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Multiply Deposit Creation Big Question: How are deposits/MS created?

Multiply Deposit Creation Big Question: How are deposits/MS created? 4 Players in the Money Supply Process Central Bank (Fed. Res.) Banks (bank deposits are largest component of MS) Depositors Borrowers from banks (loans and bonds) Federal Reserve System Functions:

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Multiply Deposit Creation Big Question: How are deposits/MS created?

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  1. Multiply Deposit Creation Big Question: How are deposits/MS created? 4 Players in the Money Supply Process • Central Bank (Fed. Res.) • Banks (bank deposits are largest component of MS) • Depositors • Borrowers from banks (loans and bonds) Federal Reserve System Functions: • Conducts monetary policy (open market operations) • Clears checks (banks hold reserves for clearing checks) • Regulates banks (Fed sets reserve requirement ratio, RRR)

  2. Assets FED RESLiab.+NW Assets HHsLiab.+NW Currency CHK Dep.s Savings MMDA CDs Other assets Currency in Circulation FX Reserves Loans Treasury Bonds Reserves Disc. Loans Net Worth Assets BANKsLiab.+NW Reserves Treasury Bonds Loans CHK Dep.s Savings MMDA CDs Disc. Loans Net Worth

  3. Federal Reserve Open Market Purchase • Fed buys T-Bill from bank A • Bank Excess Reserves • r = reserve requirement = 10% Assume banks max. P => ER = 0 Bank A T-Bill +100 Reserves +100 Excess Res. +100 T-Bills -100 Excess Res. -100 Loans +100 Asset Exchange Portfolio Rebalance D Deposits = (1/r) x D Reserves $1,000 = (1/0.10) x $100 Credit Union B Req. Reserves +10 Loans +90 Deposits +$100 M1 = Curr + Chk Deposits Savings & Loan C HH Sector Assets Liabilities The act of originating a loan, is the act of creating money Req. Reserves +9 Loans +81 Deposits +$90 Dep. +100 Loans +100 Dep. +90 Loans +90 Dep. +81 Loans +81 Banks are the heart/pump of the economy Sum = Dep. + 1,000 Loans + 1,000

  4. Let x = loaned out/pass through % Let r = required reserve ratio = 1 - x Sum of Infinite Geometric Series S = 1 + x + x2 + x3 + … S = 1 + x [1 + x + x2 + …] S = 1 + x [ S] S – x S = 1 S = 1/(1 - x) S = 1/r  Simple deposit multiplier (ratio of D chk deposits / D reserves) If r = 10%, then multiplier = 10 D checking deposits = 1/r * D reserves $1,000 = 10 * $100

  5. Econ 330 Chapter 13 Homework Due Friday, March 14 Chapter 13 Questions & Applied Problems 1, 4, 5, 8, 14, 15, 22, 23

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