Lecture 26 multiple deposit creation
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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

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Lecture 26: Multiple deposit creation

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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.


Summary of single bank case


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.


Formula for multiple deposit creation


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


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