Chapter 13 Money, Banking and the Creation of Money 1/16/17
V. Functions and History of the
VI Fractional Reserve System
VII. The Monetary Multiplier
VIII. Recent Developments 1 video
IX. Additional Money Creation and History Reading
X. Twentieth Century Banking History by decade
XI. Visual Learning Stuff
XII. Quick Notes Economic Reviews for those pressed for time.
I. Functions of Money
A. Medium of exchange: facilitate exchange eliminating barter which
requires people with mutually needs.
B. Standard of value: allows for the pricing of heterogeneous goods.
C. Store of value: maintains value and provides liquidity so extra spending
power is available as needed. Maintaining money's value requires
1. A sound fiscal policy (a reasonable federal debt)
2. A sound monetary policy (not using inflation to pay the federal debt)
3. A brief history of U S dollar debasement?
D. Standard of deferred payment: makes credit contracts possible so credit
transactions are possible.
E. Trade necessitated the development of modern money replaces barter Video 7 min.
F. Unit 1 Review Functions of Monet are Medium of Exchange, Standard of Value,
Store of Value
II. The Supply and Demand
A. Three categories of the supply of money
1. M1 = Currency, coins, and demand deposits (checking accounts).
2. M2 = M1 plus near monies such as small time deposits (savings
accounts) and short-term government securities.
3. M3 = M2 plus large time deposits (over $100,000)
B. What backs the dollar?
1. In 1971 President Nixon took the U.S. off a partial gold standard. See The Gold Reserve Act
2. It is a debt of the federal government.
3. Backed by faith in the government's ability to control inflation.
4. Value is determined by acceptability (it is legal tender and scarce).
5. Commodity money, such as tobacco used as money in the Virginia colony, has intrinsic
value of its own.
6. It's fiat (by decree of the government) money.
a. Fiat money's first appearance in the U.S. when Congress issued Continental currency
with no gold backing
1. Gresham's Law (bad money chases good) caused it to disappear after the war.
2. State issued their own money.
3. Ben Franklin on Paper Money Economy
b. Greenbacks (demand notes on the Treasury) that were green in color were issued as legal
tender during the Civil War.
c. An intermittent return to Gold Standard (only gold is money) followed although the U.S.
left gold for good in 1971as high inflation caused a run on gold that the U.S. Treasury
could not satisfy.
7. Today, coins are called token money because they have little intrinsic value.
9. Types of money has more information
1923 Germany Hyperinflation in the Weimar Republic A 50,000,000 (50 million) mark banknote
C. The Demand for Money
1. Transaction D, Dt, results because people hold money, often in
a money market account, to use as a medium of exchange.
2. Asset Demand, Da, results because people accumulate money,
often held in an investment account, to buy assets.
3. The demand for money Dm= D t + Da
4. Interest rates are set in the money market. more interesting history.
5. For more information visit Demand for money
Unit II. Review Types of money are M1 cash, DD are only backed by faith, M2 are Near moneys like savings accounts and treasury bonds, B3 M2 plus time deposits > $100,000
Source The Economist 4/5/14
Editor's Note: How much of recent price stability is the FED and How much is world-wide competition.?
States Private Banking System
A. Two kinds of banks
1. Commercial banks offer demand deposits (checking accounts)
2. Savings and loan associations used to specialize in time deposits (saving
accounts) and home mortgages. Now, because of deregulation during
the early 1980's, they are similar to commercial banks.
B. Federal deregulation contributed to banking difficulties in the 1980's.
C. Visit brief history provided by the Federal Reserve Bank for
a time line of the U.S. banking System. Be sure to point at each date
to see what happens during that period.
Private Banking System has Commercial Banks have savings accounts and demand deposits, Savings Banks just savings accounts and The Federal Reserve System
A . Board of Governors oversee the Federal Reserve System
Unit IV. Summary
FED is a somewhat private-sector entities established
Federal Open Market Committee meeting at the Federal Reserve in Washington, DC
The Federal Reserve System
Functions and History of the FED
1. Regulate the money supply
2. Check collection and clearing
3. Fiscal agent for the government
4. Supervise and audit member banks
5. Hold reserves (deposits) for member banks
6. Compile economic statistics such as the Latest Beige Book
quarterly summary of each districts' recent economic activity.
Unit V. Review Functions include regulate money supply, check processing, federal fiscal agent, supervise and audit financial system, hold reserves, compile the Beige Book 1
Profit isn't usually listed as a function of the FED but $325 from 20010 -13 isn't chicken feed. 1/11/14 Source
1. The Bank that Hamilton Built
2. ANDREW JACKSON took on the eastern bankers, vetoed
the charter extension of the Second Bank of the United States
because he felt it had excessive power over farmers.
3. THEODORE ROOSEVELT took on the corporate monopoly
Trusts that control railroad rates and routes and thus destroyed
small towns and farms.
a. Panic of 1907
b. T.R. vs. J.P
4. Nixon Shock inflationary pressure and French President De Gaulle
force the US to stops the convertibility of dollars to gold and
a new mandate adds low unemployment to the job.
5. Cooperation, conflict and the emergence of the FED
6. Greenspan's Latest Bio
a. The Man Who New Video
b. Book review from Brookings is a good summary
7. Other Histories
a. A Century of U.S. Banking: Fall 2013 Ben Bernanke
b. How the Federal-reserve-was-created-100-years-ago
c. Philadelphia Reflections: Whither, Federal Reserve?
is a well done, concise history of banking in the United States.
Fractional Reserve System/Creation of Money
A. Commercial banks are required to keep a reserve (cash) of about 12%
of their demand deposits (checking accounts) at their bank or on deposit
with the Federal Reserve (required reserves). The remainder, (Excess
Reserves) may be loaned out even though they support deposits.
B. Money is created by these loans as long as the demand deposits (DD) created
by them stay within the banking system, that is, the money loaned is redeposit
as a DD into a bank within the system. The banks owe the demand deposits
created by the loans to each other. These inter-brain debts are canceled with
a bookkeeping entry. It should be pointed out that the demand deposits
created by such loans are spent, and goods transferred, just as if the
transaction involved currency.
C. Example: Bank A has $50,000 in demand deposits. A reserve requirement of
10% would yield required reserves of .10 x $50,000 = $5,000. If Bank A
had $7,000 in reserve, it could loan up to $2,000 in the form of demand
deposits. Suppose Bank B does exactly the same with both banks' customers
depositing their DD in the other bank. Banks would owe cashed checks to
each other, would cancel interbank debts, and money has been created.
D. The system works in reverse with money destroyed if reserves leave the system.
E. Required reserves, reserves not loaned, and loans of cash (reserves) represent
a leakage which eventually stops money supply growth.
F. Readings and Video
1. The Truth is Out: Money is Just an IOU and the Banks are Rolling In It
2. Money Creation in the Modern Economy
3. Money Creation Video 13.03 minutes is well done
Unit VI. Review Banks allowed to hold less in reserves than demand deposits
creating money for borrowers.
and prediction of coming inflation A. Laffer, 6/11/14
VII. The Monetary Multiplier
A. An infusion of reserves into the system by the Treasury as directed by the
Federal Reserve can be loaned a number of times by the commercial
banking system. For example, the Federal Reserve may buy a $100
Treasury bond from Ms. A who deposits the Federal Reserve check
(reserves) into Bank A.
B. Bank A's new DD of $100 requires them to keep $10 (10%) in reserve
leaving $90 excess to loan to Mr. B who deposits it in Bank B.
C. Bank B needs to keep only $9 ($90 x .1) in reserve and may loan out $81.
D. This process continues and as long as the demand deposits being created
by the loans stay within the commercial
banking system, interbank debts are canceled and money has been created
E. Monetary multiplier (M) sets the upper limit of the expansion
1. R = reserve requirement = 10% = .1
2. M = 1/R = 1/.1 = 10
F. In the above example the total amount of DD created beginning with Bank
A's $90 in excess reserves would equal
Excess Reserves x M = $90 x 10 = $900. If the $100 infusion by the
Federal Reserve is included, the increase is 10 x 100 = $1,000.
G. Video 2.43 minute Practice Problems Video 3.02
H. Visit The Banking System and the Money Multiplier from Jay Kaplan
of the University of Colorado at Boulder for more information.
Unit VII. Review Monetary multiplayer measures the amount actual increase in loan created demand deposits in relation to the FED created excess reserve.
VIII. Recent Developments
Unit VIII. Review Fewer
controls and anti-activities of late 20th century.
IX. Additional reading
Other Macro Chapters
Twentieth Century U.S. Political
Economy is About Money
Source Concise U.S. Economic History
The 19th Century ended
Monarchs in control and liberal economic thought expanding.
One has to wonder why Warren Buffet Predicted the 2007-8 Financial Crisis
in 2002 three years before Greenspan's 2005 retirement.
XI. Visual Learning Stuff.
Some Central Banks Are Easing to Create Growth,
Some Are Not