INTRODUCTION TO MONEY AND BANKING. Tables and Graphs Part 3

INTRODUCTION TO

MONEY AND BANKING

Tables and Graphs

Part 3

Table of Definitions

• TR = Total Reserves-Definition*

• RR = Required Reserves-Definition*

• ER = Excess Reserves-Definition*

• r = Minimum Reserve Ratio = RR/DD = ΔRR/ΔDD

• GS = Government Securities

• LL = Loans

• DD = Demand Deposits

• A = Assets

• L = Liabilities

• NW = A – L = Net Worth

Figure D-2.1: Bank A’s Balance Sheet

Bank A

A L

TR = $1m RR = $1m ER = $0m GS = $6m LL = $4m

DD = $10m

NW = $1m

NOTE: (1) r = 10% and since ER = 0, Bank A is fully loaned up.

(2) TR = RR + ER.

(3) A = L + NW and TR + GS + LL = DD + NW.

Figure D-2.2: The Banking System’s Balance Sheet When r = 10%

Banking System

A L

TR = $50m RR = $50m ER = $0m GS = $120m LL = $355m

DD = $500m

NW = $25m

NOTE: r = 10% and since ER = 0, the Banking

System is fully loaned up (ER = 0 for all banks

in the Banking System).

Figure D-2.3: The Fed’s Balance Sheet

Federal Reserve District Bank

A L

GS = $140m MBS =$500m

FRN = $80m

MBR = $550m

T = $10m

GS = Government Securities

FRN = Federal Reserve Notes

MBR = Member Bank Reserves

T = Treasury Checking Account

MBS = Mortgage Backed Securities

Figure D-2.4a: Purchase of $1M in GS from Bank A: The Fed’s First Balance Sheet

Federal Reserve District Bank

A L

GS = $140m MBS = $500m

FRN = $100m MBR = $550m T = $10m

1.

Figure D-2.4b: Purchase of $1M in GS from Bank A: The Fed’s Second Balance Sheet

Federal Reserve District Bank

A L

GS = $141m MBS = $500m

FRN = $100m MBR = $551m T = $10m

The Fed purchases $1m in GS from Bank A.

2.

Figure D-2.5a: Bank A’s First Balance Sheet

Bank A

A L

TR = $1m RR = $1m ER = $0m GS = $6m LL = $4m

DD = $10m

NW = $1m

NOTE: r = 10% and since ER = 0, Bank A is fully loaned up.

1.

Figure D-2.5b: Bank A’s Second Balance Sheet

Bank A

A L

TR = $2m RR = $1m ER = +$1m GS = $5m LL = $4m

DD = $10m

NW = $1m ΔLL = +$1m ΔDD = +$1m ΔTR = -$1m ΔDD = -$1m 2.

a.

b.

c.

2.a. The Fed purchases $1m in GS from Bank A.

b. Money Creation Step: Bank A loans out $1m and creates a DD of $1m.

c. Clearing Step: $1m is spent and deposited in Bank B.

Bank B gains $1m in TR and Bank A loses $1m in TR.

Figure D-2.5c: Bank A’s Third Balance Sheet

Bank A

A L

TR = $1m RR = $1m ER = 0 GS = $5m LL = $5m

DD = $10m

NW = $1m 3.

NOTE: Bank A is fully loaned up and

its Balance Sheet balances.

Figure D-2.6a: Bank A’s First Balance Sheet

Bank A

A L

TR = $1m RR = $1m ER = $0m GS = $6m LL = $4m

DD = $10m

NW = $1m

NOTE: r = 10% and since ER = 0, Bank A is fully loaned up.

1.

Figure D-2.6b: Bank A’s Second Balance Sheet

Bank A

A L

TR = RR = ER = GS = LL =

DD =

NW = $1m

ΔLL = ΔDD =

ΔTR = ΔDD =

2.

a.

b.

c.

2.a. The Fed purchases $1m in GS from Bank A.

b. Money Creation Step: Bank A loans out $1m and creates a DD of $1m.

c. Clearing Step: $1m is spent and deposited in Bank B.

Bank B gains $1m in TR and Bank A loses $1m in TR.

Figure D-2.6c: Bank A’s Third Balance Sheet

Bank A

A L

TR = RR = ER = GS = LL =

DD =

NW = 3.

NOTE: Bank A is fully loaned up and

its Balance Sheet balances.

Figure D-2.6d: Bank B’s First Balance Sheet

Bank B

A L

TR = $1m RR = $1m ER = $0m GS = $6m LL = $4m

DD = $10m

NW = $1m

NOTE: r = 10% and since ER = 0, Bank B is

fully loaned up.

Figure D-2.6e: Bank B’s Second Balance Sheet

Bank B

A L

TR = RR = ER = GS = LL =

DD =

NW =

ΔLL = ΔDD =

ΔTR = ΔDD =

2.

a.

b.

c.

2.a. A check for $1m is deposited in Bank B and Bank B receives $1m in TR from Bank A in the clearing step.

b. DD Creation: Bank B loans out $0.9m and creates DD of $0.9m.

c. Clearing Step: $0.9m is spent and deposited in Bank C.

Bank C gains $0.9m in TR and Bank B loses $0.9m in TR.

Figure D-2.6f: Bank B’s Third Balance Sheet

Bank B

A L

TR = RR = ER = GS = LL =

DD =

NW = 3.

NOTE: Bank B is fully loaned up and

its Balance Sheet balances.

Table D-2.1a: Summary of Deposit Expansion Process

Bank ΔTR ΔRR ΔER ΔLL ΔDD ΣΔDD A $1.00m $0.00m $1.00m $1.00m $1.00m $1.00m B $1.00m $0.10m $0.90m $0.90m $0.90m $1.90m C $0.90m $0.09m $0.81m $0.81m $0.81m $2.71m D $0.81m $0.08m $0.73m $0.73m $0.73m $3.44m E

Other

Banks

Totals

Figure D-2.7a: The Banking System’s First Balance Sheet When r = 10%

Banking System

A L

TR = $50m RR = $50m ER = $0m GS = $140m LL = $335m

DD = $500m

NW = $25m

NOTE: r = 10% and since ER = 0, the Banking System is fully loaned up (ER = 0 for all banks in the Banking System).

1.

Figure D-2.7b: Banking System’s Second Balance Sheet

Banking System

A L

TR = $51m RR = $50m ER = +$1m GS = $139m LL = $335m

DD = $500m

NW = $25m ΔLL = +$10m ΔDD = +$10m 2.

a.

b.

2.a. Fed purchases $1m in GS from Bank A

b. Money Creation Step: Banking System creates a multiple

number of LLs and DDs. (Note that the Banking System

can do this because it does NOT lose the DDs it creates.)

Figure D-2.7c: Banking System’s Third Balance Sheet

Banking System

A L

TR = $51m RR = $51m ER = 0

GS = $139m LL = $345m

DD = $510m

NW = $25m 3.

NOTE1: Banking System is fully loaned up

and the Money Supply (DDs) has increased.

Figure D-2.8a: The Banking System’s First Balance Sheet When r = 10%

Banking System

A L

TR = $50m RR = $50m ER = $0m GS = $140m LL = $335m

DD = $500m

NW = $25m

NOTE: r = 10% and since ER = 0, the Banking System is fully loaned up (ER = 0 for all banks in the Banking System).

1.

Figure D-2.8b: Banking System’s Second Balance Sheet

Banking System

A L

TR = RR = ER = GS = LL =

DD =

NW =

ΔLL = ΔDD =

2.

a

b.

2.a. Depositors convert $1m in DDs to C

b. Money Destruction Step: Banking System destroys a

multiple number of LLs and DDs. (As people use DDs to

pay off their LLs banks do not renew loans.)

Figure D-2.8c: Banking System’s Third Balance Sheet

Banking System

A L

TR = RR = ER = GS = LL =

DD =

NW = 3.

NOTE: Banking System is fully loaned up

and the Money Supply (DDs) has decreased.

Complex Multiplier Formulas

c = Currency Deposit Ratio = C/DD > 0 er = Excess Reserve Ratio = ER/DD > 0 MB = Monetary Base = TR + C

mm* = Complex Multiplier mm* = (1 + c)/(r + er + c)

M

= C + DD

∆M

= ∆C + ∆DD M

= mm*(MB)

∆ M

= mm*(∆ MB)

Figure E-1.1: Supply and Demand for Money

1/P P

M

$1.00 100

$0.66 150

$0.50 200

250

$0.40

M

M

Figure E-1.2: Illustrating an Excess Demand for Money in the Money Market

M 1/P

Money Market M

M

$0.50

M

M

NOTE: When the price level is P = 250 there is an ES in the goods markets and ED in the money market. The adjustment process in the goods markets drives prices down in all markets (deflation)instantaneously.

$0.40

ED

Figure E-1.3: Illustrating an Excess Supply of Money

M 1/P

Money Market M

M

$0.50

ES

M

M

$0.66

NOTE: When the price level is

there is an ED in the

goods markets and ES in the money market. The adjustment

process in the goods markets drives prices up in all markets

(inflation) instantaneously

Figure G-1.1: Illustrating the Inflationary

Process When a Central Bank Overissues Money

M 1/P

Money Market M

M

1/P

ES

M

M

1/P

NOTE: When the money supply increases from M

to M

the Central Bank has over issued money. But the only

indication that it has that overissue has occurred is when the adjustment process has run its long and disruptive course with prices rising to P

(no instantaneous adjustment).

M

Figure G-1.2: Illustrating the Adjustment Process when Free Banks Overissue Money

M 1/P

Money Market

M

M

1/P

ES

M

M

1/P

NOTE: When the price level is P

and free banks overissue money so that the money supply is now M

there is an

immediate reaction to reduce the money supply (because of adverse clearings) and all the adjustment occurs in the short- run in the money market, not the goods market.

M