Lecture 26: Multiple deposit creation

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# Lecture 26: Multiple deposit creation - PowerPoint PPT Presentation

Lecture 26: Multiple deposit creation. Mishkin Ch 13 – part B page 341-349. Review. Monetary base ( MB ) = currency in circulation ( C ) + reserves ( R ) Open market operations Open market purchase  increase MB Open market sale  decrease MB Discount loans

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### Lecture 26: Multiple deposit creation

Mishkin Ch 13 – part B

page 341-349

Review
• Monetary base (MB) = currency in circulation (C) + reserves (R)
• Open market operations
• Open market purchase  increase MB
• Open market sale  decrease MB
• Discount loans
• Fed has more control over MB than over reserves
Introduction
• money supply = monetary base * money multiplier. How can high-powered money be multiplied?
• How deposits are created? A simple model of multiple deposit creation.
• When the Fed supplies the banking system with \$1 of additional reserves, deposits increase by a multiple of this amount, this is called multiple deposit creation.
Deposit creation: single bank
• First national bank gained \$100 additional reserves from selling bonds to the Fed.
• make \$100 loans to a borrower who deposit this \$100 in checking account.
• The bank creates deposits by lending: money supply.
Deposit creation: single bank – cont’d
• The borrower may use the \$100 to purchase goods and services.
• When the borrower uses \$100 by writing checks, the \$100 reserves leaves First National bank.
Deposit creation: the banking system
• Suppose the \$100 of deposit created by First national bank’s loan is deposited at bank A which keeps no excess reserves.
• If the required reserve ratio is 10%, Bank A can make \$90 loan.
Deposit creation: the banking system – cont’d
• If the borrower deposit the \$90 to another bank B, then checkable deposits in the banking system increase by another \$90.
• But bank B can again make new loans of \$81.
• Bank C …
Summary of multiple banks case
• If all banks make loans for the full amount of their excess reserves, initial \$100 increase in reserves will result in \$1000 in deposit.
• The increase is tenfold, the reciprocal of 10%, the reserve requirement.
• If banks use excess reserves to purchase securities, the effect is the same as making loans.
A comparison
• When we have only one bank, it can create deposits equal only to the amount of its excess reserves.
• However, in a system of multiple banks, there is a multiple expansion of deposits, because when a bank loses its excess reserves, these reserve do not leave the banking system but are used to make additional loans and create additional deposits.
Why this is useful?
• If the Fed can set the level of reserves (R) and the required reserve ratio (r), then can Fed control the level of checkable deposit (D)?
Critique of the simple model
• Banks may not use all of their excess reserves to buy securities or make loans
• Holding cash stops the process