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Money!

Money! . The Money Multiplier. http:// blog.spendingdoctor.com / wp -content/uploads/2011/12/piles-of-money1.png. How banks create money. Fractional Reserves Banks do not hang on to all of your deposits They need to use them to make a profit You deposit some currency

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Money!

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  1. Money! The Money Multiplier http://blog.spendingdoctor.com/wp-content/uploads/2011/12/piles-of-money1.png

  2. How banks create money • Fractional Reserves • Banks do not hang on to all of your deposits • They need to use them to make a profit • You deposit some currency • Bank holds on to some of it: “Reserves” • Bank loans the rest out. • Those loans turn into currency • People buy stuff with borrowed money. • The borrowed money goes into circulation…

  3. How banks create money:

  4. That’s how banks create money. • Now… how much do they create? http://www.illustrationsource.com/stock/image/37887/businesswoman-and-money-bag-on-see-saw/?&results_per_page=1&detail=TRUE&page=19

  5. The Money Multiplier • Basic Theory: • Given a Reserve Ratio of 10% • $500 turns into…. • $5,000 • Assuming a perfect, bank-deposit-only world. • Checkable deposits ÷ Reserve ratio. • What would a reserve ratio of 20% do? • $500 turns into • $2,500… • The bank has to hold on to more.

  6. Real life isn’t quite that simple. • Where could money leak out of this system? • People carry money in their wallets • Not 100% of every loan goes to a merchant • Sales tax • Money leaves the GDP… • Banks can hold excess reserves http://www.costrecoveryagents.com/images/Leaky%20bucket_resized.jpg

  7. The money supply depends on • Currency • How much people choose to hold vs. spend • How much currency is in circulation • Bank deposits • How much banks hold excess reserves • The Federal Reserve sets required reserve ratios • Link: http://www.federalreserve.gov/monetarypolicy/reservereq.htm - table1 • Anything more the bank wants to hold = excess • Normal times, they don’t want these…

  8. Subtle difference that’s important now • Monetary Base • Fed can control: • Currency in circulation, plus • Reserves held by banks • Money Supply • Created by the market: • Currency in circulation, plus • Checkable Bank Deposits (aka Demand Deposits)

  9. Monetary Base vs. Money Supply

  10. What’s the real money multiplier? • Ratio of the money supply to the monetary base. • In the U.S., it used to be ~1.9 • So, every dollar of bank reserves supports $1.90 of money supply.

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