Chapter 15 - Money Creation

What is the role of the deposit insurance in a FRS?

The FDIC is crucial to the system because it gives bankers the confidence that a their money is safe regardless of a banks decisions.

What is the monetary multiplier and how does it relate to the reserve ratio?

The money multiplier is the inverse of the reserve ratio. This can be understood intuitively; if more money is held in reserves in banks, then less is available to be lent out - if less money is available to be lent out, then the less money will be created. Thus, the higher the reserve ratio, the lower the money multiplier and the less the money supply.

actual reserves

how many reserves are actually in the bank

What risk did goldsmiths inroduce into the payments system by issuing loans in the form of gold receipts

if the goldsmith issued more receipts than he had in gold the goldsmith was vulnerable to "panics" or "runs"

A decrease in the reserve requirement causes the size of the money multiplier to

increase, the amount of excess reserves in the banking system to rise, and the money supply to increase

Explain why merchants accepted gold receipts as a means of payment even though the receipts were issued by goldsmiths and not the gov't

merchants were willing to accept receipt because they knew that it could be exchanged for gold or reused to purchase goods and services for the merchant

excess reserves

the amount by which a commercial bank's or thrift institutions actual reserves exceed its required reserves; equal to actual reserves-required reserves

What happens when reserves temporarily fall slightly below those legally required?

the bank will borrow funds from other banks in the Federal funds market at the FFR

Explain why a single commercial bank can safely lend only an amount equal to its excess reserves, but the commercial banking system as a whole can lend by a multiple of its excess reserves

When a bank grants a loan, it can expect that the borrower will not leave the proceeds of the loan sitting idle in his or her account. Most people borrow to spend. Therefore the lending bank can expect that checks will be written against the loan and that the bank will shortly lose reserves to other banks, as the checks are presented for payment, to the full extent of the loan. In short, when a bank grants loans to the full extent of its excess reserves, it can shortly expect to lose these excess reserves to other banks. From this it can be seen why a bank cannot safely lend more than its excess reserves. If it did, it would soon find its cash reserves below its legal reserve requirement.

reserve ratio

the fraction of checkable deposits that each commercial bank or thrift institution must hold as reserves at its local Fed or in its vault

required reserves

the funds that each commercial bank and thrift institution must deposit with its local Fed bank (or hold as vault cash) to meet the legal required reserves; a fixed percentage of each bank's or thrift's checkable deposits

federal funds rate

the interest rate that US banks and other depository institutoins charge one another on overnight loans made out of their excess reserves

Why does the Fed require commercial banks to have reserves?

reserves provide the Fed a means of controlling the money supply

What are the major assets and claims on a commerical bank's blance sheet

reserves, securities, loans and vault cash

monetary multiplier

the multiple of its excess reserves by which the banking system can expand checkable deposits and thus the money supply by making new loans (or buying securities); equal to 1/reserve requirement

Explain why reserves are assets to commercial banks and liabilities to the Fed.

these funds are cash belonging to commercial banks, but they are a claim the commercial banks have against the Fed

How do you calculate the amount of excess reserves held by the bank? What is the significance of excess reserves?

Excess reserves = actual reserves - required reserves; excess reserves can be lent out and can be used to increase the money supply

Why is the banking system in the United States referred to as a fractional reserve banking system?

Fractional Reserve Banking means that a bank is only required to hold a portion of all deposited money in their reserves.

balance sheet

a statement of the assets, liabilites and net worth of a firm or individual at some given time

fractional reserve banking system

a system in which commercial banks and thrift institution hold less than 100% of their checkable-deposit liabilities as reserves of currency held in bank vaults or as deposits at the central bank

vault cash

the currency a bank has on hand in its vault and cash drawers