<< Chapter < Page Chapter >> Page >

By the end of this section, you will be able to:

  • Utilize the money multiplier formulate to determine how banks create money
  • Analyze and create T-account balance sheets
  • Evaluate the risks and benefits of money and banks

Banks and money are intertwined. It is not just that most money is in the form of bank accounts. The banking system can literally create money through the process of making loans. Let’s see how.

Money creation by a single bank

Start with a hypothetical bank called Singleton Bank. The bank has $10 million in deposits. The T-account balance sheet for Singleton Bank, when it holds all of the deposits in its vaults, is shown in [link] . At this stage, Singleton Bank is simply storing money for depositors and is using these deposits to make loans. In this simplified example, Singleton Bank cannot earn any interest income from these loans and cannot pay its depositors an interest rate either.

Singleton bank’s balance sheet: receives $10 million in deposits

The assets are reserves ($10 million). The liabilities + net worth are deposits ($10 million).

Singleton Bank is required by the Federal Reserve to keep $1 million on reserve (10% of total deposits). It will loan out the remaining $9 million. By loaning out the $9 million and charging interest, it will be able to make interest payments to depositors and earn interest income for Singleton Bank (for now, we will keep it simple and not put interest income on the balance sheet). Instead of becoming just a storage place for deposits, Singleton Bank can become a financial intermediary between savers and borrowers.

This change in business plan alters Singleton Bank’s balance sheet, as shown in [link] . Singleton’s assets have changed; it now has $1 million in reserves and a loan to Hank’s Auto Supply of $9 million. The bank still has $10 million in deposits.

Singleton bank’s balance sheet: 10% reserves, one round of loans

The assets are reserves ($1 million) and loan to hank’s auto supply ($9 million). The liabilities + net worth are deposits ($10 million).

Singleton Bank lends $9 million to Hank’s Auto Supply. The bank records this loan by making an entry on the balance sheet to indicate that a loan has been made. This loan is an asset, because it will generate interest income for the bank. Of course, the loan officer is not going to let Hank walk out of the bank with $9 million in cash. The bank issues Hank’s Auto Supply a cashier’s check for the $9 million. Hank deposits the loan in his regular checking account with First National. The deposits at First National rise by $9 million and its reserves also rise by $9 million, as [link] shows. First National must hold 10% of additional deposits as required reserves but is free to loan out the rest

First national balance sheet

The assets are reserves (+ $9 million). The liabilities + net worth are deposits (+ $9 million).

Making loans that are deposited into a demand deposit account increases the M1 money supply. Remember the definition of M1 includes checkable (demand) deposits, which can be easily used as a medium of exchange to buy goods and services. Notice that the money supply is now $19 million: $10 million in deposits in Singleton bank and $9 million in deposits at First National. Obviously these deposits will be drawn down as Hank’s Auto Supply writes checks to pay its bills. But the bigger picture is that a bank must hold enough money in reserves to meet its liabilities; the rest the bank loans out. In this example so far, bank lending has expanded the money supply by $9 million.

Questions & Answers

A golfer on a fairway is 70 m away from the green, which sits below the level of the fairway by 20 m. If the golfer hits the ball at an angle of 40° with an initial speed of 20 m/s, how close to the green does she come?
Aislinn Reply
cm
tijani
what is titration
John Reply
what is physics
Siyaka Reply
A mouse of mass 200 g falls 100 m down a vertical mine shaft and lands at the bottom with a speed of 8.0 m/s. During its fall, how much work is done on the mouse by air resistance
Jude Reply
Can you compute that for me. Ty
Jude
what is the dimension formula of energy?
David Reply
what is viscosity?
David
what is inorganic
emma Reply
what is chemistry
Youesf Reply
what is inorganic
emma
Chemistry is a branch of science that deals with the study of matter,it composition,it structure and the changes it undergoes
Adjei
please, I'm a physics student and I need help in physics
Adjanou
chemistry could also be understood like the sexual attraction/repulsion of the male and female elements. the reaction varies depending on the energy differences of each given gender. + masculine -female.
Pedro
A ball is thrown straight up.it passes a 2.0m high window 7.50 m off the ground on it path up and takes 1.30 s to go past the window.what was the ball initial velocity
Krampah Reply
2. A sled plus passenger with total mass 50 kg is pulled 20 m across the snow (0.20) at constant velocity by a force directed 25° above the horizontal. Calculate (a) the work of the applied force, (b) the work of friction, and (c) the total work.
Sahid Reply
you have been hired as an espert witness in a court case involving an automobile accident. the accident involved car A of mass 1500kg which crashed into stationary car B of mass 1100kg. the driver of car A applied his brakes 15 m before he skidded and crashed into car B. after the collision, car A s
Samuel Reply
can someone explain to me, an ignorant high school student, why the trend of the graph doesn't follow the fact that the higher frequency a sound wave is, the more power it is, hence, making me think the phons output would follow this general trend?
Joseph Reply
Nevermind i just realied that the graph is the phons output for a person with normal hearing and not just the phons output of the sound waves power, I should read the entire thing next time
Joseph
Follow up question, does anyone know where I can find a graph that accuretly depicts the actual relative "power" output of sound over its frequency instead of just humans hearing
Joseph
"Generation of electrical energy from sound energy | IEEE Conference Publication | IEEE Xplore" ***ieeexplore.ieee.org/document/7150687?reload=true
Ryan
what's motion
Maurice Reply
what are the types of wave
Maurice
answer
Magreth
progressive wave
Magreth
hello friend how are you
Muhammad Reply
fine, how about you?
Mohammed
hi
Mujahid
A string is 3.00 m long with a mass of 5.00 g. The string is held taut with a tension of 500.00 N applied to the string. A pulse is sent down the string. How long does it take the pulse to travel the 3.00 m of the string?
yasuo Reply
Who can show me the full solution in this problem?
Reofrir Reply
Got questions? Join the online conversation and get instant answers!
Jobilize.com Reply

Get Jobilize Job Search Mobile App in your pocket Now!

Get it on Google Play Download on the App Store Now




Source:  OpenStax, Macroeconomics. OpenStax CNX. Jun 16, 2014 Download for free at http://legacy.cnx.org/content/col11626/1.10
Google Play and the Google Play logo are trademarks of Google Inc.

Notification Switch

Would you like to follow the 'Macroeconomics' conversation and receive update notifications?

Ask