Banking System

Money Supply

• Affects AD when increased: - r down, Ig up, AD up (Vertical)
• Decreases - MS down, r up, Ig down, AD down

Financial Sector

• Financial. Assets - Stocks and bonds provide expected future benefits
• Benefits owner from issuer of asset meeting certain obligations
• Fin. Liabilities - Incurred by issuer of financial asset to stand behind issued asset
• Interest Rate - $ paid to use financial asset
• Stocks – Financial asset that represent ownership in a company
• Bonds - Promise to pay $ and interest in the future

Banks

Financial Intermediary - use liquid assets to fund investments of borrowers -> Fractional Reserve Banking

Liquid assets include currency in bank vaults and bank reserves

Banks creates 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

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
• 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

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 bank

• 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