend out 90% of every dollar they receive as illustrated by the following example of multiple deposit creation (Larsson, 2005):
John deposits $10,000 into his checking account at Bank a.
Bank a Deposit: $10,000
Reserve (10%): $1,000
Lendable Amount: $9,000
Mary borrows $9,000 from Bank a and buys a car. The car dealer then deposits $9,000 into their account at Bank B.
Bank B
Deposit: $9,000
Reserve (10%): $900
Lendable Amount: $8,100
Mark borrows $8,100 from Bank B. And has surgery. The doctor then deposits $8,100 into his account at Bank C.
Bank C
Deposit: $8,100
Reserve (10%): $810
Lendable Amount: $7,290
This process continues until the lendable amount is 0. When M1 is measured, the original $10,000 deposit will have created a total of $100,000 in deposits system wide (Larsson, 2005).
Bibliography
Beale, L. How banks create money. Retrieved October 20, 2006 from Web site: http://ecedweb.unomaha.edu/ve/library/HBCM.PDF
Larsson, T. (2005, February 1). How banks create money. Retrieved October 20, 2006 from Web site: http://www.gold-investor.com/article.php/20050201204730229
Obringer. L.A. How banks work. Retrieved October 20, 2006 from Web site: http://money.howstuffworks.com/bank1.htm
Money Multiplier: How it Works The process of creating money begins with the Federal Reserve, which controls the amount of currency that enters the system (University of Rhode Island, 2004). The currency it supplies is called high-powered money, which is directly controlled by the Federal Reserve. However, this is not the money supply. The high-powered money is distributed to two places - the vaults of the banks as reserves, or the
Demand for Money The international community is currently facing the most severe crisis since the Great Depression of 1929 -- 1933. It started within the American real estate sector and soon expanded to the rest of the sectors, as well as to the rest of the global economies. The causes and impacts of the crisis have often been discussed in the media and within the specialized literature, and the discussion is far
Monetary Policy Discuss some of the major determinants of the demand for money by sector and in total. Discuss some differences in the demand for money which might exist for countries other than the U.S. An effective formulation of the Monetary Policy depends on the determining factors of the demand for money. Money Demand acts as a channel on transmission mechanism for monetary policy. Therefore the consistency of the money demand function
shadow banking system, its role in the subprime mortgage crisis, and failures of regulation within the shadow banking system. The term "shadow banking system" was coined by PIMCO's Paul McCulley in 2007 (Spanos, 2012) and refers to a banking system that includes financial intermediaries that are involved in creating credit across the global financial system, whose functions are not subject to regulatory oversight (Investopedia, 2012). The question has been
New Deal and Programs to Cure the Great Depression Back in the 1930s, the Americans experienced the worst financial crisis that has ever occurred in the United States' history. In attempts to get back from this particular disaster, the New Deal- a chain of laws and programs, meant to provide assistance to the Americans- was established by Franklin D. Roosevelt. However, an argument has always existed regarding the usefulness of
Federal Funds Rate The federal fund rate was part of the solution, comprised in the Federal Reserve Act of 1913, to centralize the banking system and gain public control of the money supply, inflation, and economic growth. The banking crisis of 1907 was a result of decentralized, unregulated banking that caused confusion with private bank notes being used as currency. There were occasional episodes of monetary mismanagement where the money supply
Our semester plans gives you unlimited, unrestricted access to our entire library of resources —writing tools, guides, example essays, tutorials, class notes, and more.
Get Started Now